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Archive for November, 2008

Via TheBigPicture:

mega-bear-quartet-large

Time should be kept in perspective; we can argue that we are 1 year into this bear market, with the fate of the big 3 unresolved, 4 banks (B of A, JP Morgan, Goldman Sachs & Morgan Stanley) left without a government back stop like Citi received, and unemployment still relatively low in comparison to the economic crises in the chart above, at 6.5%.

So when everyone starts talking about a bottom, think about how long it took to manufacture bottoms in the past, and then think about the relative severity of each recession.

My mental calculator tells me 1-1.5 more years of recession, followed by 2.5-3 years of recovery until the next expansion.

When you have low expectations, its a nice surprise if/when they are exceeded.

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From TheBigPicture:

If we add in the Citi bailout, the total cost now exceeds $4.6165 trillion dollars. People have a hard time conceptualizing very large numbers, so let’s give this some context. The current Credit Crisis bailout is now the largest outlay In American history.

Jim Bianco of Bianco Research crunched the inflation adjusted numbers. The bailout has cost more than all of these big budget government expenditures – combined:

Marshall Plan: Cost: $12.7 billion, Inflation Adjusted Cost: $115.3 billion
Louisiana Purchase: Cost: $15 million, Inflation Adjusted Cost: $217 billion
Race to the Moon: Cost: $36.4 billion, Inflation Adjusted Cost: $237 billion
S&L Crisis: Cost: $153 billion, Inflation Adjusted Cost: $256 billion
Korean War: Cost: $54 billion, Inflation Adjusted Cost: $454 billion
The New Deal: Cost: $32 billion (Est), Inflation Adjusted Cost: $500 billion (Est)
Invasion of Iraq: Cost: $551b, Inflation Adjusted Cost: $597 billion
Vietnam War: Cost: $111 billion, Inflation Adjusted Cost: $698 billion
NASA: Cost: $416.7 billion, Inflation Adjusted Cost: $851.2 billion

TOTAL: $3.92 trillion

That is $686 billion less than the cost of the credit crisis thus far.

The only single American event in history that even comes close to matching the cost of the credit crisis is World War II: Original Cost: $288 billion, Inflation Adjusted Cost: $3.6 trillion

The always reliable Barry Ritholz…I wish he were wrong sometimes. So the bailout, as a percentage of our GDP is now (4.6165/14.000) or 32.975% of our pre-recession GDP; I’m assuming it hasn’t been reduced by the credit crisis, falling house prices, and wealth evaporation.

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First, here’s a little history about the Glass-Steagall act, courtesy of PBS‘s Frontline:

Following the Great Crash of 1929, one of every five banks in America failed. In 1933, Senator Carter Glass (D-Va.) and Congressman Henry Steagall (D-Ala.) introduced historic legislation which sought to limit the conflicts of interest created when commercial banks are permitted to underwrite stocks or bonds.

The new law banned commercial banks from underwriting securities, forcing them to choose between being a simple lender or an underwriter (brokerage). The act also established the Federal Deposit Insurance Corporation (FDIC), insuring bank deposits, and strengthened the Federal Reserve’s control over credit.

In retrospect, this ideology was the right prognosis for America; we had just had a nasty stock market crash, and were in the midst of the great depression. Years later, we would exit the depression only to achieve the greatest period of economic growth in our history…yet in 1986, we weren’t so sure:

In the spring of 1987, the Federal Reserve Board voted 3-2 in favor of easing regulations under Glass-Steagall Act, overriding the opposition of Chairman Paul Volcker. Thomas Theobald, then vice chairman of Citicorp, argued that three “outside checks” on corporate misbehavior had emerged since 1933: “a very effective” SEC; knowledgeable investors, and “very sophisticated” rating agencies. Volcker was unconvinced, and expressed his fear that lenders would recklessly lower loan standards in pursuit of lucrative securities offerings and market bad loans to the public.

Sorry, I can’t help myself…the very argument for repealing Glass-Steagall is monumentally flawed – let’s review each of the three “outside checks” one-by-one, since we have the benefit of hindsight being 20/20:

  1. Was the SEC “effective” in granting Goldman Sachs, Morgan Stanley, Bear Stearns, Merrill Lynch, and Lehman Brothers permission to exceed the market mandated level of leverage from 10:1 to 40:1? (Notice 3 of these brokers no longer exist, and 2 of them have become holding banks)
  2. “Knowledgeable investors”…not exactly true. Collateralized Debt Obligations, Credit Default Swaps, Mortgage Backed Securities, Credit Linked Notes….we could spend a day running off all of the instruments of structured finance, which is esoteric by nature – and understood by very few.
  3. “Sophisticated Rating Agencies” might be the most laughable of all; not only did they incorrectly gauge the health of the components in our financial system, but they were also stubbornly late in making adjustments to their ratings. In recent months they have only exacerbated problems in the credit markets, because by downgrading a company’s debt in the peak of a credit crisis, they are causing investors to demand a higher yield at the very point when the company is most vulnerable; if the damage is done, they shouldn’t push companies to the edge of bankruptcy – if you disagree or don’t know what I’m talking about, click the link above for more about this point (it’s actually really funny to watch the CNBC anchor rip apart S&P’s head of financial institution’s ratings).

