“Moody’s Investors Service, the ratings agency, said in a report last week that many states ‘are increasingly pushing down their problems to their local governments.’ The Moody’s report warned that this would be “the toughest year for local governments since the economic downturn began.” (See “States Pass Budget Pain to Cities,” http://www.nytimes.com/2011/03/24/us/24cities.html?hp.)
“The state budget squeeze is fast becoming a city budget squeeze, as struggling states around the nation plan deep cuts in aid to cities and local governments that will almost certainly result in more service cuts, layoffs and local tax increases.”
Homes, over the last fifty years, served as the piggy-bank for the middle classes and the working classes as the rising price of houses during this time served as the major source for these people to increase their wealth. We are learning more and more that the inflated values of land and commercial real estate and the growing wealth of these classes also served as a piggy-bank for other sectors of the economy, such as state and local governments.
And, this piggy-bank was the source for increasing employment, rising wages, and other benefits in the public sectors of the economy.
Now the piggy-bank is broken and state and local governments are feeling the pain as have home owners, small commercial banks and small businesses over the past three years. (See my post http://seekingalpha.com/article/259867-banking-and-real-estate-the-problems-are-still-there.)
People are learning that those that “live” by inflation, “suffer” by deflation.
Ben Bernanke and the Federal Reserve are trying as hard as they can to create inflation once again so as to preserve the banking system, the housing market, and, now, state and local governments.
The economy, however, may not be responding as the Fed might want it to.
In a real sense there are two economies. There are the better off, those that benefitted from the credit inflation of the last fifty years, the people that learned how to use inflation and who have the resources to protect themselves against changes in prices. Then there are the others, those who can’t protect themselves from changing prices.
One result of this is that the income distribution in the United States is skewed more toward the wealthy than ever before in the history of the country.
The history: in the early 1960s, there were many intellectuals and policy makers who believed that inflation was beneficial to the worker because a little inflation was not a bad trade off for higher levels of employment. This trade off was captured in something called the Phillips Curve.
Although the Phillips Curve was intellectually contested by the end of the 1960s, the myth of the Phillips Curve lived on in many official circles and some still believe in it to this day.
Yet, the credit inflation that was supposed to be a ‘boon’ to the blue-collar worker and the middle class resulted in a withering of American manufacturing capability in steel, autos, and then other industries. It resulted in substantial amounts of under-employment for working age people. It decimated the housing industry. It has made many of the smaller commercial banks in the United States insolvent. And, it has now bankrupt the American system of local government.
We have had a bailout of the steel industry. We have had two bailouts of the auto industry. Labor unions in the manufacturing industries are so week that union leaders are now training people to go into other countries and build up labor unions there. We have had a bailout of the banking industry. We are now going through a workout and possible bailout of state and local governments.
Labor unions in the public sector, teachers unions, are now acting in much the same way as did the auto unions and the steel unions before them, as the economic base for their benefits have faded away.
People and organizations can only live beyond their means for so long and credit inflation can create the “good days” for only so long. And, when the good days are over, people must return to a more controlled and disciplined life style. The pain of the ‘return’ is not easy to bear.
The efforts by Mr. Bernanke and the Federal Reserve to create another round of credit inflation is, unfortunately, producing a further bifurcation of American society.
While the middle class and the blue collar workers continue to suffer and continue to restructure their budgets and balance sheets, those who have more are taking advantage of the Federal Reserve’s actions to further strengthen their position.
Large commercial banks are bigger than they were when they were “too big to fail” in 2008. Payrolls and bonuses at financial institutions are exceeding earlier years.
Large corporations are sitting on “tons” of cash and possess immense borrowing power at miniscule interest rates. And, we see one large merger taking place here and another large merger taking place there: AT&T and T-Mobile; Deutsche Bőrse and the NYSE Euronext; Warren Buffet and Lubrizol, and Caterpillar and Bucyrus. The projection is for more of this to take place in America...and in the world.
And, the wealthy? Consumer spending is picking up but the strength is not at the lower end of the value chain. Manufacturing is picking up but for higher end goods. Overall, the pickup is just modest because it is not supported throughout the income spectrum.
