When does a financial institution write down an asset?
To those in the banking industry the answer has always been, “Not until I am not responsible for that portfolio anymore.”
My experience with lenders is that when making a loan they tend to be pessimistic and, in addition, require collateral. Unless, of course, they are securitizing the asset created and selling it off.
However, when overseeing a loan portfolio, lenders tend to be very optimistic. “Well, the borrower is just experiencing a slight setback, but things will get better.” “The economy is going to improve soon and then the loan will be alright.” “Yes, the borrower made a mistake, but he has learned from the mistake and is getting his act in order.”
Lenders (bankers) are reluctant to write down anything if they don’t have to. And, this applies to all aspects of their asset portfolios.
But, a big cloud is hanging over the financial industry going into 2011 in the United States, and also in Europe. The big cloud relates to number of bank assets that will need to be refinanced during the year. These numbers are staggering.
My guess is that this is one of the major reasons why commercial banks are not lending now. (See “Little or No Life in the Banking Sector,” http://seekingalpha.com/article/241507-little-or-no-life-in-the-banking-sector.) Banks do not want to write off any more assets now and are reluctant to add any more funds than they have to in order to build up their loan loss reserves. They add to these reserves as little as possible, as little as the regulators will let them get away with, so that they can build up their equity capital positions. If they then let the loans that are maturing run off without replacing them, their capital positions improve. The debt/equity ratio can fall as debt can be reduced while capital is being increased.
Making new loans does not fit into this strategy because the new loans will have to be financed and that will tend to raise the debt/equity ratio. So commercial banks are not lending now.
So what is this cloud and why is it so scary?
There are two specific areas that are being highlighted these days that stand out as potential problems for the banks: the first is the commercial real estate sector; and the second is governments, local, state, and nation.
In all cases a lot of loans or securities are going to mature in 2011 and the bet is that a large number of these assets that are found on bank balance sheets will either not be sufficiently credit worthy to be able to refinance or will not be able to handle the interest rates they will have to pay on the new debt to be issued..
In November 2010, commercial real estate loans made up almost 40 percent of the loan portfolios of the banks not among the largest 25 commercial banks in the United States and over 25 percent of their total assets. If these “smaller” banks had to write down 10 percent of their commercial real estate loans that would amount to about 3 percent of their assets: a substantial blow to their capital positions.
The problem is not so great in the largest 25 banks in the country as commercial real estate loans make up only 14 percent of their loan portfolios and about 8 percent of total assets.
This situation is the one pointed to by Elizabeth Warren in congressional testimony when she stated that 3,000 commercial banks, primarily the smaller ones, faced substantial problems ahead in this part of their loan portfolio.
The other problem mentioned has to do with government securities. More and more concern is being expressed about the condition of the finances of state and city governments in the United States. Layoffs are taking place all over the place, with many of the layoffs threatening health and safety. Yet, there is still substantial concern that the unfunded commitments of these state and city governments embedded in their pension funds have not really fully been addressed.
They may have to be addressed in 2011.
And so we get articles like “Bankrupt City, USA” (http://www.ft.com/cms/s/3/07eabcdc-06c8-11e0-86d6-00144feabdc0.html#axzz185wrM18g) which carry statements like this, “A Congressional Budget Office report reaches a conclusion to terrify investors in America’s $2.8 trillion municipal bond market. Municipal bankruptcy, permitted in 26 states, should be considered by city leaders to restructure labor contracts and debts.”
And the yields on municipal securities are the highest they have been in over a year. (http://online.wsj.com/article/SB10001424052748704681804576018022360684088.html?mod=ITP_moneyandinvesting_0) The situation related to state-issued securities is not too different.
The smaller banks, as defined above, have around 25 percent of their securities portfolio in state and local political issues. This makes up about 5 percent of the total assets of these banks. Again, a write down in this area could cause substantial damage to bank capital positions.
But, this problem relating to government debt is not constrained to United States banks. “Eurozone countries will have to refinance more debt next year than at any time since the launch of the euro amid investors’ warnings that the debt crisis in the region will intensify in the new year….Eurozone nations will have to refinance or repay €560 billion ($740 billion) in 2011, €45 billion more than 2010 and the highest amount since the launch of the single currency in January 1999.” (http://www.ft.com/cms/s/0/f9d781f6-0619-11e0-976b-00144feabdc0.html#axzz1860QqksJ) Much of this debt is held by banks.
