The most important thing for government regulators at this time is to handle the problems in the banking industry in an orderly fashion. Don’t panic; don’t show fear; just keep plugging ahead.
This seems to be exactly what the FDIC and the Federal Reserve are doing.
The FDIC announced that there are now 829 banks on the problem watch list as of June 30, 2010. Given that 45 banks failed in the second quarter of 2010 this means that 99 additional banks were added to the list. One should note that this figure, 99 banks, compares with 113 banks that were added to the list in the first quarter of 2010. The highest number ever reached for the problem list was 993 and this came in 1993.
Remember, though, that Elizabeth Warren indicated in Congressional testimony that there were 3,000 banks that faced serious problems with respect to loans and assets on their books that probably needed to be written down and that these banks had not seen the full effect of the problems in the commercial real estate sector.
One can also add that these institutions have not really recognized the problems that state and local governments are having in their finances. Note that Pennsylvania’s capital, Harrisburg, announced that it will default on a $3.29 million municipal-bond payment in two weeks making it the second largest general-obligation municipal bond default this year.
With the 32 banks that have failed so far in the third quarter, the total number of failures in the year reached 118, well ahead of the pace from last year when only 140 banks were closed overall.
Using the rule of thumb that one-third of the banks on the problem list will fail over the next 18 months, this would mean that we will experience 276 more bank failures and an average rate of bank failures at 3.5 per week during this time span. In 2010, the pace of bank failures has hovered around this average.
But, the FDIC is working through this tremendous case load in an orderly fashion. There are very few surprises and this is the best thing that can happen given the condition of the banking system.
The Federal Reserve is also contributing to this work out situation in the banking industry. Perhaps the most important thing it is doing is the subsidization of the large banks in the United States. By keeping its target interest rate around zero percent, the Fed is paying a big bonus to the big banks and the payoff for this policy is that the profits at the largest financial institutions have been at record levels and that about 75 percent of the assets of the banking system seem to be well protected.
The profit picture of the banking industry improved in the second quarter with the industry recording the highest level of profits since before the financial crisis. The FDIC reported that nearly two-thirds of United States banks reported a year-over-year improvement. The biggest booster to this performance was the reduction loan-loss provisions.
However, it should be noted that 20 percent of the banks, primarily the smaller banks, reported a net loss and that more than 60 percent of banks, mainly the smaller institutions, continued to increase their loan loss reserves.
Another place where one can find information on the problems the commercial banking industry is having is the report of the Federal Reserve on Enforcement Actions taken by Federal Reserve Banks against some of the financial institutions it regulates.
So far in the third quarter of 2010, the Federal Reserve has engaged in 56 enforcement actions against financial institutions bringing the total up to 192 for the full year to date. Last year only 172 enforcement actions were taken.
Enforcement actions can take one of two forms: a written agreement or a prompt corrective action directive.
The most recent written agreement is a legal action taken by the Federal Reserve Bank of Kansas City, the State of Colorado Division of Banking and First American Bancorp and First American State Bank, both of Greenwood Village, Colorado. This written agreement aims to bring the banks into compliance with every “applicable provision” of the Agreement reached between “the Bancorp, the Bank, and their institution-affiliated parties”, the Reserve Bank and the Division. The agreement specifically deals with Board Oversight, Credit Risk Management, Lending and Credit Administration, Asset Improvement, Internal Audit, Allowance for Loan and Lease Losses, Capital Plan, Earnings Plan and Budget, Liquidity/Funds Management, Dividends and Distributions, Debt and Stock Redemptions, Cash Flow, and, Compliance with Laws and Regulations. The specifics of each of these sections present a very definite list of things the bank(s) must do in order to comply with the agreement. Furthermore, specific dates are given for achieving compliance. And, “The provisions of this Agreement shall not bar, estop, or otherwise prevent the Board of Governors, the Reserve Bank, the Division or any other federal or state agency from taking any other action affecting” the affected parties or this successors and assigns.
The most recent Prompt Corrective Action is that taken against the First Community Bank of Taos, New Mexico. In this agreement very specific actions are required such to “increase the Bank’s equity” and to “enter into and close a contract to be acquired by a depository institutions holding company or combine with another insured depository institution.” The Bank is restricted from making capital distributions or the payment of dividends. The Bank shall not “solicit and accept new deposit accounts, etc.. The Bank shall restrict the payment of bonuses to senior executive officers and increases in compensation of such officers.” And, the bank is restricted in terms of asset growth, acquisitions, branching, and new lines of business.
These enforcement actions are very serious and a reading of some of them can give one an idea of the problems that exist “out there” in the banking industry. And, 192 of these have been given out so far this year!
As more and more information is made available, the more one realizes that the banking industry is being re-constructed. In the next five years or so we will observe a banking industry that is much smaller than the one that exists today and this industry will be even more dominated by the larger institutions making up the industry. I believe that the number of domestically chartered banks in the United States will fall from a present level of about 7,800 banks to around 4,000 banks. I believe that the largest 25 domestically chartered banks in the United States will control about 75 percent of the banking assets in the country up from around 67 percent now.
I am more confident about this latter number than the former one. It is hard to believe that 3,975 banks can profitably be operated when they only control 25 percent of the banking assets. The smaller banks are just not going to be profitable and cannot compete in the world of the 21st century!
Wednesday, September 1, 2010
Tuesday, August 31, 2010
The World Continues to Move to Smaller and Faster
Given all the headlines about double-dip recessions, consumer and business de-leveraging, and unemployment it is good to get back to some basic trends that, in my mind, are not going to change.
On the front page of the New York Times we read “Advances Offer Path to Shrink Computer Chips Again” (http://www.nytimes.com/2010/08/31/science/31compute.html?ref=todayspaper). “Scientists at Rice University and Hewlett-Packard are reporting this week that they can overcome a fundamental barrier to the continued rapid miniaturization of computer memory that has been the basis for the consumer electronics revolution.” And to the revolution in the waging of war and keeping of secrets, on advances in finance and business technology and so on and so on.
The problem had been that “the limits of physics and finance faced by chip makers had loomed so large that experts feared a slowdown in the pace of miniaturization that would act like a brake on the ability to pack ever more power into ever smaller devices…”
The new method, discovered at Rice University “involves filaments as thin as five nanometers in width…”
“Separately, H. P. is to announce on Tuesday that it will enter into a commercial partnership with a major semiconductor company to produce a related technology that also has the potential of pushing computer data storage to astronomical densities in the next decade.”
