Sunday, October 07, 2007

It's All Good

The Wall Street Journal came out with an article on write downs tied to mortgage debt Saturday. Their bar graph (left) displays about 20.7 billion in 3rd quarter losses. Washington Mutual with 1 billion of charges this quarter didn't even make the list. The amount shown for the Bear Sterns doesn't really reflect what happened when this mess started (BS had a 1.6 billion hedge fund bankruptcy). Of course Amaranth is long forgotten.

The above chart is mixing brokerage houses with banks. So these write offs or what ever, could be coming from several different places, bad housing loans, credit card debt and hedge fund investments. Don't worry everything is "contained." Yea, right!

Here's a list of the top world banks. The banks in the top picture seem to have a handle on projected losses if you compare their net holdings (left) to declared write downs (top). But this is just third quarter losses. So do we multiply this by four to come up with a yearly total? It sounds logically conservative and nightmarish. [Note: Morgan Stanley in the top pic and JP Morgan Chase in the one at the left are not the same company, the first is a brokerage house and the latter is a bank, they were one entity at one time]

HSBC wrote off 11 billion in March, Citibank plans to announce earnings October 15 and refers to earnings as "abysmal" in their news release last week. Two banks not saying much are Bank America, and JP Morgan. It could be an eye opener when they report quarterly earnings.

Now mix in 2.46 trillion dollars of credit card debt. Here is list of the top ten issuers of general purpose credit cards:

1. Bank of America
2. J P Morgan Chase
3. Citigroup
4. American Express
5. Capital One
6. Discover Card
8. Washington Mutual
9. Wells Fargo
10.U S Bancorp

The puzzle is starting to come together. We know who the players are. Citigroup made all three lists, which doesn't sound too good. They might have company, if Bank of America and J P Morgan "measure up" in the next week or two when they announce earnings. The real problem is the three month time frame this mess transpired in. How can we believe that things are now OK?

The stock market is still going up, go figure. I guess you could call it herd (heard) mentality. Follow your favorite stock commentator over the cliff.


Anonymous said...

Dear Jim:

I have been reading your posted articles and they are very well written. I try to remain positive about the markets to the extent one can (and "take it all with a grain of salt"). I recently started reading articles by Jim Sinclair (at his Mineset website). I do not know if you are familiar with him and his back ground. However, what I discern from reading his articles is that he believes that the "real" problem is "over the counter derivitives" and that it is basically "a 20 trillion dollar mountain of debt", and that the sub-prime mess is simply a side show, for this "real" problem.

It appears that from things I read and see on T.V., the experts are saying one or all of the following:
a. the markets are great in the areas of metals and comodities because of globalization;
b. the economy is great, so don't get left behind;
c. basic economic theory (the botton line) has no relevance in the new economy; or
d. Don't think about the 9 trillion dollars of debt that exists;

Keeping all of the above comments and others that I have read or heard in the back of my mind, I was reading through the Investors Business Daily Saturday (Oct. 6, 2007) when I came across a small article from Reuters. I have pasted it below for your review.

So I guess my question is, what is going on and where are we headed; Are we watching a slow motion train wreck or has the global economy turned all known economic theory on its head?

What are your thoughts?


By Thomas Atkins

ZURICH, Oct 5 (Reuters) - The global credit crisis is far from over and may come in waves, a source close to the Basel Committee on Banking Supervision said on Friday.

Regulators from around the world will meet next week to discuss what the source described as the "hard-core liquidity crisis" which has forced central banks to inject billions of dollars in emergency liquidity into the banking system.

But the source, who declined to be named, said the Basel Committee was unlikely even to discuss suggestions that central banks should become market makers of last resort when liquidity dries up, saying such an idea is out of the question.

Stock markets have hit record highs in recent days due to optimism that the worst of the credit crisis may be over, while primary U.S. bond markets and some loan markets have revived following the Federal Reserve's interest rate cut on Sept. 18.

But regulators on the Basel Committee are less optimistic as they gather in the Swiss city. "In banking and in supervisory circles, this crisis is far from over," said the source. "This crisis may unfold itself in waves."

The Committee will put the liquidity crisis, in which banks have been largely unwilling to lend to each another, at the top of its agenda, the source said.

"Liquidity hasn't played a big role so far but now we can see that we have a hard-core liquidity crisis," said the source. "This is something that has very rarely happened before ... where banks don't trust each other."