What would you do if you were running a bank and were facing the possibility that a substantial portion of your portfolio would have to refinance in 2011? Oh, by-the-way, you also have foreclosures and business bankruptcies running at a relatively high rate as well.
You probably would stop lending, try to shrink you balance sheet as much as you could without damaging profitability and build up as much capital as you could before the time of refinancing arrived.
The question that we don’t have an answer for at the moment relates to whether or not the bankers, themselves, have a good handle on which assets will present the biggest refinancing problems and just how much will have to be written off due to these refinancings. Are they still just “hoping for the best.”
In addition, a rising interest rate environment would be one of the worst scenarios possible given all the refinancings that are going to have to take place.
Happy New Year!
Showing posts with label state finances. Show all posts
Showing posts with label state finances. Show all posts
Tuesday, December 14, 2010
Tuesday, January 12, 2010
The Problem with Debt
The economy is recovering. The areas that seem to show the most life are those sectors that have had sufficient debt relief so as to be able to move forward. The big banks are moving out in a very robust fashion, just how robust we will begin to hear this week. The auto industry seems to be moving ahead, albeit a little more slowly than the big banks. And, there are other areas that show signs of moving forward, the health industry and firms in the information technology industry.
The big cloud hanging over all of this is the debt that still is outstanding in many sectors of the economy. The problem with debt is that it just won’t go away. Regardless of any adjustments made to who owes what to whom, if there is debt outstanding, someone has to pay for it in some fashion.
The big banks were saved, but who picked up the tab for the bailout? The taxpayer did, or, at least the taxpayer has footed the bill pending a potential Obama tax on the banks to “recover” some of the bailout monies.
Who saved the auto industry and subsequently holds the IOU for the rescue? A large part of the financial restructuring came at the expense of those that had provided credit or equity funds to the car companies. And, the federal government also paid a share.
If homeowners got relief from their mortgage and consumer debt, who would pay the bill? Shareholders of the bank, holders of mortgage-backed securities, and the federal government. (You might check out this little piece by Peter Eavis in today’s Wall Street Journal: http://online.wsj.com/article/SB20001424052748704081704574652660161217386.html#mod=todays_us_money_and_investing.)
And, what about the debt that is related to commercial real estate lending? Shareholders of banks, holders of commercial mortgage vehicles, and the federal government.
Then we move to the financial problems of the states. Recent information points to the fact that 36 states in the United States are having financial problems and these could lead to deficits in the state budgets of around $350 billion this year and next. Where is the money going to come to pay for these shortfalls? States have already attempted to sell off properties, outsource functions to the private sector, and even turn some things over to the federal government.
Part of the problem here is that the tax base in most states has collapsed as unemployment and under-employment have risen, as property values have fallen, and as business earnings have collapsed. Rating agencies have begun to lower credit ratings on some states. The best guess is that ratings will drop on many other states before the year is over.
And, what about local and municipal governments? Same problems.
And, then, what about the federal government? Without totaling up the bill for the problems mentioned above, let alone the escalation of wars here and there all over the world, health care reform, and some kind of energy bill, many expect federal deficits over the next ten years to total $15 to $18 trillion!
Who is going to purchase all or almost all of this debt? China?
What I find scary is that our “friends” are voicing concern in different ways. For example, the Financial Times this morning carries the opinion piece of Gideon Rachman titled “Bankruptcy Could Be Good for America”: http://www.ft.com/cms/s/0/a8486284-fee9-11de-a677-00144feab49a.html. The point Rachman makes is that the Brics, Brazil, Russia, India, and China all went through economic reform before they “broke out” into their current ascendency. Brazil’s reform came in the 1990s, Russia defaulted in the late 1990s, India embraced economic reform in 1991, and China moved to a new mindset in the early 1990s. “Those much discussed emerging powers, the Brics, all needed a fiscal crisis to set them on the road to economic reform and national resurgence. America may one day be lucky enough to experience its very own national fiscal crisis.”