These discoveries, if they prove successful, will help to maintain Moore’s Law, the idea that industry can roughly double the computing power of chips every 18 months, and the Storage Law, the idea that industry can roughly double the amount of data that can be stored every two years. These capabilities have been the back-bone of computing power for the past fifty years or so.
Trends like these are going to continue because there is too much to be lost if they do not. For one, governments cannot allow their countries to fall behind in the development of computing power. There are two reasons for this: first, governments need to keep secrets and so must be able to keep others from breaking codes; second, powerful governments must continue to be able to kill people better than other governments in order to maintain their position in the world. Thus the United States government must continue to finance the development of these capabilities. This is why one can continue to expect the development of a fully operational quantum computer in the next decade.
As with the Eniac computer that was developed in the 1940s to improve the accuracy of firing
shells into the enemy, military needs come first, business benefits follow.
It is my belief in the continuation of such trends that lead me to suggest such things as the ineffectiveness of the newly minted financial regulations even before they become operational. Finance is information. This became apparent in the 1960s when the new computer technology produced faster and faster computers and also produced computers that had the ability to store massive amounts of data from the stock markets. This led to a new industry…quantitative finance. The boom in finance Ph. D.’s got its start with the portfolio theory and CAP-M models developed in these years as it became evident that lots and lots of dissertations could be written given all the data that were now available to researchers.
This industry only grew as computers got faster and data storage capacities continued to increase. And, since we were only dealing in information and the manipulation of information, it became apparent that people in this field really did not need to know much finance because the crucial talent became mathematical model building and data mining. Consequently, backgrounds in physics and mathematics became very useful and the application of Information Theory to data streams provided a source for understanding signals that otherwise appeared to be “white noise.” (A readable source for all these developments can be found in the book “The Quants”: http://seekingalpha.com/article/188342-model-misbehavior-the-quants-how-a-new-breed-of-math-whizzes-conquered-wall-street-and-nearly-destroyed-it-by-scott-patterson.)
This financial engineering continues. This is why I believe that the financial reform package has been legacy from the start. The organizations that the financial reform package are supposed to regulate are, in many cases, already beyond the current legislation, and if they are not yet beyond it, the technology is such that they will be soon.
Is financial innovation going to continue to take place? Yes, and, in fact the pace at which it occurs will accelerate. And, this financial innovation is serving as a model for other markets, even for goods and services. This development is related to what is called “Information Markets” and, with the growth in computing power and the expansion of data bases, these markets are going to become more and more a part of how people transact in the future. (Note for example the new commodity ETF called U. S. Commodity Index Fund (trading symbol USCI). http://professional.wsj.com/article/SB10001424052748703418004575456221354231844.html.The economist Robert Shiller (author of Irrational Exuberance) has written path-breaking work in this area.)
Such developments have led to a boom in employment in the finance industry over the last forty years. This relative shift in employment will continue well into the future because it is information based and the use of information technology is going to spread and prosper.
This is why one person, Andy Kessler, a former hedge fund manager, has suggested (tongue-in-cheek) that one way turn the economy around is to import people that would buy homes. He writes: “I would wager there is a backlog of high-paying jobs for educated foreigners well beyond what H1-B visas allow to trickle in. In the name of financial stability, create a million visas for qualified immigrants, say, those with a masters or Ph. D., and watch home prices start to rise.” (http://professional.wsj.com/article/SB10001424052748704147804575455951017059416.html?mod=WSJ_Opinion_LEFTTopOpinion&mg=reno-wsj)
The important distinction here is that Kessler is writing about “educated foreigners” and not unemployed Americans. This seems to be an issue that many analysts are bringing up these days. The jobs that are available for workers are not the jobs that many of the unemployed or underemployed in the United States are able to fill. And, I don’t perceive that there will be a slowdown in the advancement of computing power and other technologies in the future which leads one to conclude that unless something is done about education and training, the United States workforce is going to bifurcate even further between those that can work productively in the 21st century and those that cannot perform at this level. Programs of fiscal stimulus that puts people back into the jobs they formerly held will not succeed only attempt to re-create the past.
Technology will evolve to produce “things” that are smaller and faster and these “things” will be used more and more in the creation and production of “information goods”. Furthermore, the speed at which these advancements take place will continue to accelerate. Organizations set up to operate within the past, like labor unions, are going to have to change and adapt to this environment. Otherwise, they are more of a dis-service to their constituents than a help. But, that is the future.
On the front page of the New York Times we read “Advances Offer Path to Shrink Computer Chips Again” (http://www.nytimes.com/2010/08/31/science/31compute.html?ref=todayspaper). “Scientists at Rice University and Hewlett-Packard are reporting this week that they can overcome a fundamental barrier to the continued rapid miniaturization of computer memory that has been the basis for the consumer electronics revolution.” And to the revolution in the waging of war and keeping of secrets, on advances in finance and business technology and so on and so on.
The problem had been that “the limits of physics and finance faced by chip makers had loomed so large that experts feared a slowdown in the pace of miniaturization that would act like a brake on the ability to pack ever more power into ever smaller devices…”
The new method, discovered at Rice University “involves filaments as thin as five nanometers in width…”
“Separately, H. P. is to announce on Tuesday that it will enter into a commercial partnership with a major semiconductor company to produce a related technology that also has the potential of pushing computer data storage to astronomical densities in the next decade.”
These discoveries, if they prove successful, will help to maintain Moore’s Law, the idea that industry can roughly double the computing power of chips every 18 months, and the Storage Law, the idea that industry can roughly double the amount of data that can be stored every two years. These capabilities have been the back-bone of computing power for the past fifty years or so.
Trends like these are going to continue because there is too much to be lost if they do not. For one, governments cannot allow their countries to fall behind in the development of computing power. There are two reasons for this: first, governments need to keep secrets and so must be able to keep others from breaking codes; second, powerful governments must continue to be able to kill people better than other governments in order to maintain their position in the world. Thus the United States government must continue to finance the development of these capabilities. This is why one can continue to expect the development of a fully operational quantum computer in the next decade.
As with the Eniac computer that was developed in the 1940s to improve the accuracy of firing
shells into the enemy, military needs come first, business benefits follow.