Liquidity -- or lack of it -- is one of the top risks for banking institutions, but rulebooks such as the international Basel II accord which the Committee drew up have focused instead on capital requirements.


Committee deliberations are unlikely to result in proposals for a new liquidity risk charge -- which would force banks to set aside more emergency cash -- but rather in guidelines or "soft regulations" on how to cope with crises, the source said.

"The core of the issue is stress testing and contingency plans," the source said.

The source said Committee members were unlikely even to debate suggestions by some private-sector bankers that central banks become market makers of last resort for illiquid assets to keep the wheels of international finance turning.

"This is out of the question. This is something the market wants but at the current time there is no debate on this," the source said.

"If any central bank opened this possibility, they would be flooded, literally flooded, with hundreds of billions in asset backed commercial paper," the source said. "This would be a classical case of bailing out the speculators."

The global credit crisis that developed in August was triggered by defaults on U.S. mortgage debt that had been extensively repackaged and sold as asset backed securities to institutions, including hedge funds, around the world.

Regulators have been torn between ensuring that markets keep working by providing emergency liquidity, and the risk that this will simply inflate another market bubble following the equities boom of the late 1990s and the property boom of this decade.

They are also anxious to avoid "moral hazard" in which investors, shielded from risk by official bailouts, are encouraged to behave increasingly recklessly.

Jim in San Marcos said...

Hi Anon 7:23

I wrote a piece a while back in June 2006 that covered the derivatives market here is a link to it (The Invisible Derivatives Market).

With the liquidity problem, notice that the game continues when someone buys your one million dollar house for two million. When the price of the house drops, money is leaving the money pool.

The issue with the banks in the article you quoted, is somewhat different. Governments want to keep interest rates low as so to stimulate commerce. Banks have no problem getting money if they need it. They just raise interest rates until they have what they need. The banks make their money off of the spread paid to the depositor and borrower.

Most likely what we are looking at is the fact that no one is borrowing to purchase items of inventory (ie car house etc). They are borrowing to keep their store open and running. Most business have fixed costs that are there whether they sell something or not. Here is another link with more on that (The Wyle E Coyote Acme Credit Loan August 2007).

I think that the thing that needs to be understood is that all of this is inter related. You can't force people to buy what they can't afford. The mind set of "Let's get rich by buying a house," is gone.

The peculiar thing about keeping interest rates artificially low, is that there is no incentive to save money especially with inflation at 10%. So then you have credit card debt going up.

I'm going to stop here, because it is starting to overlap with something I am writing for later in the week.

It's defiantly a complex issue. Thank you for the article

Anonymous said...

Hey Anon 7:23, I`ve been told that as long as the consumer keeps spending, "it`s all good".

Anonymous said...

I looked at a graph of the Chinese stock market today...HOLY COW!!! talk about the proverbial "moon shot", I mean I heard that it was going up, but wow!. Is that sustainable? If it`s a bubble, and it burst, will it affect all markets?

Jim in San Marcos said...

Hi Anon 5:05

China is a communist country. So when that market crashes, it ought to set capitalism back 100 years. Just the idea of a stock market in a communist country ought be a dead giveaway. Its just a Ponzi scheme run amok.

I doubt its collapse would be able to financially influence other markets. But it's hard to say when you have to consider the human psyche reaction. You could get a knee jerk reaction in other markets.

LtRand said...

Speaking of China, I find the historical context absolutely scary.

Germany was doing alright until the Great Depression. Why? Simple, the could pay back their war debts in small installments that didn't freeze their economy.

As soon as the modern world went into a "liquidy freeze", Germany was called up to pay in full immediately, which sent them into a worse depression than the rest of us experienced.

What happens when China crashes? I have a feeling they'll be telling us to pay up, now, in full. That's when things will get interesting. The entire house of cards rests on China not busting, and us not pissing them off. Given how are politicians are trying to push China, I doubt we have long to contemplate or prepare. They don't even realize that pushing China will hurt us more than just allowing them to continue pegging their currency.

Jim in San Marcos said...

Hi Itrand

I think that China will get burned., but it will be minor to what is happening to the rest of the world. As a communist socialist state, it should hold together.

Its the rest of the world that will learn a lesson in economics 101.