Even if we print money to pay for the federal debt, as the Federal Reserve has done over the last year or so, (the monetary base rose 23% from December 2008 to December 2009, and rose by 101% over the previous 12 months) someone, somewhere will pay this debt in terms of a reduction in purchasing power.
Need I mention that since January 1961 the purchasing power of one dollar has dropped to roughly $0.15. Inflating the United States government out of its debts has a long, post-World War II history.
Might this process of “printing money” continue?
Seems like a lot of people believe that it will. For one there is the problem of rising long term interest rates. More and more worry is being expressed about the expected increases. Why? Well most analysts believe that the Federal Reserve has helped to keep long term interest rates lower than they would have been in order to provide liquidity to the financial markets and to support the mortgage market. On January 6, 2010, the Fed held on their balance sheet $777 billion in U. S. Treasury securities, $160 billion in Federal Agency debt securities, and $909 billion in Mortgage-backed securities.
This totals $1.846 trillion in securities held by the central bank! The concern is that in the last week of August, 2008, the Fed had provided only $741 billion in funds to the banking system through some kind of market or auction based transaction.
How much affect these purchases have had on keeping long term interest rates lower than they would have been is currently being debated. What is not in question is that, sooner or later, interest rates are going to begin to rise, first because the Fed’s artificial support will be removed, but rates will rise as the economy begins to improve, further pressure will be put on rates as issuers of bonds race to place debt before the rise takes place (See “Rate Rise Fears Spark Rush to Issue Bonds: http://www.ft.com/cms/s/0/6f46f226-fef2-11de-a677-00144feab49a.html), and as inflationary expectations are incorporated into bond yields.
How fast will the Fed allow interest rates to rise because rising interest rates will slow down economic recovery. Also, the Fed has created another problem by keeping short term interest rates so low. Not only have these low rates created arbitrage possibilities for domestic investment, borrow short term money in the 35 to 65 basis point range and invest in 10-year government bonds at 3.50% to 3.80% but also for the international carry trade. It is argued that the Fed cannot allow rates to go up too fast or big financial institutions and other investors will get trapped in losses that will not help the economic recovery.
The point of all this discussion is that any “exit” strategy that the Fed is planning to reduce the securities held on its balance sheet from current levels to even a level of $1.0 trillion, let alone the $741 billion mentioned above, is already in jeopardy. And, many are arguing that in the face of such overwhelming future deficits, the Fed will be forced to print even more money than it has over the last 17 months.
The problem with debt is that debt, once issued, really does not go away. Someone has to pay for it!
The big cloud hanging over all of this is the debt that still is outstanding in many sectors of the economy. The problem with debt is that it just won’t go away. Regardless of any adjustments made to who owes what to whom, if there is debt outstanding, someone has to pay for it in some fashion.
The big banks were saved, but who picked up the tab for the bailout? The taxpayer did, or, at least the taxpayer has footed the bill pending a potential Obama tax on the banks to “recover” some of the bailout monies.
Who saved the auto industry and subsequently holds the IOU for the rescue? A large part of the financial restructuring came at the expense of those that had provided credit or equity funds to the car companies. And, the federal government also paid a share.
If homeowners got relief from their mortgage and consumer debt, who would pay the bill? Shareholders of the bank, holders of mortgage-backed securities, and the federal government. (You might check out this little piece by Peter Eavis in today’s Wall Street Journal: http://online.wsj.com/article/SB20001424052748704081704574652660161217386.html#mod=todays_us_money_and_investing.)
And, what about the debt that is related to commercial real estate lending? Shareholders of banks, holders of commercial mortgage vehicles, and the federal government.
Then we move to the financial problems of the states. Recent information points to the fact that 36 states in the United States are having financial problems and these could lead to deficits in the state budgets of around $350 billion this year and next. Where is the money going to come to pay for these shortfalls? States have already attempted to sell off properties, outsource functions to the private sector, and even turn some things over to the federal government.
Part of the problem here is that the tax base in most states has collapsed as unemployment and under-employment have risen, as property values have fallen, and as business earnings have collapsed. Rating agencies have begun to lower credit ratings on some states. The best guess is that ratings will drop on many other states before the year is over.
And, what about local and municipal governments? Same problems.