It is my belief in the continuation of such trends that lead me to suggest such things as the ineffectiveness of the newly minted financial regulations even before they become operational. Finance is information. This became apparent in the 1960s when the new computer technology produced faster and faster computers and also produced computers that had the ability to store massive amounts of data from the stock markets. This led to a new industry…quantitative finance. The boom in finance Ph. D.’s got its start with the portfolio theory and CAP-M models developed in these years as it became evident that lots and lots of dissertations could be written given all the data that were now available to researchers.
This industry only grew as computers got faster and data storage capacities continued to increase. And, since we were only dealing in information and the manipulation of information, it became apparent that people in this field really did not need to know much finance because the crucial talent became mathematical model building and data mining. Consequently, backgrounds in physics and mathematics became very useful and the application of Information Theory to data streams provided a source for understanding signals that otherwise appeared to be “white noise.” (A readable source for all these developments can be found in the book “The Quants”: http://seekingalpha.com/article/188342-model-misbehavior-the-quants-how-a-new-breed-of-math-whizzes-conquered-wall-street-and-nearly-destroyed-it-by-scott-patterson.)
This financial engineering continues. This is why I believe that the financial reform package has been legacy from the start. The organizations that the financial reform package are supposed to regulate are, in many cases, already beyond the current legislation, and if they are not yet beyond it, the technology is such that they will be soon.
Is financial innovation going to continue to take place? Yes, and, in fact the pace at which it occurs will accelerate. And, this financial innovation is serving as a model for other markets, even for goods and services. This development is related to what is called “Information Markets” and, with the growth in computing power and the expansion of data bases, these markets are going to become more and more a part of how people transact in the future. (Note for example the new commodity ETF called U. S. Commodity Index Fund (trading symbol USCI). http://professional.wsj.com/article/SB10001424052748703418004575456221354231844.html.The economist Robert Shiller (author of Irrational Exuberance) has written path-breaking work in this area.)
Such developments have led to a boom in employment in the finance industry over the last forty years. This relative shift in employment will continue well into the future because it is information based and the use of information technology is going to spread and prosper.
This is why one person, Andy Kessler, a former hedge fund manager, has suggested (tongue-in-cheek) that one way turn the economy around is to import people that would buy homes. He writes: “I would wager there is a backlog of high-paying jobs for educated foreigners well beyond what H1-B visas allow to trickle in. In the name of financial stability, create a million visas for qualified immigrants, say, those with a masters or Ph. D., and watch home prices start to rise.” (http://professional.wsj.com/article/SB10001424052748704147804575455951017059416.html?mod=WSJ_Opinion_LEFTTopOpinion&mg=reno-wsj)
The important distinction here is that Kessler is writing about “educated foreigners” and not unemployed Americans. This seems to be an issue that many analysts are bringing up these days. The jobs that are available for workers are not the jobs that many of the unemployed or underemployed in the United States are able to fill. And, I don’t perceive that there will be a slowdown in the advancement of computing power and other technologies in the future which leads one to conclude that unless something is done about education and training, the United States workforce is going to bifurcate even further between those that can work productively in the 21st century and those that cannot perform at this level. Programs of fiscal stimulus that puts people back into the jobs they formerly held will not succeed only attempt to re-create the past.
Technology will evolve to produce “things” that are smaller and faster and these “things” will be used more and more in the creation and production of “information goods”. Furthermore, the speed at which these advancements take place will continue to accelerate. Organizations set up to operate within the past, like labor unions, are going to have to change and adapt to this environment. Otherwise, they are more of a dis-service to their constituents than a help. But, that is the future.
Monday, August 30, 2010
National Discipline or the Lack Thereof
I read with dismay an editorial piece in the Financial Times this morning entitled “Germany’s rebound is no cause for cheer,” (http://www.ft.com/cms/s/0/2becafc4-b398-11df-81aa-00144feabdc0.html) by Wolfgang Mϋnchau. The conclusion of the piece: “Germany’s economic strength is likely to be persistent, toxic and quite possibly self-defeating in the long-run.
Germany’s economic strength is likely to be persistent because it is more disciplined than other countries in the Eurozone. The German fiscal budget is more under control than is that of other Eurozone countries, especially those on the periphery like Belgium, Italy, Greece, Spain, and Portugal and German wage moderation is significantly different from these other areas. This discipline is likely “to be persistent.”
Germany’s economic strength is likely to be toxic because the adjustment mechanisms do not seem to be in place within the European Union because it seems that “it remains surprisingly hard to shop cross-border in Europe and “the European labour market remains almost perfectly fragmented.” Furthermore these “peripheral” nations seem to lack the fiscal discipline of the Germans and they seem to be more dependent upon labor unions and those receiving “social benefits” than do the Germans. After years of giving out substantial “social benefits” to their people and after years of credit inflation to stimulate local economies and “keep the dance going” the politicians of these nations are not going to back off what has kept them in office in the past. Without changing their path, the peripheral nations will continue to suffer relative to the Germans and will continue to identify the Germans as the real problem-maker.
And, according to Mr. Mϋnchau, Germany’s economic strength is likely to be “quite possibly self-defeating in the long-run” because the European Union cannot allow these imbalances to continue and still keep the Union together. That is, Germany must become like these other countries or the political union will fall apart. Thus, by continuing to maintain its self-discipline, Germany could cause the dissolution of the European Union which would not be beneficial to it in the long-run.
I am very uncomfortable with this argument.
This argument, to me, says that in playing golf I should not work several hours every day on the practice range hitting ball-after-ball-after-ball, and I should not play several rounds of golf every week against very competitive golfers, and I should not practice my putting for each day for a lengthy period of time, and I should not train in the gym or run 35 miles every week to develop my physical conditioning, and I should not watch my diet and weight. Such discipline gives me an unfair advantage relative to those that are not willing to maintain this kind of discipline. My efforts will cause the resulting inequality in performance “to be persistent, toxic, and quite possibly self-defeating in the long-run.” Thus, I should not practice, etc..
Discipline, in the longer-run, conquers lack of discipline.
Now, I am not advocating the making of discipline into an idol. It is just that in order to achieve other goals and objectives, hopefully good goals and objectives, discipline is an important factor helping one to accomplish these other things.