I raised the question earlier, in such an environment “Will the Financial Industry Dance Alone?” (http://seekingalpha.com/article/255748-will-the-financial-industry-dance-alone) The answer to this question seems to be “No, the financial industry will not dance alone. Big corporations will dance along too as will the wealthy.” There was concern in the 2000s that the benefits of the economic growth at that time were not spread evenly throughout the economy.
My feeling is that you haven’t seen anything yet.
The efforts by the Federal Reserve to inflate the economy are not going to be spread evenly throughout the economy. State and local governments are going to have to re-structure and downsize. The people in these bodies are going to have to lower their expectations as well as the people that have been served by them.
Similar to the situation with the smaller banks, one hopes to get through this adjustment period without major disturbances. That is, government officials and regulators are working overtime to keep a lid on things so that insolvencies and bankruptcies do not overwhelm the system. The efforts to contain these problems seem to be having some success. Ever Meredith Whitney, the financial analyst who predicted massive defaults in the municipal bond area still contends that there will be a large number of defaults although not as many as she first feared.
Still, things are changing and will my guess is that in many areas of the society we will not return to the “plush” years experienced in the last half of the twentieth century.
Showing posts with label state financial crisis. Show all posts
Showing posts with label state financial crisis. Show all posts
Thursday, March 24, 2011
Monday, January 3, 2011
What to Watch For in Early 2011
There are four situations in the financial area that require special attention in, at least, the early part of 2011. These situations pertain to the European debt problem, both sovereign and corporate, the problems being experienced by state and municipal governments in the United States, the problems connected with the rolling over of commercial real estate loans, and the consolidation that is taking place in the United States banking system.
The European situation seems to be the first out-of-the-box for the new year. Although most of the attention on Europe has been focused on the sovereign debt problem, the potential for problems to arise in the corporate sector should not be overlooked.
Europe cannot put its debt problems behind it because its leaders are not really facing up to the real problem. The real problem relates to the fiscal integration of the countries within the European Union.
As I have stated many times over the past year, a region cannot have just one currency if capital flows within the region are not restricted and if the political entities within the union continue to conduct their fiscal policies independently of one another. The European Union cannot be successful over time if it tries to maintain all three of these objectives.
Simon Johnson in “The Baseline Scenario” states that “Most experienced watchers of the eurozone are expecting another serious crisis to break out in early 2011. This projected crisis is tied to the rollover funding needs of weaker eurozone governments…” A solution will not be reached until the leaders of the European Union really face the fundamental facts of their crisis.
But, the sovereign debt of Europe is not the only concern. Although the corporate sector has been relatively successful in staying out of the limelight, concern is rising over what might happen here in 2011 if there are spillover effects coming from the “sovereign” sector. Especially worrisome is the amount of speculative-grade bonds maturing in the future and the potential number of defaults connected with the roll-overs. (See “Gearing up for 2011,” http://www.ft.com/cms/s/3/4b13a710-1363-11e0-a367-00144feabdc0.html#axzz19ypGKK7a.)
The second uncomfortable situation that is looming over 2011 is the fiscal soundness of many states and municipalities in the United States. Almost daily, new information comes out about the condition of our state and municipal governments, the cutbacks in police, firemen, educators, and social workers, the un-funded pension funds, and the labor unrest that is stirring because of the changes being proposed.
Bankruptcy is an issue. In some states, the bankruptcy of a municipality is unrecognized. For example, the situation in Hamtramck, Michigan is extremely bad, yet, the state of Michigan will not let the city declare bankruptcy. (See http://www.freep.com/article/20101205/NEWS02/12050500/Hamtramck-can-t-declare-bankruptcy-state-says.) Harrisburg, Pennsylvania and a host of other municipalities are just plugging holes attempting to avoid the worst.
But, many states are not doing much better.
And, the unrest in these areas continues to grow. However, this unrest is not just associated with the citizens losing services, the unrest is connected with the workers and the unions that are losing jobs and benefits. More than 50% of the union workers in the United States are in state and local governments so the potential conflicts with budget needs can be substantial. But, the times may be changing: “In California, New York, Michigan, and New Jersey, states where public unions wield much power and the culture historically tends to be pro-labor, even longtime liberal political leaders have demanded concessions—wage freezes, benefit cuts and tougher work rules.” (See http://www.nytimes.com/2011/01/02/business/02showdown.html?_r=1&scp=1&sq=public%20workers%20facing%20outrate%20in%20budget%20crisis&st=cse.)
