Earthside Comments: Here's your dose of economic reality for today.
The first two articles are good explanations of what is happening to 'American' banks. The third article shows how you, the average taxpayer, is going to help subsidize Bank of America's acquisition of Countrywide (if it actually goes through). Finally a report on what retailers are planning for in 2008 -- contraction in the face of consumer inability to go even further in debt to buy, buy, buy.
All the signs point to very difficult economic times ahead.
Link: American Banks Set for Further Big Write-Downs | Independent
Two of Wall Street's biggest banks are preparing to write off tens of billions of dollars of investments in the US mortgage market, and to replace the capital with an $18bn cash infusion from emerging market investors.
The "clean slate" strategy being pursued by Merrill Lynch and Citigroup is aimed at drawing a line under the six-month-old credit crisis, and in so doing it will dramatically reshape the ownership of the American financial industry.
Both banks are due to report their 2007 financial results this week and their advisers were scurrying over the weekend to finalise a rescue refinancing that will hand substantial equity stakes to the governments of China, Kuwait and other emerging markets, as well as to other wealthy private investors.
The pair have been among the worst hit by the financial crisis, which has been snowballing since last summer, but new chief executives at each are determined to start 2008 with as close to a clean sheet as possible.
Merrill Lynch, where the former head of the New York Stock Exchange, John Thain, was installed in November, is expected on Thursday to write down the value of its mortgage market investments by up to a further $15bn (£7.7bn) – on top of the $7.9bn write-down it took at the end of the third quarter.
Citigroup's new chief executive, Vikram Pandit, who was promoted last month after the ousting of Chuck Prince, is expected to write down its mortgage-related assets by up to $15bn too.
It is common practice for incoming executives to "kitchen sink" their early financial results, taking as large a loss as possible in order to establish a clean slate from which to grow in the future. However, this strategy is complicated in the banking industry, where companies must maintain a sufficient capital base to allow them to continue to grow their lending operations. Neither Merrill nor Citigroup could easily afford to write down billions of dollars without replacing much of that money, and it is for this reason that both are this week expected to accompany their financial results with news of substantial cash infusions from new investors.
Jeff Harte, finance industry analyst at Sandler O'Neill, said different banks have written off different percentages of their investments in sub-prime mortgages and derivatives such as collateralised debt obligations (CDOs).
Merrill will need additional funds if it decides it wants to write off as much as $15bn, Mr Harte calculates. "Estimating CDO/sub-prime write-downs is quite subjective given the range of marks we have seen from peers. Our current estimate of $10bn represents an estimated mark-down to $0.40 on the dollar from Merrill's starting exposure levels. While this mark-down is arguably quite aggressive, certain peers have been even more aggressive in putting these issues behind them. For example, we estimate that Morgan Stanley marked its exposure in the range of $0.25 on the dollar. We continue to believe that more aggressive loss assumptions than we are modelling would likely necessitate a capital raise."
Rumours swirling around Wall Street in recent days suggest that Merrill Lynch is planning to do just such a capital raising, attracting $3bn to $4bn from a Middle Eastern government investment vehicle – one of the so-called "sovereign wealth funds" swollen in recent years by oil revenues. Mr Thain has already sold a $5bn stake, ultimately worth 5 to 10 per cent of the company, to Temasek, an arm of the Singapore government.
Citigroup is understood to be putting the finishing touches to an even more ambitious recapitalisation plan. The Kuwaiti government and its largest existing shareholder, the Saudi prince Alwaleed bin Talal, are among those said to be ready to invest in a $14bn rescue refinancing. The biggest single new investor is likely to be the Chinese government, which has used the financial crisis to snap up large chunks of the US finance industry. Most recently it paid $5bn for a stake in Morgan Stanley, and is also putting $1bn into Bear Stearns.
Sovereign wealth fund investments have so far been broadly welcomed by US politicians, who are more concerned about averting a financial crisis, but the scale of the investments due to be announced in the coming days could reopen a debate about the long-term wisdom of giving foreign governments significant financial leverage over the US financial system.
Link: Banking on Thin Ice | Kenneth Couesbouc/CounterPunch.org
The banking system has two historic functions. The first is to make the circulation of money easier, safer and faster, by allowing depositors to pay by cheque, bank card, etc. The second is to create account money, by granting credit. The two functions are distinct, but both concern the payment of value and cannot avoid interacting.
Accounts are kept of all deposits. Small and large sums are credited and debited, moving among different accounts in the same bank or between banks. Once a day, all these movements are added up by a clearing-house, and each bank is given the state of its balance. (As the larger banks are doing business 24/24, 7/7, all around the world, the daily clearing process has lost its precision. On the other hand, computer technology makes it possible for banks to appraise their balances constantly.) For some banks, the sums credited are larger than the sums debited. For the others, the situation is reversed. Some banks have a surplus of money on their accounts. The others are in the red and must settle that debt before they can begin a new day's business. Usually, the banks with the surplus lend it to the banks in the red.
The other function of banks is to grant credit to depositors. To do this they increase the value of deposits with virtual money. This is possible because only a small fraction of the total deposits actually moves around at the end of the day. As most of the value deposited never leaves the bank, it can be increased at will. However, as a security, banks are obliged to own collateral, such as gold, currency, bonds, stocks, real estate, etc. The value of which must be superior to a certain minimum fraction of the credit granted (currently 8%).