One problem that arises when one fails to maintain self-discipline is that other problems often arise making it even more difficult to re-establish discipline when you try to get your life back in order. That is, a lack of discipline can make it just that much harder and painful to become competitive when one finally reaches the stage that getting back in the game is a vitally important goal.
The United States, to me, is an example of a nation that has lost its self-discipline. But, this loss is not just a recent problem. The movement in this direction began in the early 1960s and has been going on for about fifty years. Beginning in January 1961, the Gross Federal Debt has increased at a compound rate of more than 7 percent every year up to the current time. Inflation became such a problem that wages and prices were frozen in August 1971 and an extremely restrictive monetary policy had to be enforced in the late 1970s.
Economic leadership of the United States currently rests in the hands of individuals that were an instrumental part in the excessive credit inflation of the 2000s. Ben Bernanke was a member of the Board of Governors of the Federal Reserve System and a vocal supporter of Alan Greenspan’s move to keep the Federal Funds target rate around one percent in 2003 and beyond, having joined the Board in 2002. Timothy Geithner became President of the Federal Reserve Bank of New York in 2003. This position has a permanent vote on the Open Market Committee, so that Geithner was in on all votes during this time as was Bernanke. After a short stint as the Chairman of the President’s Council of Economic Advisors in 2005-2006, Bernanke became Chairman of the Board of Governors of the Federal Reserve System in February 2006. Geithner moved from the New York Fed to become Treasury Secretary in January 2009.
These two leaders, arguably the most important leaders in economics and finance in the United States government, have held top positions and been voting members of policy boards during one of the most un-disciplined times in United States history. And, their lack of discipline continues, as is evident by the speech given by Bernanke last Friday at Jackson Hole, Wyoming. The only policy that these two people follow is one of throwing everything they can at a problem and seeing what works.
The problem is that their interest rate efforts in the 2003 to 2005 period led to a housing bubble and stock market bubble which resulted in the collapse of the sub-prime market in 2006 and 2007. Their response to this break-down resulted in the financial disaster of the 2008 to 2009 period when the government threw just about everything it could at the disaster in order to try and avoid worse. We are now in 2010 and the evidence of the lack of discipline is still around us. Consumers are plagued with debt fostering record numbers of foreclosures and personal bankruptcies. Businesses are overwhelmed with debt, not only with high-yield bond debt but also with commercial real estate loans and foreclosures and bankruptcies are also high in this area. State and local governments are piled high with debt and we find that states and cities are cutting back on the most basic of services including the release of fire fighters and police. And, the federal government faces budget deficits that some estimate will result in $15 trillion or more in additional debt over the next ten years.
The United States has lived off of its position as Number One economic and military power for years and this has allowed it to be so profligate. Only China, in my lifetime, really seems as if it might be a potential threat to this position.
This lack of discipline has shown up in one spot, however. Since the United States dollar was floated in August 1971, it has declined by about 40 percent in value. There were three periods within this time frame when this general trend was challenged. First, was during the time that Paul Volcker headed the Fed and caused interest rates to reach post-World War II highs. Second, during the Clinton administration as the federal budget moved into surplus territory. Third, during the financial crises when the world seemed to be falling apart and there was a “flight to strength.”
In my book, history shows that discipline wins over the longer run. The United States is struggling because it lost its self-discipline. The criticism of Germany presented above shows the mentality in the west that is indicative of this undisciplined approach to living in the world today.
Germany’s economic strength is likely to be persistent because it is more disciplined than other countries in the Eurozone. The German fiscal budget is more under control than is that of other Eurozone countries, especially those on the periphery like Belgium, Italy, Greece, Spain, and Portugal and German wage moderation is significantly different from these other areas. This discipline is likely “to be persistent.”
Germany’s economic strength is likely to be toxic because the adjustment mechanisms do not seem to be in place within the European Union because it seems that “it remains surprisingly hard to shop cross-border in Europe and “the European labour market remains almost perfectly fragmented.” Furthermore these “peripheral” nations seem to lack the fiscal discipline of the Germans and they seem to be more dependent upon labor unions and those receiving “social benefits” than do the Germans. After years of giving out substantial “social benefits” to their people and after years of credit inflation to stimulate local economies and “keep the dance going” the politicians of these nations are not going to back off what has kept them in office in the past. Without changing their path, the peripheral nations will continue to suffer relative to the Germans and will continue to identify the Germans as the real problem-maker.
And, according to Mr. Mϋnchau, Germany’s economic strength is likely to be “quite possibly self-defeating in the long-run” because the European Union cannot allow these imbalances to continue and still keep the Union together. That is, Germany must become like these other countries or the political union will fall apart. Thus, by continuing to maintain its self-discipline, Germany could cause the dissolution of the European Union which would not be beneficial to it in the long-run.
I am very uncomfortable with this argument.
This argument, to me, says that in playing golf I should not work several hours every day on the practice range hitting ball-after-ball-after-ball, and I should not play several rounds of golf every week against very competitive golfers, and I should not practice my putting for each day for a lengthy period of time, and I should not train in the gym or run 35 miles every week to develop my physical conditioning, and I should not watch my diet and weight. Such discipline gives me an unfair advantage relative to those that are not willing to maintain this kind of discipline. My efforts will cause the resulting inequality in performance “to be persistent, toxic, and quite possibly self-defeating in the long-run.” Thus, I should not practice, etc..
Discipline, in the longer-run, conquers lack of discipline.
Now, I am not advocating the making of discipline into an idol. It is just that in order to achieve other goals and objectives, hopefully good goals and objectives, discipline is an important factor helping one to accomplish these other things.
One problem that arises when one fails to maintain self-discipline is that other problems often arise making it even more difficult to re-establish discipline when you try to get your life back in order. That is, a lack of discipline can make it just that much harder and painful to become competitive when one finally reaches the stage that getting back in the game is a vitally important goal.
The United States, to me, is an example of a nation that has lost its self-discipline. But, this loss is not just a recent problem. The movement in this direction began in the early 1960s and has been going on for about fifty years. Beginning in January 1961, the Gross Federal Debt has increased at a compound rate of more than 7 percent every year up to the current time. Inflation became such a problem that wages and prices were frozen in August 1971 and an extremely restrictive monetary policy had to be enforced in the late 1970s.