Commercial real estate is another potential disaster area. For twelve months or more, commercial real estate loans have been on the list of major looming problems, in Europe as well as the United States. Yet, a crisis never seems to occur. One reason is that “banks on both sides of the Atlantic have been ‘ever-greening’ loans—or essentially extending the maturities, and practicing forbearance to avoid recognizing losses.” (See Gillian Tett, “Commercial Property Loans Pose New Threat”, http://www.ft.com/cms/s/0/c23e885e-1422-11e0-a21b-00144feabdc0.html#axzz19yRTp3ed.)
“Banks and borrowers have been able to conduct such ever-greening because interest rates have been rock-bottom low. But if rates rise, this ever-greening will be harder to maintain.”
Tett concludes with something we all need to keep in mind: “while a sense of peace might have returned to parts of the financial system in the past two years, this has only been achieved by virtue of government aid—and rock-bottom interest rates.”
As I have said over and over again, Federal Reserve policy has been aimed at achieving “a sense of peace” so that banks and others could work out of their debt problems: so that the FDIC could close banks in as quiet an environment as possible. And, some participants believe that the reduction in the size of the banking system will still be in the 1,000s over the next four or five years.
The question remains: has deleveraging taken place by a significant enough amount so that we can declare the bank crisis over?
The first three situations described above indicate that the deleveraging still has a ways to go and that as this deleveraging takes place the banks, in both the United States and Europe, could face further stress. There is certainly concern “out there” that the problems in the banking sector are not over. See, for example “Banks Pushed Together in a Wave of Deals,” http://professional.wsj.com/article/SB10001424052748704774604576035732836200772.html?mod=ITP_moneyandinvesting_0&mg=reno-wsj, and “Bailed-Out Banks Slip Toward Failure,” http://professional.wsj.com/article/SB10001424052970203568004576044014219791114.html?mod=ITP_moneyandinvesting_0&mg=reno-wsj.
In terms of closing banks in an orderly fashion, another problem has existed: the FDIC has just not had the resources to act as quickly as needed to fully deal with those banks that are seriously facing financial difficulties. Thus, even in troubled banks, “ever-greening” is a methodology for keeping the doors open because this buys time and “who knows what might happen” if a bank can keep open. “There’s just not enough manpower and coordination to catch all these failing institutions at once.” For more on this see “Hard Call for FDIC: When to Shut Bank,” http://professional.wsj.com/article/SB10001424052970204685004576045912789516274.html.
I am not saying that it is a sure thing that we will face eruptions in these four areas in 2011. And, I am not saying that these four situations are the only ones to be looking at during the year. It is just that the problems that exist in these four areas have not been resolved and will have to be resolved at some time in the future for the economic recovery to really pick up steam. The interesting times are not over.
The European situation seems to be the first out-of-the-box for the new year. Although most of the attention on Europe has been focused on the sovereign debt problem, the potential for problems to arise in the corporate sector should not be overlooked.
Europe cannot put its debt problems behind it because its leaders are not really facing up to the real problem. The real problem relates to the fiscal integration of the countries within the European Union.
As I have stated many times over the past year, a region cannot have just one currency if capital flows within the region are not restricted and if the political entities within the union continue to conduct their fiscal policies independently of one another. The European Union cannot be successful over time if it tries to maintain all three of these objectives.
Simon Johnson in “The Baseline Scenario” states that “Most experienced watchers of the eurozone are expecting another serious crisis to break out in early 2011. This projected crisis is tied to the rollover funding needs of weaker eurozone governments…” A solution will not be reached until the leaders of the European Union really face the fundamental facts of their crisis.
But, the sovereign debt of Europe is not the only concern. Although the corporate sector has been relatively successful in staying out of the limelight, concern is rising over what might happen here in 2011 if there are spillover effects coming from the “sovereign” sector. Especially worrisome is the amount of speculative-grade bonds maturing in the future and the potential number of defaults connected with the roll-overs. (See “Gearing up for 2011,” http://www.ft.com/cms/s/3/4b13a710-1363-11e0-a367-00144feabdc0.html#axzz19ypGKK7a.)