And, then, what about the federal government? Without totaling up the bill for the problems mentioned above, let alone the escalation of wars here and there all over the world, health care reform, and some kind of energy bill, many expect federal deficits over the next ten years to total $15 to $18 trillion!
Who is going to purchase all or almost all of this debt? China?
What I find scary is that our “friends” are voicing concern in different ways. For example, the Financial Times this morning carries the opinion piece of Gideon Rachman titled “Bankruptcy Could Be Good for America”: http://www.ft.com/cms/s/0/a8486284-fee9-11de-a677-00144feab49a.html. The point Rachman makes is that the Brics, Brazil, Russia, India, and China all went through economic reform before they “broke out” into their current ascendency. Brazil’s reform came in the 1990s, Russia defaulted in the late 1990s, India embraced economic reform in 1991, and China moved to a new mindset in the early 1990s. “Those much discussed emerging powers, the Brics, all needed a fiscal crisis to set them on the road to economic reform and national resurgence. America may one day be lucky enough to experience its very own national fiscal crisis.”
Even if we print money to pay for the federal debt, as the Federal Reserve has done over the last year or so, (the monetary base rose 23% from December 2008 to December 2009, and rose by 101% over the previous 12 months) someone, somewhere will pay this debt in terms of a reduction in purchasing power.
Need I mention that since January 1961 the purchasing power of one dollar has dropped to roughly $0.15. Inflating the United States government out of its debts has a long, post-World War II history.
Might this process of “printing money” continue?
Seems like a lot of people believe that it will. For one there is the problem of rising long term interest rates. More and more worry is being expressed about the expected increases. Why? Well most analysts believe that the Federal Reserve has helped to keep long term interest rates lower than they would have been in order to provide liquidity to the financial markets and to support the mortgage market. On January 6, 2010, the Fed held on their balance sheet $777 billion in U. S. Treasury securities, $160 billion in Federal Agency debt securities, and $909 billion in Mortgage-backed securities.
This totals $1.846 trillion in securities held by the central bank! The concern is that in the last week of August, 2008, the Fed had provided only $741 billion in funds to the banking system through some kind of market or auction based transaction.
How much affect these purchases have had on keeping long term interest rates lower than they would have been is currently being debated. What is not in question is that, sooner or later, interest rates are going to begin to rise, first because the Fed’s artificial support will be removed, but rates will rise as the economy begins to improve, further pressure will be put on rates as issuers of bonds race to place debt before the rise takes place (See “Rate Rise Fears Spark Rush to Issue Bonds: http://www.ft.com/cms/s/0/6f46f226-fef2-11de-a677-00144feab49a.html), and as inflationary expectations are incorporated into bond yields.
How fast will the Fed allow interest rates to rise because rising interest rates will slow down economic recovery. Also, the Fed has created another problem by keeping short term interest rates so low. Not only have these low rates created arbitrage possibilities for domestic investment, borrow short term money in the 35 to 65 basis point range and invest in 10-year government bonds at 3.50% to 3.80% but also for the international carry trade. It is argued that the Fed cannot allow rates to go up too fast or big financial institutions and other investors will get trapped in losses that will not help the economic recovery.
The point of all this discussion is that any “exit” strategy that the Fed is planning to reduce the securities held on its balance sheet from current levels to even a level of $1.0 trillion, let alone the $741 billion mentioned above, is already in jeopardy. And, many are arguing that in the face of such overwhelming future deficits, the Fed will be forced to print even more money than it has over the last 17 months.
The problem with debt is that debt, once issued, really does not go away. Someone has to pay for it!
Friday, December 18, 2009
Headlines of the Day: How Are Governments to Finance Themselves?
More and more attention is being directed toward the problems that governments are having with their financial situation. We have spent so much time this year discussing the problems in the financial industry, in housing, in credit cards, in consumer credit, in business bankruptcies, in debt-swaps, and in commercial real estate, that the plight of governments, other than the federal government, has taken a back seat.
Is 2010 to be dominated by the financial problems of government: federal, state, and local?
The cloud is certainly on the horizon.
Budget and debt problems on the national level have risen to prominence in the last few weeks. Just to list a few, you can start with Ireland, Greece, Spain, Mexico, and Dubai.