Economic leadership of the United States currently rests in the hands of individuals that were an instrumental part in the excessive credit inflation of the 2000s. Ben Bernanke was a member of the Board of Governors of the Federal Reserve System and a vocal supporter of Alan Greenspan’s move to keep the Federal Funds target rate around one percent in 2003 and beyond, having joined the Board in 2002. Timothy Geithner became President of the Federal Reserve Bank of New York in 2003. This position has a permanent vote on the Open Market Committee, so that Geithner was in on all votes during this time as was Bernanke. After a short stint as the Chairman of the President’s Council of Economic Advisors in 2005-2006, Bernanke became Chairman of the Board of Governors of the Federal Reserve System in February 2006. Geithner moved from the New York Fed to become Treasury Secretary in January 2009.
These two leaders, arguably the most important leaders in economics and finance in the United States government, have held top positions and been voting members of policy boards during one of the most un-disciplined times in United States history. And, their lack of discipline continues, as is evident by the speech given by Bernanke last Friday at Jackson Hole, Wyoming. The only policy that these two people follow is one of throwing everything they can at a problem and seeing what works.
The problem is that their interest rate efforts in the 2003 to 2005 period led to a housing bubble and stock market bubble which resulted in the collapse of the sub-prime market in 2006 and 2007. Their response to this break-down resulted in the financial disaster of the 2008 to 2009 period when the government threw just about everything it could at the disaster in order to try and avoid worse. We are now in 2010 and the evidence of the lack of discipline is still around us. Consumers are plagued with debt fostering record numbers of foreclosures and personal bankruptcies. Businesses are overwhelmed with debt, not only with high-yield bond debt but also with commercial real estate loans and foreclosures and bankruptcies are also high in this area. State and local governments are piled high with debt and we find that states and cities are cutting back on the most basic of services including the release of fire fighters and police. And, the federal government faces budget deficits that some estimate will result in $15 trillion or more in additional debt over the next ten years.
The United States has lived off of its position as Number One economic and military power for years and this has allowed it to be so profligate. Only China, in my lifetime, really seems as if it might be a potential threat to this position.
This lack of discipline has shown up in one spot, however. Since the United States dollar was floated in August 1971, it has declined by about 40 percent in value. There were three periods within this time frame when this general trend was challenged. First, was during the time that Paul Volcker headed the Fed and caused interest rates to reach post-World War II highs. Second, during the Clinton administration as the federal budget moved into surplus territory. Third, during the financial crises when the world seemed to be falling apart and there was a “flight to strength.”
In my book, history shows that discipline wins over the longer run. The United States is struggling because it lost its self-discipline. The criticism of Germany presented above shows the mentality in the west that is indicative of this undisciplined approach to living in the world today.
Friday, August 27, 2010
Bernanke in the Hole
"Regardless of the risks of deflation, the FOMC
will do all that it can to ensure continuation of the economic recovery."
Ben Bernanke, Chairman of the Board of Governor of the Federal Reserve System at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, August 27, 2010.
Translation: Over the past three years or so, I have led the Federal Reserve in throwing everything it can against the wall to see what would stick. I will continue to do so in the future!
May I quote my post of August 12 (http://seekingalpha.com/article/220224-does-the-fed-even-know-what-it-s-doing-anymore).
"The Federal Reserve has two basic problems right now. First, those running the Fed don’t seem to know what they are doing. Second, they are doing a terrible job explaining this to the world.
Never have I seen such confusion in such an important institution. Never have I seen such inadequate leadership.
We have experienced the end of the Fed’s exit strategy, the effort undertaken by the Fed to reduce the size of the Fed’s balance sheet. The exit strategy was designed to reduce the massive amounts of reserves pumped into the financial system by the Fed so that a period of hyper-inflation would not result. That exit strategy saw the Fed’s balance sheet grow by $331 billion over the twelve-month period the “exit” strategy was in place. Excess reserves held by the banking system rose by 38% during the same time period. (Details here.)"
I see nothing from the current speech to clarify the situation!
will do all that it can to ensure continuation of the economic recovery."
Ben Bernanke, Chairman of the Board of Governor of the Federal Reserve System at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, August 27, 2010.
Translation: Over the past three years or so, I have led the Federal Reserve in throwing everything it can against the wall to see what would stick. I will continue to do so in the future!
May I quote my post of August 12 (http://seekingalpha.com/article/220224-does-the-fed-even-know-what-it-s-doing-anymore).
"The Federal Reserve has two basic problems right now. First, those running the Fed don’t seem to know what they are doing. Second, they are doing a terrible job explaining this to the world.
Never have I seen such confusion in such an important institution. Never have I seen such inadequate leadership.
We have experienced the end of the Fed’s exit strategy, the effort undertaken by the Fed to reduce the size of the Fed’s balance sheet. The exit strategy was designed to reduce the massive amounts of reserves pumped into the financial system by the Fed so that a period of hyper-inflation would not result. That exit strategy saw the Fed’s balance sheet grow by $331 billion over the twelve-month period the “exit” strategy was in place. Excess reserves held by the banking system rose by 38% during the same time period. (Details here.)"
I see nothing from the current speech to clarify the situation!
Thrift Industry News--Down Again
The Office of Thrift Supervision (OTS) released statistics on the state of the thrift industry for the second quarter of 2010 on August 25. The industry is limping along, but the signs of a disappearing industry are all over the report.
The cloud over the whole industry is that the OTS will be merged into the Office of the Comptroller of the Currency (OCC) in the upcoming year. (See my post “So Long to the Savings and Loan Industry”, http://seekingalpha.com/article/214460-so-long-to-the-savings-and-loan-industry.) This, of course, is impacting decisions and affecting performance.
Two major figures stand out.
First, industry assets decreased by 15 percent from the second quarter of 2009 to the second quarter of 2010 to $931 billion from $1.1 trillion. From the second quarter of 2008 to the second quarter of 2009, industry assets fell by 27 percent from $1.51 trillion to $1.1 trillion.
Second, the number of supervised institutions declined from 792 thrifts at the end of the second quarter of 2009 to 753 at the end of the second quarter of 2010, just about a 5 percent decline. Yes, there have been thrift failures, but there has also been the constant drop in the number of thrift institutions in existence due to thrift conversions into commercial banks. This latter trend is expected to accelerate as the merger with the OCC proceeds.