Greenspan, who was appointed FED chairman in 1987, favored the repeal because he felt that deregulation would help U.S. banks compete with big foreign institutions. Leaving the lack of truth aside, his agenda is what developed our financial system into what it is today; Citigroup immediately merged with Travelers Corp., something which never could have happened under Glass-Steagall; a combination of insurance underwriting, securities underwriting, and commercial banking.

So to answer the question above, I say yes.

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Halt trading – give these computer drone traders a vacation, and let them come back to reality. Let congress vote on the future of General Motors, Ford, and Chrysler; whatever the result may be, let it settle without any trading.

If they choose to let the Big 3 file bankruptcy, they should facilitate it such that the American Autos have temporary access to a credit line. This would allow them to carry on business as usual without closing their doors; as they try to keep creditors away, they can straighten out their business model and break the unions, all while preventing a Chapter 7 bankruptcy – which would lead to liquidation and 100,000 jobs lost.

From here – during the halted trading – the SEC should reinstate the uptick rule, which should temper the volatility going forward (as we saw, banning short selling on Financials is NOT the answer…as soon as it is lifted? Bombs away!)

There should be nothing hindering any of the above actions, except the bureaucratic nature of our government, which we no longer have time for at this juncture.

While we’re at it, we might as well consider an interest rate cut, as it should at least have a placebo effect on the markets…the reason I say that is the effective Federal Funds interest rate has been well below the targeted 1% for quite some time:

effective-fed-funds

As for Barack Obama, he should take preliminary action in appointing some cabinet members; get an all-star team of financial geniuses for a special committee – Buffett, Summers, Volker, Soros, Roubini – some of the smartest people in the world live in this country, and their talent should be utilized.

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A good list from Doug Kass, of thestreet.com:

    1. Obama recommends a massive stimulus.2. Obama lowers middle-class tax rates.

    3. Obama announces his intention to introduce a $25 billion aid package to domestic automobile manufacturers.

    4. The new Administration introduces large tax incentives for home ownership.

    5. Obama immediately announces Cabinet appointees with the broadest experience and the highest credibility, from both within the two political parties (a team of rivals) and within industry.6. The Fed cuts interest rates.

    7. One or two high-profile hedge funds must fail.

    8. The uptick rule is reinstated in order to reduce the negative influence of the quant funds.

I think this list captures all of the conceivable catalysts which could stop the precipitous drop we’re experiencing – if only to give the broader market the chance to cash out on a rally.

Here are some other interesting points to consider for a longer term view:

    1. Six trillion dollars of wealth has been lost in home prices over the last year and a half.
    2.
    Eighteen trillion dollars of wealth has been lost in global equities in only seven weeks.
    3. Deleveraging continues to restrict accessibility to credit.
    4. Job Losses are accelerating.

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There’s really 1 reason that’s important, and the others don’t matter when considering this (from “The New Republic”):

“Bankruptcy need not mean that the company disappears.” But, while it’s worked out that way for the airlines, among others, it’s unlikely a GM business failure would play out in the same fashion. In order to seek so-called Chapter 11 status, a distressed company must find some way to operate while the bankruptcy court keeps creditors at bay. But GM can’t build cars without parts, and it can’t get parts without credit. Chapter 11 companies typically get that sort of credit from something called Debtor-in-Possession (DIP) loans. But the same Wall Street meltdown that has dragged down the economy and GM sales has also dried up the DIP money GM would need to operate.That’s why many analysts and scholars believe GM would likely end up in Chapter 7 bankruptcy, which would entail total liquidation. The company would close its doors, immediately throwing more than 100,000 people out of work. And, according to experts, the damage would spread quickly.

When poorly run ‘too big to fail’ companies went bankrupt in the past, there was ample credit to tide them over through the process of solving some of their inefficiencies. If one thing is clear, it’s they don’t have enough money to run their business this time around, and we cannot allow them go bankrupt and hope they fix this one on their own.

While the effect on the real economy would be devastating, the effect of a big 3 default on the credit markets is talked about much less. Credit default swaps make up a $62 trillion market – how many of these contracts were sold to protect GM and Ford bond investors against default (or bankruptcy)? That is a huge question, because AIG along with all of the bulge bracket banks sold this kind of insurance (where their reward from this side of the bet is limited to the price of the insurance, while the risk is having to cover the entire value of the losses on a defaulted bond – something they do not count on happening). If GM defaults, we could certainly count on more bleeding out of AIG who is undoubtedly intricately involved in this.

bond-defaultGM is rated ‘Caa2’ which is junk status, meaning that Wall Street brokered bets using the riskiest instruments (CDS’s) on the riskiest products (junk bonds).

Like with everything these days, no one really knows what will happen. So as usual, we’ll have to wait and see.

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The answer: I don’t know. If I had to guess, I’d say Bank of America since they bought Countrywide and Merrill Lynch (One would think they could have gotten both for free – the JP Morgan way).

From Citi’s town hall presentation:

banks-balance-sheets3

Notice that even with Wachovia, Wells Fargo has by far the smallest balance sheet. This chart is by no means useful in describing the underlying assets of each company, as the arbitrary nature of “other loans” dominates a portion of every bank’s balance sheet (if we were really curious and did some research, we would probably find that this section is comprised of Hybrid ARM’s, Alt-A mortgages, and maybe even some Sub-prime mortgages).

I guess we haven’t achieved adequate transparency quite yet…

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