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EXTEND & PRETEND: An Accounting Driven Recovery
SHOCK & AWEBeginning in October 2007, the world survived a Financial Crisis like no other in modern times. It was the first truly Global Financial Crisis ever experienced. This crisis brought to light a vast array of financial instruments (CDO’s, CDS’s, CLO’s, etc.) being offered by murky financial entities (SIV’s, VIE’s, SPE’s, QSPE’s etc.) that were completely unregulated, often offshore, always off balance sheet and never traded through any regulated exchange. Sovereign governments do not regulate nor adequately understand them. Minimally, this is a recipe for fraud. But definitely, it has been a modern day financial “wild west” for the innovative and aggressive!
LEND: To pull the US and Global economies out of the abyss of the Financial Crisis the authorities have been forced to accept the implementation in the US of ZIRP (Zero Interest Rate Policy). A policy that has resulted in a Fed Funds LENDING Rates of 0.25% but 30 to 90 day Treasury Bills offered at absurd 3 – 7 basis points. With a +3.5% inflation rate we have an unheard of -3.25% [0.25 – 3.50] Real Rate. The tax payer is effectively paying the banks to borrow money!
BEND: Since the banks aren’t willing to pour this money back into the US Economy and specifically into US expansion and consumer credit, the Federal Reserve has additionally implemented the central bankers “Nuclear Option” called QE (Quantitative Easing). As such the Fed has purchased $1.4T in Agency Debt and Mortgaged Backed Securities (MBS) & $300B in US Treasuries. This has contributed to effectively disconnecting the US Debt market yields from any source of reality.
If this is not enough, we have implemented the greatest experiment in Monetary Policy in the history of the capitalist system with the implementation of: 1) TARP, 2) TALF 3) PDCF 4) TAF 5) TDWP 6) TSLF 7) CPFF 8) MMIF 9) AMLF and 10) Massive foreign currency SWAPS. All of these initiatives were aimed at BENDING a failed system back into operation through Government Guarantees that ‘temporarily’ removed inherent risk. It is to be seen just how temporary these programs will become. Remember, Income tax was originally implemented to solve a temporary funding crisis! These initiatives intentionally improve banking profits by an extraordinary degree and the banks will no doubt lobby to ensure some measure of the initiatives remain.
SPEND: Further to the above Monetary Initiatives, we have implemented Fiscal SPENDING Policies based on the 1930’s Keynesian Economic doctrine of Deficit Stimulus Spending as a framework in which to restore economic growth. This has resulted in a 2009 deficit of $1.4 Trillion and a 2010 deficit expected to be closer to $1.8 Trillion. This will give the US a national debt of $14 Trillion, which will be larger than 12% of GDP, not including Federal Unfunded Liabilities of $62.5 Trillion (according to the official government estimates).
The G-20 in total have now authorized 2.2 Trillion in stimulus programs to restore growth. The Global economies together have Lent, Spent or Bent $27 Trillion in financial assets. Meanwhile, despite this, total US worker unemployment continues to rise.
EXTEND & PRETEND: An Artificial, Manipulated Recovery
All of the US $11 Trillion “Lend, Bend & Spend” Initiatives, on the US $12 Trillion economy, could at best be described as “Triage” actions to stop the immediate hemorrhaging & stabilize the Financial System. The next stage has focused on the effective “Recovery”. Despite the $787 Billion “American Recovery & Reinvestment Act”, ‘we have not achieved a real recovery. We have achieved an artificial perception of a recovery through policies that simply ‘kick the can down the road’! It is our view that since March 2009 we have witnessed an ‘Accounting Recovery’ driven by the implementation of the modern Behavioral Economics theory of MOPE (Management of Perspective Economics). The prime objective has been the recapitalization of the banks through asset appreciation and capital raising versus the unpopular nationalization alternative debated at the onset of the financial crisis. Currently, with an elevated stock market, the Fed has been very clear to the banks that NOW is the time to increase capital. Consequentially in recent secondary offerings, Citigroup has raised $21.1B, Bank of America $12.2B and Wells Fargo $12.2B.