One other interesting structural fact concerning the thrift industry I would like to mention. Of the 753 thrift institutions that exist, 402 of these thrifts are owned by 441 thrift holding company enterprises. These 402 thrifts have assets totaling $714 billion which represents 77 percent of all thrift assets. But, one should also note that these thrift holding companies control approximately $4.1 trillion in United States domiciled consolidated assets.
Note that at the end of the second quarter of 2009, there were 459 thrift holding companies supervised by the OTS and these institutions control $5.5 trillion in U. S. domiciled consolidated assets. The decline from this figure to the second quarter 2010 figure is over 25 percent.
Just in comparison, according to the National Credit Union Association, there are close to 7,500 credit unions in the United States, down about 250 from the same time in 2009. However, assets at these credit unions totaled almost $900 billion at the end of the first quarter of 2010, up just about 5 percent from the end of the same quarter in 2009. Total shares and deposits at credit unions rose by 6.7 percent, year-over-year, to a little over $773 billion. The credit union industry continues to grow and in many areas of the country, Philadelphia for one, major expanded credit unions are becoming a force in the local banking markets.
Overall, in the aggregate data released by the Federal Reserve, deposits at all thrift institutions, including credit unions, rose by 0.5 percent from July 2009 to July 2010. The conclusion one can draw for these numbers is that funds are leaving the OTS regulated thrift institutions to go to commercial banks and credit unions.
It is going to be very interesting to watch the credit union sector over the next several years. The interesting question here is whether or not the larger, expanding credit unions can pick up the consumer funds that are leaving savings and loans, savings banks, and commercial banks. Could the banking industry bifurcate into primarily “business” banks and “consumer” banks?
Given all the other factors that are impacting depository institutions one can safely say that the whole landscape of banking and finance is going to change dramatically over the next five to ten years.
The cloud over the whole industry is that the OTS will be merged into the Office of the Comptroller of the Currency (OCC) in the upcoming year. (See my post “So Long to the Savings and Loan Industry”, http://seekingalpha.com/article/214460-so-long-to-the-savings-and-loan-industry.) This, of course, is impacting decisions and affecting performance.
Two major figures stand out.
First, industry assets decreased by 15 percent from the second quarter of 2009 to the second quarter of 2010 to $931 billion from $1.1 trillion. From the second quarter of 2008 to the second quarter of 2009, industry assets fell by 27 percent from $1.51 trillion to $1.1 trillion.
Second, the number of supervised institutions declined from 792 thrifts at the end of the second quarter of 2009 to 753 at the end of the second quarter of 2010, just about a 5 percent decline. Yes, there have been thrift failures, but there has also been the constant drop in the number of thrift institutions in existence due to thrift conversions into commercial banks. This latter trend is expected to accelerate as the merger with the OCC proceeds.
One other interesting structural fact concerning the thrift industry I would like to mention. Of the 753 thrift institutions that exist, 402 of these thrifts are owned by 441 thrift holding company enterprises. These 402 thrifts have assets totaling $714 billion which represents 77 percent of all thrift assets. But, one should also note that these thrift holding companies control approximately $4.1 trillion in United States domiciled consolidated assets.
Note that at the end of the second quarter of 2009, there were 459 thrift holding companies supervised by the OTS and these institutions control $5.5 trillion in U. S. domiciled consolidated assets. The decline from this figure to the second quarter 2010 figure is over 25 percent.
Just in comparison, according to the National Credit Union Association, there are close to 7,500 credit unions in the United States, down about 250 from the same time in 2009. However, assets at these credit unions totaled almost $900 billion at the end of the first quarter of 2010, up just about 5 percent from the end of the same quarter in 2009. Total shares and deposits at credit unions rose by 6.7 percent, year-over-year, to a little over $773 billion. The credit union industry continues to grow and in many areas of the country, Philadelphia for one, major expanded credit unions are becoming a force in the local banking markets.
Overall, in the aggregate data released by the Federal Reserve, deposits at all thrift institutions, including credit unions, rose by 0.5 percent from July 2009 to July 2010. The conclusion one can draw for these numbers is that funds are leaving the OTS regulated thrift institutions to go to commercial banks and credit unions.
It is going to be very interesting to watch the credit union sector over the next several years. The interesting question here is whether or not the larger, expanding credit unions can pick up the consumer funds that are leaving savings and loans, savings banks, and commercial banks. Could the banking industry bifurcate into primarily “business” banks and “consumer” banks?
Given all the other factors that are impacting depository institutions one can safely say that the whole landscape of banking and finance is going to change dramatically over the next five to ten years.
Thursday, August 26, 2010
The Drag Caused by American Household Debt
Today I would like to reference an article by William Galston on the website of the New Republic (http://www.tnr.com/blog/77215/getting-out-the-recession-stimulus-spending-debt-banks).
Galston’s point is this: the value of assets on the balance sheets of households in the United States has declined relative to the amount of money owed by these same households.
To quote Galston: “As the value of assets used as collateral collapses, so does borrowing. This depresses consumption (because the real net worth of households has declined), and the real economy dips, making it much harder for businesses and households to service the debts incurred during boom times. Household consumption remains sluggish until debt is reduced to a level that can comfortably be serviced out of current income, a process that cannot proceed without an increase in the household savings rate. The larger the debt overhang, the longer it will take to work off the excess.”
The figures Galston quotes: in late 2007, household debt was $12.5 trillion which was 133 percent of disposable income. In the first quarter of 2010, total household debt had declined to $11.7 trillion around 122 percent of disposable income.
The Federal Reserve Bank of San Francisco has suggested, in a May 2009 analysis, that this ratio will need to fall to around 100 percent for households to feel more comfortable and begin to loosen up their pocketbooks a little bit more.
For this ratio to decline to 100 percent, the study argues, it would take up to a decade, even if the household savings rate were to rise to 10 percent. The household savings rate is now a little above 6 percent.
Government stimulus programs are not going to counteract this de-leveraging unless they were to create sufficient new inflation to get the value of assets rising rapidly once again!
It is not surprising that small- and medium-sized businesses are in a similar situation. Many of the smaller businesses in the United States used debt much as households did during the buildup of financial leverage because…they were the same people!
And, small- to medium-sized banks are having solvency problems (http://seekingalpha.com/article/222005-where-is-banking-headed-not-up).