The second uncomfortable situation that is looming over 2011 is the fiscal soundness of many states and municipalities in the United States. Almost daily, new information comes out about the condition of our state and municipal governments, the cutbacks in police, firemen, educators, and social workers, the un-funded pension funds, and the labor unrest that is stirring because of the changes being proposed.
Bankruptcy is an issue. In some states, the bankruptcy of a municipality is unrecognized. For example, the situation in Hamtramck, Michigan is extremely bad, yet, the state of Michigan will not let the city declare bankruptcy. (See http://www.freep.com/article/20101205/NEWS02/12050500/Hamtramck-can-t-declare-bankruptcy-state-says.) Harrisburg, Pennsylvania and a host of other municipalities are just plugging holes attempting to avoid the worst.
But, many states are not doing much better.
And, the unrest in these areas continues to grow. However, this unrest is not just associated with the citizens losing services, the unrest is connected with the workers and the unions that are losing jobs and benefits. More than 50% of the union workers in the United States are in state and local governments so the potential conflicts with budget needs can be substantial. But, the times may be changing: “In California, New York, Michigan, and New Jersey, states where public unions wield much power and the culture historically tends to be pro-labor, even longtime liberal political leaders have demanded concessions—wage freezes, benefit cuts and tougher work rules.” (See http://www.nytimes.com/2011/01/02/business/02showdown.html?_r=1&scp=1&sq=public%20workers%20facing%20outrate%20in%20budget%20crisis&st=cse.)
Commercial real estate is another potential disaster area. For twelve months or more, commercial real estate loans have been on the list of major looming problems, in Europe as well as the United States. Yet, a crisis never seems to occur. One reason is that “banks on both sides of the Atlantic have been ‘ever-greening’ loans—or essentially extending the maturities, and practicing forbearance to avoid recognizing losses.” (See Gillian Tett, “Commercial Property Loans Pose New Threat”, http://www.ft.com/cms/s/0/c23e885e-1422-11e0-a21b-00144feabdc0.html#axzz19yRTp3ed.)
“Banks and borrowers have been able to conduct such ever-greening because interest rates have been rock-bottom low. But if rates rise, this ever-greening will be harder to maintain.”
Tett concludes with something we all need to keep in mind: “while a sense of peace might have returned to parts of the financial system in the past two years, this has only been achieved by virtue of government aid—and rock-bottom interest rates.”
As I have said over and over again, Federal Reserve policy has been aimed at achieving “a sense of peace” so that banks and others could work out of their debt problems: so that the FDIC could close banks in as quiet an environment as possible. And, some participants believe that the reduction in the size of the banking system will still be in the 1,000s over the next four or five years.
The question remains: has deleveraging taken place by a significant enough amount so that we can declare the bank crisis over?
The first three situations described above indicate that the deleveraging still has a ways to go and that as this deleveraging takes place the banks, in both the United States and Europe, could face further stress. There is certainly concern “out there” that the problems in the banking sector are not over. See, for example “Banks Pushed Together in a Wave of Deals,” http://professional.wsj.com/article/SB10001424052748704774604576035732836200772.html?mod=ITP_moneyandinvesting_0&mg=reno-wsj, and “Bailed-Out Banks Slip Toward Failure,” http://professional.wsj.com/article/SB10001424052970203568004576044014219791114.html?mod=ITP_moneyandinvesting_0&mg=reno-wsj.
In terms of closing banks in an orderly fashion, another problem has existed: the FDIC has just not had the resources to act as quickly as needed to fully deal with those banks that are seriously facing financial difficulties. Thus, even in troubled banks, “ever-greening” is a methodology for keeping the doors open because this buys time and “who knows what might happen” if a bank can keep open. “There’s just not enough manpower and coordination to catch all these failing institutions at once.” For more on this see “Hard Call for FDIC: When to Shut Bank,” http://professional.wsj.com/article/SB10001424052970204685004576045912789516274.html.
I am not saying that it is a sure thing that we will face eruptions in these four areas in 2011. And, I am not saying that these four situations are the only ones to be looking at during the year. It is just that the problems that exist in these four areas have not been resolved and will have to be resolved at some time in the future for the economic recovery to really pick up steam. The interesting times are not over.
Tuesday, December 14, 2010
Known Unknowns: Debt Refinancings in 2011
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!
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!
Thursday, October 7, 2010
Discipline, Especially Related to Financial Discipline, is a Bad Word
What appears as the lead in the Huffington Post this morning?