AN “ACCOUNTING” DRIVEN RECOVERY In March 2009 the market bottomed and suddenly began a dramatic recovery. This occurred immediately after the reversal of FASB 157 in March 2009. Congress placed such pressures, including potential legislative measures, that it forced the Accounting Standards Boards to reverse the Level 1 Capital Ratio standards regarding the treatment of “Mark-to-Market” of the massive ‘toxic’ assets on the books of the banks. This change took insolvent banks and obscured problems by making them completely non-transparent to any analysis. The government’s ‘stress tests’ and underlying economic assumptions, were subsequently never made public. As Commercial Real Estate values plummeted and now approach 45 – 60% declines, the government in July changed the accounting regulations so banks and financial institutions would not have to reflect their true market value. This problem is so huge it makes the Sub-Prime Crisis look like child’s play but has been ‘removed’ through accounting treatment. This treatment would have been called ‘fraud’ before the changes and was a felony that involved prison time. This obscuring of the facts does not take away from the reality that there is a $2.7 Trillion iceberg floating ‘dead ahead’! As the Housing foreclosures mounted the government additionally changed the accounting, in this case on how non-performing mortgages could be treated. As an example, many of the 8 Million homeowners who have completely stopped paying their mortgages are presently being left alone so that their mortgage loans can be accounted for at the original loan-value book value by the banks and other financial institutions. In December the FDIC further allowed the banks to defer FASB 166 /167 – even more accounting games! What else is going on that we are not privy too? We hear in the AIG Congressional testimony some financial matters are to be considered to be of “national security”. What about investor security?
MARCH 2009 FASB 157 04-02-09 - Summary - FASB Pre-Codification Standards 04-02-09 - FASB approves more mark-to-market flexibility - MarketWatch
03-18-09 - UPDATE 2-FASB issues proposals on mark-to-market guidance s. Reuters 04-03-09 - FASB Eases Mark-to-Market Rules - WSJ.com 04-14-09 - FASB Looks to Expand Mark Rules - WSJ.com
OCTOBER 2009 BANK REGULATORS: PRUDENT COMMERCIAL REAL ESTATE LOAN WORKOUTS POLICY 10-31-09 - Policy Statement on Prudent Commercial Real Estate Loan Workouts 10-31-09 - Bank regulators extend and pretend 10-31-09 - Banks Get New Rules on Property WSJ
NOVEMBER 2009 BANK REGULATORS: THREE ‘CAULDRONS’ EASING 11-14-09 - Bankers hold houses, manipulate market Pittsburgh PG 11-11-09 - Housing- 'Shadow Inventory' Dwarfs Loan Modifications CNBC 10-28-09 - Strategic Non-Foreclosure 09-23-09 - Delayed Foreclosures Stalk Market WSJ
01-15-10 - Big Banks Accused of Short Sale Fraud CNBC
DECEMBER 2009 FASB Financial Accounting Statements: Standards Issued in January 2010 Nos. 166 (Transfers of Financial Assets) Nos. 167 (Amendments to FASB Interpretation of No. 46(R))
12-15-09 FDIC Approves Giving Banks Reprieve from Capital Requirements
JANUARY 2010 SYSTEM WIDE FEDERAL BANK EXAMINER REINFORCEMENT TRAINING: “to underscore expectations” 01-27-10 - FRB: Testimony--Greenlee, Commercial Real Estate--January 27, 2010
WHAT THESE ACTIONS ATTEMPT TO OBSCURE
WHAT THIS MEANS: A ‘Back-of-the Envelope’ Analysis & Some Common Sense.
HOME MORTGAGES
The banks have in addition to not yet accounting for Mortgage values in a realistic manner, have not prepared for the next major wave in mortgage resets & defaults!
The Case-Shiller 20 City Composite indicates a -7.3% drop in national prices (1).
Robert Shiller, co-founder of the composite, has indicated he would not be surprised to see another 5% to 10% drop in the spring (2).
Is it any wonder he has this “suspicion” when you consider the chart to the right?
THE REALITY: - 7.3% Composite 20 city Drop (1) & about to get much worse!
BANK ACCOUNTING: - 1.5% Drop in Home Mortgage Asset Values
From a recent report from Deutsche Bank's Bill Prophet, entitled "Alternative Universe" (5)
COMMERCIAL REAL ESTATE
Does the chart to the right look like a 1% drop in Commercial Real Estate Values to you?
THE REALITY: - 40% + Drop in CRE Asset Values (3)
BANK ACCOUNTING: - 1% Drop in CRE Asset Value Holdings
From a recent report from Deutsche Bank's Bill Prophet, entitled "Alternative Universe," (5)
HOME EQUITY LOANS
Home Equity Loans dominated loan growth for years. Do we really believe people are defaulting on their mortgages, going into foreclosure and yet paying their Home Equity Loan?