Foreclosures, bankruptcies, and bank failures are a common part of such an environment (http://seekingalpha.com/article/222238-why-52-is-not-a-pretty-number).
Regulators and the courts are trying to work out the difficulties connected with such problems as efficiently and smoothly as possible. Galston is just pointing up the fact that correcting such a situation is not going to be accomplished over night. Even the program Galston suggests as a way out of this malaise, a “national infrastructure bank”, would not shorten the time span needed to once again achieve a robust economy with substantially lower unemployment.
Galston’s point is this: the value of assets on the balance sheets of households in the United States has declined relative to the amount of money owed by these same households.
To quote Galston: “As the value of assets used as collateral collapses, so does borrowing. This depresses consumption (because the real net worth of households has declined), and the real economy dips, making it much harder for businesses and households to service the debts incurred during boom times. Household consumption remains sluggish until debt is reduced to a level that can comfortably be serviced out of current income, a process that cannot proceed without an increase in the household savings rate. The larger the debt overhang, the longer it will take to work off the excess.”
The figures Galston quotes: in late 2007, household debt was $12.5 trillion which was 133 percent of disposable income. In the first quarter of 2010, total household debt had declined to $11.7 trillion around 122 percent of disposable income.
The Federal Reserve Bank of San Francisco has suggested, in a May 2009 analysis, that this ratio will need to fall to around 100 percent for households to feel more comfortable and begin to loosen up their pocketbooks a little bit more.
For this ratio to decline to 100 percent, the study argues, it would take up to a decade, even if the household savings rate were to rise to 10 percent. The household savings rate is now a little above 6 percent.
Government stimulus programs are not going to counteract this de-leveraging unless they were to create sufficient new inflation to get the value of assets rising rapidly once again!
It is not surprising that small- and medium-sized businesses are in a similar situation. Many of the smaller businesses in the United States used debt much as households did during the buildup of financial leverage because…they were the same people!
And, small- to medium-sized banks are having solvency problems (http://seekingalpha.com/article/222005-where-is-banking-headed-not-up).
Foreclosures, bankruptcies, and bank failures are a common part of such an environment (http://seekingalpha.com/article/222238-why-52-is-not-a-pretty-number).
Regulators and the courts are trying to work out the difficulties connected with such problems as efficiently and smoothly as possible. Galston is just pointing up the fact that correcting such a situation is not going to be accomplished over night. Even the program Galston suggests as a way out of this malaise, a “national infrastructure bank”, would not shorten the time span needed to once again achieve a robust economy with substantially lower unemployment.
Wednesday, August 25, 2010
52 is Not a Pretty Number!
Reading an article in the Wall Street Journal this morning I was hit twice by the number 52. (For those that are looking for signs it can be noted that you can reverse today’s date and get 52 as well!)
The first sighting, Robert Taubman, chief executive of Taubman Centers, Inc. decided earlier this year to stop covering interest payments on it $135 million mortgage on the Pier Shops at Caesars in Atlantic City, N. J. “Taubman, which estimates the mall is now worth only $52 million, gave it back to its mortgage holder. (See http://professional.wsj.com/article/SB10001424052748703447004575449803607666216.html?mod=wsjproe_hps_TopMiddleNews.)
The second sighting: “Of the $1.4 trillion of commercial-real-estate debt coming due by the end of 2014, roughly 52% is attached to properties that are underwater, according to debt-analysis company Trepp LLC.”
The question raised in this article: is it a smart economic decision for commercial real estate firms to just stop making mortgage payments on properties whose values have fallen FAR BELOW the mortgage amounts?
This discussion parallels the discussions that took place many months ago about whether or not it was a smart economic decision for homeowners to just walk away from mortgages on properties whose values have fallen FAR BELOW the mortgage amounts.
The burning issue is between morality and economic incentives. And, what does the economist say about this? Well, everyone has a price. One of the rules I frequently hear is “Don’t say that you wouldn’t sell out for a particular price until you have actually been faced with the decision in real life and actually decided that you wouldn’t sell out for that price.” It’s easy NOT to walk away from a property if you have never been faced with the temptation!
This situation raises concerns relating to two major interpretations of the current economic situation.
First, debates are raging about whether or not we are in a deflationary period. For the last nine months the Consumer Price Index has shown a positive year-over-year rate of increase reaching about 3.0% during this time. For July the year-over-year growth rate was 1.3%.
Yet, the value of real properties seems to be going down and down.
But, isn’t this the same problem that existed in the early 2000s only on the other side of the coin? Then the Consumer Price Index was showing very little inflation, yet the value of real properties was increasing in the 10% to 15% range.
The problem was that the Consumer Price Index measured the price of “flow” goods and services and not the value of the “stock”, the value of the asset. Rent is what is measured in the Consumer Price Index and this is an “imputed” figure. Much concern was raised at the time about the validity of the estimates for rental prices used in the index. Perhaps the same issue should be raised now.
Second, this brings up the issue about whether or not we are in a period of debt deflation. This is the other side of the problem of the early 2000s when we had a credit inflation. In a period of credit inflation the problem is that there is too much credit chasing too few goods and services around. The credit keeps “the music playing” and as long as the music is playing, according to Chuck Prince, Chairman and CEO of Citigroup at the time, you have to keep dancing. A credit inflation is cumulative.
The problem with a debt deflation is that there is too much debt around. When there is too much debt around people have to de-leverage. And, de-leveraging takes a long time and is very, very painful.
One remedy to a debt deflation is for the government to re-flate the economy. This is what many economists, politicians, and pundits would like to see happen. If the government can cause prices to rise again the real value of the debt will go down and guess what? The music starts playing again.
The problem with this solution is that there are historical periods when the amount of debt outstanding becomes unsustainable. People have to accept the fact that “credit bubble” they lived in for so long, no longer exists. And, when this happens, people have to get their balance sheets back in order and live more practically within their means. In times like these, governments and others find it more and more difficult to push them back into profligate habits of spend, spend, spend.
The realization of this hit Europe earlier this year and the pain is evident.
Yet the fundamentalist ministers of “inflationary finance” like Paul Krugman, like many fundamentalist ministers when they are not being listened to, cry out that those who do not respond to their teachings are just members of a cult. These people that oppose them have been misled to a false teaching and are heretics.