“What a Waste: Companies Using Piles of Cash to Buy Back Stock, Not Generate Jobs!” This headline points to an article in the Washington Post: http://www.washingtonpost.com/wp-dyn/content/article/2010/10/06/AR2010100606772.html?hpid=topnews.
It was the lack of discipline that got this country where it is now. The recipe that some people are pushing for is “more of the same!”
The United States has been a show case for the “lack of discipline” over the last fifty years. The credit inflation initiated by the federal government has grown and expanded to almost every sector of the economy. Almost everyone, public and private, has leveraged up to the hilt over this time period.
The question remains: did we reach levels of debt that were unsustainable and had to be reduced?
Other questions follow: Have we misdirected resources in ways that have left one out of every five people of employment age untrained for employment in today’s workforce? Have we, like Japan, created surplus capacity in industry through fiscal stimulus and excessively low interest rates? Have we provided incentives that the wealthy can take advantage of, which the less-well-off cannot?
And, the problems swirl around us.
Elizabeth Warren pointed to the 3,000 commercial banks in the United States that are seriously in trouble and face enormous pressures due to the commercial real estate loans that are coming due or re-pricing over the next 12 to 18 months.
There have been numerous articles over the past week or so about the fiscal woes that cities face. (See the New York Times article “Fiscal Woes Deepening for Cities, Report Says”: http://www.nytimes.com/2010/10/07/us/07cities.html?ref=todayspaper.)
“The nation’s cities are in their worst fiscal shape in at least a quarter of a century and have probably not yet hit the bottom of their slide,” states a report by the National League of Cities.
What about the financial health of the states? “Right now there isn’t really anywhere to turn” as many states are now cutting aid to cities, says Christopher Hoene, one of the authors of the report. “The state budgets are in a position where they are more likely to hurt than to help.”
And, this doesn’t get into the problems individuals are having holding onto their jobs or homes.
Who seems to be doing well and positioning themselves to move into the future? Well it seems as if large companies and large banks are doing all the positioning at the present time. (See my post http://seekingalpha.com/article/228507-corporations-are-hoarding-cash-and-keeping-their-powder-dry.) Corporations buy back stock to better position themselves for future moves in the acquisition area. A higher stock price gives them more bargaining power when they are negotiating a “for-stock” transaction.
We are just seeing the tip of this iceberg. In August, acquisitions were unusually high in the manufacturing area for this time of year. We have not seen the September figures yet, but we are seeing lots of movement.
How can one doubt this movement with headlines like this one that appeared this morning in the Wall Street Journal: “GE Goes On Binge For Deals” (http://professional.wsj.com/article/SB10001424052748703735804575535872986083474.html?mod=ITP_marketplace_0&mg=reno-wsj).
In the article, John Krenicki, chief executive of GE Energy is quoted as saying, “This is another sign we’re playing offense.” There are “lots of choices organically and inorganically to grow the business.”
The article goes on: “GE Vice Chairman John Rice said last month the company has the firepower to spend about $30 billion on acquisitions over the next two to three years.” He added, however, that “we’re not going to run out and buy something just for the sake of buying it.”
But, this is not going to add jobs to the economy and it is not going to produce a lot of investment expenditures, both of which would help to spur on an economic recovery.
The United States is re-structuring. It appears as if more discipline is being exercised by those in a position to move forward. It also appears that those that are “under water” are scrambling to get their lives back under control.
The correction will not be comfortable or easy. But, calls for people and businesses to forget their efforts to bring discipline back into their lives will just postpone the fact that discipline will, at some time, have to be brought back into their lives. In fact, we may have reached the point where there is no going back…the thrust of the last 50 years may not be able to be sustained…and discipline will be re-established.
There is no question that this re-structuring is going to be very, very hard on some people. But, that is why one needs to be disciplined in what one does, even in the go-go years. Getting back the discipline is always hard. Perhaps the hardest part is to realize is that some, in the go-go years, were pushed to go beyond what they could really achieve at the time: these individuals were given incentives to put aside their discipline with the impression that their lack of discipline would not come back to haunt them.
The lesson that apparently needs to be learned over and over again is that, ultimately, a lack of discipline catches up with you. Discipline then has to be re-established. Re-establishing discipline is painful. But, there is no such thing as a free lunch.