Solid numbers that isolate the real levels versus bank reporting are difficult to find.
Is it any wonder?
Do we really believe it is only the presently reported -4.3% rate, ever mind the insignificant 1.2% the banks haven taken from an accounting stand point?
THE REALITY: - 4.3 + Rate as of Q3 2009 and getting worse (4)
BANK ACCOUNTING: - 1.2% Drop in Home Equity Loan Values
From a recent report from Deutsche Bank's Bill Prophet, entitled "Alternative Universe" (5)
RESULTS
1- Mortgage Rates have started rising, 2- Prime Lenders are now defaulting, 3- The bulk of Option ARMS are now coming due,
SCENARIO I If we only double what the banks have already taken (which is insignificant compared to actual market values) we have additional write downs of:
Home Mortgages: 1.5% X 2.25T $34 B Commercial RE: 1.0% X 1.65T $17 B HELCO 1.2% X 0.76T $ 9 B === $ 60 B
SCENARIO II A slightly more realistic, yet conservative exposure is:
Home Mortgages: 6.0% X 2.25T $135 B Commercial RE: 25% X 1.65T $413 B HELCO 4.0% X .76T $ 30 B === $456 B
The above does not include the approximately $500B of troubled Off Balance Sheet Assets that Barclay Bank suggests are not accounted for due to the deferral of FASB 166 / 167 granted by the FDIC. (6)
For anyone buying Banking stocks or LONG the market ... Caveat Emptor!
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SOURCES:
(1) 12-29-09 - S&P/Case-Shiller Home Price Indices (2) 01-05-10 - Get ready for another housing downturn? Boston Globe (3) 10-19-09 - Moody's- US Commercial Property Prices Down 40% from Peak (4) 01-15-10 - What If Everyone Stops Paying Their Mortgage? (5) 01-15-10 - Here's Why The Financial System Isn't Out Of The Woods, And Still Has A Ton Of Deleveraging To Do The Business Insider January 15, 2010 (6) 01-16-10 – King World News Broadcast – Bill Laggner (7) 12-15-09 - FDIC Approves Giving Banks Reprieve from Capital Requirements (8) 01-27-10 - FRB: Testimony--Greenlee, Commercial Real Estate--January 27, 2010
The last Extend & Pretend article: EXTEND & PRETEND - An Accounting Driven Market Recovery
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Gordon T Long
Mr. Long is a former senior group executive with IBM & Motorola, a principle in a high tech public start-up and founder of a private venture capital fund. He is presently involved in private equity placements internationally along with proprietary trading involving the development & application of Chaos Theory and Mandelbrot Generator algorithms.
Gordon T Long is not a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible sources. Of course, he recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, you are encouraged to confirm the facts on your own before making important investment commitments.
© Copyright 2010 Gordon T Long. The information herein was obtained from sources which Mr. Long believes reliable, but he does not guarantee its accuracy. None of the information, advertisements, website links, or any opinions expressed constitutes a solicitation of the purchase or sale of any securities or commodities. Please note that Mr. Long may already have invested or may from time to time invest in securities that are recommended or otherwise covered on this website. Mr. Long does not intend to disclose the extent of any current holdings or future transactions with respect to any particular security. You should consider this possibility before investing in any security based upon statements and information contained in any report, post, comment or recommendation you receive from him.
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Gordon T Long is not a registered
advisor and does not give investment advice. His comments are an expression of
opinion only and should not be construed in any manner whatsoever as
recommendations to buy or sell a stock, option, future, bond, commodity or any
other financial instrument at any time. While he believes his statements to be
true, they always depend on the reliability of his own credible sources. Of
course, we recommend that you consult with a qualified investment advisor, one
licensed by appropriate regulatory agencies in your legal jurisdiction, before
making any investment decisions, and barring that, we encourage you confirm
the facts on your own before making important investment commitments.
Copyright and Disclaimer
© Copyright 2010,
Gordon T Long. The information herein was
obtained from sources which the Gordon T Long. believes reliable, but we do
not guarantee its accuracy. None of the information, advertisements,
website links, or any opinions expressed constitutes a solicitation of
the purchase or sale of any securities or commodities. Please note that
the Gordon T Long. or its principals may already have invested or may from
time to time invest in securities that are recommended or otherwise
covered on this website. Gordon T Long does not
intend to disclose the extent of any current holdings or future
transactions with respect to any particular security. You should
consider this possibility before investing in any security based upon
statements and information contained in any report, post, comment or
recommendation you receive from us.
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