The United States (and Europe and some other areas in the world) has a debt problem. And, a great deal of this debt is connected with real estate. And, a great deal of this debt rests on the balance sheets of depository institutions. (See my “Where is Banking Headed? Not up! http://seekingalpha.com/article/222005-where-is-banking-headed-not-up.)
What does a financial institution do when it is holding a mortgage for $135 million and the underlying property is given to them and the value of this underlying property is only $52 million? What does the banking system do knowing that 52% of the $1.4 trillion in commercial real estate debt coming due by the end of 2014 is underwater, and, by all we know, a lot of it is substantially underwater? What does the Federal Reserve and the FDIC and the Treasury Department do when they know that a very large number of the depository institutions in the United States have assets on their balance sheets that are substantially underwater?
This is what happens in a debt deflation. The economy, in a sense, implodes. But, it takes time for everything to happen because it is cumulative. First, there is the panic phase which we have gone through. Now, we are in the un-winding phase because a large number of people know what is happening, they are not surprised anymore, and are trying to work out the problems as smoothly as they can.
The best evidence I can give to support the idea that this implosion is happening is what I presented in the post cited above: on December 31, 2002 there were more than 7,888 commercial banks in the United States. As of March 31, 2010 there were only 6,772 commercial banks. In the next three to five years, many analysts expect this number to drop to 4,000 or so. Note that if the number of banks fell to 4,102 banks, this would be 52% of the number of banks that existed at the end of 2002.
The first sighting, Robert Taubman, chief executive of Taubman Centers, Inc. decided earlier this year to stop covering interest payments on it $135 million mortgage on the Pier Shops at Caesars in Atlantic City, N. J. “Taubman, which estimates the mall is now worth only $52 million, gave it back to its mortgage holder. (See http://professional.wsj.com/article/SB10001424052748703447004575449803607666216.html?mod=wsjproe_hps_TopMiddleNews.)
The second sighting: “Of the $1.4 trillion of commercial-real-estate debt coming due by the end of 2014, roughly 52% is attached to properties that are underwater, according to debt-analysis company Trepp LLC.”
The question raised in this article: is it a smart economic decision for commercial real estate firms to just stop making mortgage payments on properties whose values have fallen FAR BELOW the mortgage amounts?
This discussion parallels the discussions that took place many months ago about whether or not it was a smart economic decision for homeowners to just walk away from mortgages on properties whose values have fallen FAR BELOW the mortgage amounts.
The burning issue is between morality and economic incentives. And, what does the economist say about this? Well, everyone has a price. One of the rules I frequently hear is “Don’t say that you wouldn’t sell out for a particular price until you have actually been faced with the decision in real life and actually decided that you wouldn’t sell out for that price.” It’s easy NOT to walk away from a property if you have never been faced with the temptation!
This situation raises concerns relating to two major interpretations of the current economic situation.
First, debates are raging about whether or not we are in a deflationary period. For the last nine months the Consumer Price Index has shown a positive year-over-year rate of increase reaching about 3.0% during this time. For July the year-over-year growth rate was 1.3%.
Yet, the value of real properties seems to be going down and down.
But, isn’t this the same problem that existed in the early 2000s only on the other side of the coin? Then the Consumer Price Index was showing very little inflation, yet the value of real properties was increasing in the 10% to 15% range.
The problem was that the Consumer Price Index measured the price of “flow” goods and services and not the value of the “stock”, the value of the asset. Rent is what is measured in the Consumer Price Index and this is an “imputed” figure. Much concern was raised at the time about the validity of the estimates for rental prices used in the index. Perhaps the same issue should be raised now.
Second, this brings up the issue about whether or not we are in a period of debt deflation. This is the other side of the problem of the early 2000s when we had a credit inflation. In a period of credit inflation the problem is that there is too much credit chasing too few goods and services around. The credit keeps “the music playing” and as long as the music is playing, according to Chuck Prince, Chairman and CEO of Citigroup at the time, you have to keep dancing. A credit inflation is cumulative.
The problem with a debt deflation is that there is too much debt around. When there is too much debt around people have to de-leverage. And, de-leveraging takes a long time and is very, very painful.
One remedy to a debt deflation is for the government to re-flate the economy. This is what many economists, politicians, and pundits would like to see happen. If the government can cause prices to rise again the real value of the debt will go down and guess what? The music starts playing again.
The problem with this solution is that there are historical periods when the amount of debt outstanding becomes unsustainable. People have to accept the fact that “credit bubble” they lived in for so long, no longer exists. And, when this happens, people have to get their balance sheets back in order and live more practically within their means. In times like these, governments and others find it more and more difficult to push them back into profligate habits of spend, spend, spend.
The realization of this hit Europe earlier this year and the pain is evident.
Yet the fundamentalist ministers of “inflationary finance” like Paul Krugman, like many fundamentalist ministers when they are not being listened to, cry out that those who do not respond to their teachings are just members of a cult. These people that oppose them have been misled to a false teaching and are heretics.
The United States (and Europe and some other areas in the world) has a debt problem. And, a great deal of this debt is connected with real estate. And, a great deal of this debt rests on the balance sheets of depository institutions. (See my “Where is Banking Headed? Not up! http://seekingalpha.com/article/222005-where-is-banking-headed-not-up.)
What does a financial institution do when it is holding a mortgage for $135 million and the underlying property is given to them and the value of this underlying property is only $52 million? What does the banking system do knowing that 52% of the $1.4 trillion in commercial real estate debt coming due by the end of 2014 is underwater, and, by all we know, a lot of it is substantially underwater? What does the Federal Reserve and the FDIC and the Treasury Department do when they know that a very large number of the depository institutions in the United States have assets on their balance sheets that are substantially underwater?
This is what happens in a debt deflation. The economy, in a sense, implodes. But, it takes time for everything to happen because it is cumulative. First, there is the panic phase which we have gone through. Now, we are in the un-winding phase because a large number of people know what is happening, they are not surprised anymore, and are trying to work out the problems as smoothly as they can.
The best evidence I can give to support the idea that this implosion is happening is what I presented in the post cited above: on December 31, 2002 there were more than 7,888 commercial banks in the United States. As of March 31, 2010 there were only 6,772 commercial banks. In the next three to five years, many analysts expect this number to drop to 4,000 or so. Note that if the number of banks fell to 4,102 banks, this would be 52% of the number of banks that existed at the end of 2002.
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