“What a Waste: Companies Using Piles of Cash to Buy Back Stock, Not Generate Jobs!” This headline points to an article in the Washington Post: http://www.washingtonpost.com/wp-dyn/content/article/2010/10/06/AR2010100606772.html?hpid=topnews.
It was the lack of discipline that got this country where it is now. The recipe that some people are pushing for is “more of the same!”
The United States has been a show case for the “lack of discipline” over the last fifty years. The credit inflation initiated by the federal government has grown and expanded to almost every sector of the economy. Almost everyone, public and private, has leveraged up to the hilt over this time period.
The question remains: did we reach levels of debt that were unsustainable and had to be reduced?
Other questions follow: Have we misdirected resources in ways that have left one out of every five people of employment age untrained for employment in today’s workforce? Have we, like Japan, created surplus capacity in industry through fiscal stimulus and excessively low interest rates? Have we provided incentives that the wealthy can take advantage of, which the less-well-off cannot?
And, the problems swirl around us.
Elizabeth Warren pointed to the 3,000 commercial banks in the United States that are seriously in trouble and face enormous pressures due to the commercial real estate loans that are coming due or re-pricing over the next 12 to 18 months.
There have been numerous articles over the past week or so about the fiscal woes that cities face. (See the New York Times article “Fiscal Woes Deepening for Cities, Report Says”: http://www.nytimes.com/2010/10/07/us/07cities.html?ref=todayspaper.)
“The nation’s cities are in their worst fiscal shape in at least a quarter of a century and have probably not yet hit the bottom of their slide,” states a report by the National League of Cities.
What about the financial health of the states? “Right now there isn’t really anywhere to turn” as many states are now cutting aid to cities, says Christopher Hoene, one of the authors of the report. “The state budgets are in a position where they are more likely to hurt than to help.”
And, this doesn’t get into the problems individuals are having holding onto their jobs or homes.
Who seems to be doing well and positioning themselves to move into the future? Well it seems as if large companies and large banks are doing all the positioning at the present time. (See my post http://seekingalpha.com/article/228507-corporations-are-hoarding-cash-and-keeping-their-powder-dry.) Corporations buy back stock to better position themselves for future moves in the acquisition area. A higher stock price gives them more bargaining power when they are negotiating a “for-stock” transaction.
We are just seeing the tip of this iceberg. In August, acquisitions were unusually high in the manufacturing area for this time of year. We have not seen the September figures yet, but we are seeing lots of movement.
How can one doubt this movement with headlines like this one that appeared this morning in the Wall Street Journal: “GE Goes On Binge For Deals” (http://professional.wsj.com/article/SB10001424052748703735804575535872986083474.html?mod=ITP_marketplace_0&mg=reno-wsj).
In the article, John Krenicki, chief executive of GE Energy is quoted as saying, “This is another sign we’re playing offense.” There are “lots of choices organically and inorganically to grow the business.”
The article goes on: “GE Vice Chairman John Rice said last month the company has the firepower to spend about $30 billion on acquisitions over the next two to three years.” He added, however, that “we’re not going to run out and buy something just for the sake of buying it.”
But, this is not going to add jobs to the economy and it is not going to produce a lot of investment expenditures, both of which would help to spur on an economic recovery.
The United States is re-structuring. It appears as if more discipline is being exercised by those in a position to move forward. It also appears that those that are “under water” are scrambling to get their lives back under control.
The correction will not be comfortable or easy. But, calls for people and businesses to forget their efforts to bring discipline back into their lives will just postpone the fact that discipline will, at some time, have to be brought back into their lives. In fact, we may have reached the point where there is no going back…the thrust of the last 50 years may not be able to be sustained…and discipline will be re-established.
There is no question that this re-structuring is going to be very, very hard on some people. But, that is why one needs to be disciplined in what one does, even in the go-go years. Getting back the discipline is always hard. Perhaps the hardest part is to realize is that some, in the go-go years, were pushed to go beyond what they could really achieve at the time: these individuals were given incentives to put aside their discipline with the impression that their lack of discipline would not come back to haunt them.
The lesson that apparently needs to be learned over and over again is that, ultimately, a lack of discipline catches up with you. Discipline then has to be re-established. Re-establishing discipline is painful. But, there is no such thing as a free lunch.
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