Yeah, and what about California and New York?
More and more we are hearing about the sagging prospects for the states and for cities and other local administrative units. See, for example, “States Scramble to Close New Budget Gaps” in the Wall Street Journal, http://online.wsj.com/article/SB126110075141996495.html#mod=todays_us_page_one.
In almost all states, there is some kind of balanced budget requirement. This is also true of many local government bodies. This means that attempts must be made to bring budgets under control.
The problem is on the revenue side; funds are just not coming in at the rate even severely revised budget projections anticipated. And, all of these shortfalls cannot be filled by federal stimulus monies. Certainly some jobs, especially in education, were maintained by federal funds, but this source cannot be continually relied upon.
And, the situation is a cumulative one. Unemployment and non-existent economic growth have caused the revenues of these entities to slow down. This is resulting in more budget cuts, primarily in programs and layoffs which just exacerbate the problem in unemployment and slow economic growth. This in turn slows down the revenue flow even further. And, so on, and so on.
Just as businesses and households are doing, state and local governments are re-thinking what it is they do, what they can do, and how they are going to go about doing it. The de-leveraging and down-sizing are coming after 50 years or so of relatively constant expansion of budgets and programs.
The inflationary-bias that has existed in the United States for the last 50 years resulted in a very prosperous public sector to go along with the very prosperous private sector. As I have stated repeatedly in my posts over the last two years, inflation is wonderful for the creation of debt and for financial innovation, in the public sector, as well as in the private sector.
Ah, thank goodness for gambling, for it seems to be one of the “gap-filling moves” that states are relying on to replace revenue shortfalls. The problem with this is that “planned gambling expansions” are zero-sum games if people, on the whole, don’t increase their gambling activities. And, do we really want people to increase their gambling activities, especially at this time?
But, this leads us back to the federal sector. It seems as if future inflation is the only answer to the consequences of past inflation.
The latest official estimate for the federal deficit for 2010 is $1.5 trillion, up from 1.4 trillion the year before. Even scarier is that the Gross Federal Debt is projected to increase by $2.2 trillion this year, an increase of 18.6% from last year. Even shakier is that the public is supposed to absorb more of the increase in the federal debt than ever before: a rise of $2.0 trillion or 26.9% ahead of last year.
And, these budget figures don’t include the Pentagon “bill” that was passed yesterday with much pork and “earmarks”, buying things that the Pentagon didn’t even want! And, it doesn’t include the new Pelosi “jobs bill” which just passed the house last week. And, it doesn’t include real numbers for the health care legislation. Oh, yes, and where is the $100 billion going to come to help finance the climate concerns of the emerging or developing nations? This was just proposed two days ago. Also, where is the cost of the increased troop commitment to Afghanistan? And, there are four or five other things that could be included in this list.
Where are the funds going to come from to finance all of these expenditures?
In addition, we have a Federal Reserve System that is on the verge of “exiting” from the excessive liquidity that it has injected into the financial system over the past 15 months. The Fed has a portfolio of securities that amounts to $1.835 trillion. The composition of this portfolio is U. S. Treasury securities, $777 billion, Federal Agency securities, $158 billion, and Mortgage-Backed securities, $901 billion.
How is the government going to finance all of the new debt it must place on the market at the same time the Federal Reserve is trying to reduce the size of its balance sheet by selling off these securities?
Furthermore, the Congress is not going to be happy with the Fed selling securities to “exit” its current bloated balance sheet which will cause interest rates to rise at the same time that massive amounts of new federal debt is going to be hitting the financial markets.
Well, the Bernanke Fed is not independent of the government anyway.
So, inflation is the answer! Bring it on!
The interesting thing about the international concern over the financial health of the nations is that the value of the United States dollar has risen. International finance seems to be saying that maybe things in the United States are not that bad when you consider the state of other nations in the world.
As I wrote above, maybe in 2010 a lot more of the concern in credit markets will be with the status of government budgets and government debts. The question then becomes, how long can governments continue to bail out other governments? Maybe as long as some governments can still print money.
Is 2010 to be dominated by the financial problems of government: federal, state, and local?
The cloud is certainly on the horizon.