The interest paid on the credit granted by banks is their principal source of income. Wishing to maximise their incomes, banks face a double dilemma. Increasing the amount of credit granted means increasing the value of their collateral. But collateral is ever a fluctuating value. Stocks and real estate are particularly volatile. Their values frequently swell rapidly and deflate suddenly. And the more stable forms (gold and currency) pay neither rent nor dividends. The fluctuation of value on the market means that collateral can gain or loose value as of itself. So the problem banks face is the choice of collateral and the temptation to follow the rising market value of their collateral, by a corresponding rise in the amount of credit they grant.
The market values of the different forms of collateral rise and fall independently, each following its own particular cycle. But, every now and then, they move together in the same direction. At present, three forms of bank collateral, stocks, bonds and real estate, are valued at historic highs. The corresponding amounts of credit granted depend on these high values being maintained. It seems, however, that the three values mentioned above have peaked simultaneously. And that the desperate efforts at keeping them all up there together are doomed.
The weakest link is the rate of interest. It varies inversely to the market value of bonds. When interest rates rise, the value of bonds must drop accordingly (1). And, with inflation looming in the wake of mounting commodity prices, this two way movement seems inevitable in a very near future. And rising rates of interest will have a less immediate effect on the housing market and the value of real estate. They will also hit the stock market and credit in general, when the falling value of collateral reduces the amount of credit that can be granted (some have already called for a lowering of the necessary minimum fraction). A reduced supply that will put up the "price" of credit, cumulating with the increases due to inflation.
Rising prices and the interruption of cheap borrowing are the ordinary consequences of every credit bubble. But the cyclical coincidence of three forms of collateral, in their rise, peak and forthcoming slump, is a rare occurrence. It has facilitated an unprecedented swelling. But it also means that there are no secure forms of collateral to fall back on. As, apart from the three, currency is an obvious target for inflation. And gold is almost exclusively held by central banks and, anyway, there is nowhere nearly enough of it around.
The most likely scenario is stagnation accompanying inflation. Probably (inevitably?) for several years, as the gigantic paper structure of sub-prime junk that has filled so many balloons with hot air will not be absorbed painlessly overnight. This time the collapse will not be limited to Argentina, or the Asian "Dragons". This time it concerns the whole Developed World. A financial turmoil of such magnitude that holding it off till after the November elections seems an impossible task. And yet, the presidential candidates have not voiced an inkling of what is brewing. No one seems to realise how thin the ice is. So how will they react when it all begins to crack?
1. A bond labelled $100 pays $5 a year interest, that is 5%. If the rate of interest rises to 10%, then the $5 paid by the bond is 10% of only $50. The market value of the bond has been halved.
Link: Taxpayers to Help Foot Bank of America's $4.1 Billion Countrywide Bill | Fortune/CNN
Guess who's helping Bank of America pay for its $4.1 billion purchase of Countrywide Financial? Answer: The taxpayers of the United States.
That's because Bank of America, which is solidly profitable, will be able to use some of Countrywide's losses to offset its own taxable income. The tax break could total about half a billion dollars over the first five years, according to an estimate by tax guru Robert Willens, who left Lehman Brothers Friday after a 20-year run and will be in business as Robert Willens LLC starting next week. The losses could be worth considerably more to Bank of America starting in the sixth year, depending on how big Countrywide's losses are when Bank of America formally acquires it.
At this point, of course, no one knows how much in losses Countrywide has run up since the junk mortgage market began souring and defaults accelerated. Countrywide itself probably doesn't know. But it seems almost certain to ultimately be in the billions. ...
... So over the first five years, Bank of America can use a total of $1.35 billion of Countrywide's losses to shelter its income. (That's five years of $270 million annual losses.) If Countrywide's embedded losses when Bank of America buys it exceed $1.35 billion, Willens says, the bank will be able to deduct the rest of the losses, without limit, starting in the sixth year.
Isn't life fun?
Link: Retailers Seen Closing Stores, Paring Growth | Reuters/Yahoo! News
U.S. retailers will close stores and reduce square-footage growth plans this year to offset slowing sales, slumping stock prices, a saturated market and a penny conscious shopper, analysts said on Sunday.
"We've seen about 25,000 new stores open in our universe -- publicly traded specialty retailers -- between 2000 and 2007," said Brian Tunick, a J.P. Morgan analyst who covers specialty retailers, speaking at the National Retail Federation's annual conference.
"There's a lot of (retailers) out there that are over-stored right now," he said.
Interesting post.
To me it seems like all the cities that had hyper-appreciation of real estate values from 2000 through 2005 are now really taking some major value declines.
Here in San Diego, I subscribe to: http://www.brokerforyou.com/brokerforyou This San Diego real estate publishes a real tell-it-like-it-is blog. His 12-31-07 post Real Estate Market Predictions for San Diego in 2008 is a realistic idea about what this year will hold for not only San Diego, but, all the cities that had hyper-inflation.
Jannet
http://www.lasik-surgery-san-diego.info
Posted by: San Diego lasik doctor | Friday, January 18, 2008 at 06:15 PM