Budget and debt problems on the national level have risen to prominence in the last few weeks. Just to list a few, you can start with Ireland, Greece, Spain, Mexico, and Dubai.
Yeah, and what about California and New York?
More and more we are hearing about the sagging prospects for the states and for cities and other local administrative units. See, for example, “States Scramble to Close New Budget Gaps” in the Wall Street Journal, http://online.wsj.com/article/SB126110075141996495.html#mod=todays_us_page_one.
In almost all states, there is some kind of balanced budget requirement. This is also true of many local government bodies. This means that attempts must be made to bring budgets under control.
The problem is on the revenue side; funds are just not coming in at the rate even severely revised budget projections anticipated. And, all of these shortfalls cannot be filled by federal stimulus monies. Certainly some jobs, especially in education, were maintained by federal funds, but this source cannot be continually relied upon.
And, the situation is a cumulative one. Unemployment and non-existent economic growth have caused the revenues of these entities to slow down. This is resulting in more budget cuts, primarily in programs and layoffs which just exacerbate the problem in unemployment and slow economic growth. This in turn slows down the revenue flow even further. And, so on, and so on.
Just as businesses and households are doing, state and local governments are re-thinking what it is they do, what they can do, and how they are going to go about doing it. The de-leveraging and down-sizing are coming after 50 years or so of relatively constant expansion of budgets and programs.
The inflationary-bias that has existed in the United States for the last 50 years resulted in a very prosperous public sector to go along with the very prosperous private sector. As I have stated repeatedly in my posts over the last two years, inflation is wonderful for the creation of debt and for financial innovation, in the public sector, as well as in the private sector.
Ah, thank goodness for gambling, for it seems to be one of the “gap-filling moves” that states are relying on to replace revenue shortfalls. The problem with this is that “planned gambling expansions” are zero-sum games if people, on the whole, don’t increase their gambling activities. And, do we really want people to increase their gambling activities, especially at this time?
But, this leads us back to the federal sector. It seems as if future inflation is the only answer to the consequences of past inflation.
The latest official estimate for the federal deficit for 2010 is $1.5 trillion, up from 1.4 trillion the year before. Even scarier is that the Gross Federal Debt is projected to increase by $2.2 trillion this year, an increase of 18.6% from last year. Even shakier is that the public is supposed to absorb more of the increase in the federal debt than ever before: a rise of $2.0 trillion or 26.9% ahead of last year.
And, these budget figures don’t include the Pentagon “bill” that was passed yesterday with much pork and “earmarks”, buying things that the Pentagon didn’t even want! And, it doesn’t include the new Pelosi “jobs bill” which just passed the house last week. And, it doesn’t include real numbers for the health care legislation. Oh, yes, and where is the $100 billion going to come to help finance the climate concerns of the emerging or developing nations? This was just proposed two days ago. Also, where is the cost of the increased troop commitment to Afghanistan? And, there are four or five other things that could be included in this list.
Where are the funds going to come from to finance all of these expenditures?
In addition, we have a Federal Reserve System that is on the verge of “exiting” from the excessive liquidity that it has injected into the financial system over the past 15 months. The Fed has a portfolio of securities that amounts to $1.835 trillion. The composition of this portfolio is U. S. Treasury securities, $777 billion, Federal Agency securities, $158 billion, and Mortgage-Backed securities, $901 billion.
How is the government going to finance all of the new debt it must place on the market at the same time the Federal Reserve is trying to reduce the size of its balance sheet by selling off these securities?
Furthermore, the Congress is not going to be happy with the Fed selling securities to “exit” its current bloated balance sheet which will cause interest rates to rise at the same time that massive amounts of new federal debt is going to be hitting the financial markets.
Well, the Bernanke Fed is not independent of the government anyway.
So, inflation is the answer! Bring it on!
The interesting thing about the international concern over the financial health of the nations is that the value of the United States dollar has risen. International finance seems to be saying that maybe things in the United States are not that bad when you consider the state of other nations in the world.
As I wrote above, maybe in 2010 a lot more of the concern in credit markets will be with the status of government budgets and government debts. The question then becomes, how long can governments continue to bail out other governments? Maybe as long as some governments can still print money.
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