Archive for April, 2009
The p.r. game that protects banks from popular outrage gets stranger and stranger. President Obama makes speeches that sound just tough enough on Wall Street to make a good public impression, and he even upsets Wall Streeters with these statements while he delivers taxpayer money to the Street by the trillions. We wonder if Wall Streeters like Jim Cramer understand all this, and speak as they do to play a conscious role in our political Kabuki theater. Posts like the one Cramer published today on his website (h/t reader Ceebee) — or any number of WSJ articles depicting Obama as “anti-business” may also fool non-bankers into thinking Obama fights for them, but for us the charade is wearing thin.
Cramer titled his post, “President Obama may have stalled out the rally.” According to Cramer, Obama presumably tanked the Dow Jones Industrials by 130 or so points today from the intraday high (the Dow closed down 17.61 for the day) and maybe even forestalled a breakout, by mouthing “bash Wall Street rhetoric,” such as Obama’s following reference to the bailouts of GM and Chrysler:
“In particular, a group of investment firms and hedge funds decided to hold out for an unjustified taxpayer bailout. They were hoping that everyone else would have to make sacrifices and they would have to make none.”
In our previous post, we expressed chagrin that the banks which received government assistance, were holding up the Chrysler deal and that they shouldn’t have been allowed even to think of doing so since these banks all continue to exist by the grace of taxpayer funded support. So Obama made a great deal of sense to us, as far he went, even if he failed to say that the taxpayers are subsidizing all sides of this arrangement.
We also think Obama has coddled the banks at almost every turn so as to promote their interests over those of taxpayers. Investors benefited in the short run with this rally off the March lows, but in the long run they may pay for the way the Fed and the Treasury have tried to paper the banking crisis over and fix it on the cheap.
Then again, if you believe Cramer, this rally is for real, and the stock market is anticipating a rebound in the economy. And if that is true, statements like Obama’s will have little long run impact on share prices, which should continue to rise under those conditions. On the other hand, if the economy continues to contract through year-end, all we have is a bear market rally. In which case, Cramer rightly fears for the market’s fragility. But if the economy — and corporate earnings — continue to decline, does anyone really think that Wall Street friendly Presidential rhetoric could sustain a new bull market?
Ok, I admit it. I don’t have a clue what’s going on at the moment in the market. Two days in a row now, we’ve been down strongly overnite and during the pre-market, but within 30 minutes of the market open, it’s like it never happened. Typically, we’d get some bounce from the pre-market selling, and then we’d see some downward pressure come back into the market. Hasn’t even been close. Though we ended slightly down on the day, this market is not in any hurry to roll over. Buyers seem to be lurking behind every corner.
Even though the market seems locked in a narrow 25 point trading range, there have been some nice moves for intraday traders in certain stocks. BIDU had wild day and DNDN had some extreme trades that brought out the exchange to review before saying trades were legit. Nothing like a 50% drop in a few minutes. Should be active tonight if they get reopened. In after hours here PNRA getting hit for having expected earnings which weren’t bad, but disappointing enough for it to be down about 10% as I write. Of course it’s had a spectacular run since November. For other non news stocks we’ve had just enough to pullback to relieve most the overbought indicators on the indices in general.
Techs, which have been the flavor of the day lately, had a pullback today led by BRCM and MSFT. Ag stocks were basically flat while solar and energy stocks were down slightly. The financial stocks were down slightly with the BKX down about 3%. In other markets, gold got smacked for about $14 or 1.5% to close at 894ish, it too in the middle of its recent trading range, while silver got hit for nearly 4%. The dollar continued showing some strength.
Now seems to be a good time to keep your head down unless you’re extremely nimble, until we see some direction.
The Chrysler bankruptcy imbroglio illustrates just how conflicted the Administration’s bank bailout policy is. The taxpayers are on at least two, and possibly three sides of this deal: the automakers, their lenders, and perhaps those who hedge lenders’ claims on Chrysler with credit default swaps (CDS). Yet the lenders, many of whom are partially government owned through the Troubled Asset Relief Program (TARP) and/or survive by the grace of government life support through their borrowing from the Federal Reserve under its new extraordinary credit facilities — act as if they are private businesses with full rights to fight for their own claims on their own schedules.
The government is explicitly representing Chrysler, though not its owners such as the Cerberus hedge fund, in Chrysler’s negotiations with its lenders; an alliance in which Fiat would take a minority stake is also on the table. The banks and other lenders are negotiating against the government– aggressively, having turned down the government’s first offer and looking to take this negotiation to the eleventh hour deadlines like creditors in any other potential bankruptcy. They do this while the government is trying to save tens of thousands of jobs, with an economy in a near depression. If the lenders accept losses on their debt, the taxpayers lose to the extent that the lenders are government supported (of course there exist non-bank holders of Chrysler debt who are not government supported, too). If taxpayers pay up to the banks in order to get Chrysler on a sound footing, the taxpayers take a more explicit hit. Meanwhile to the extent that lenders have hedged themselves using CDS, or that other side bettors bought Chrysler CDS as a speculation, taxpayers could even conceivably end up funding payouts to CDS owners, since banks, insurers, and hedge funds are the big providers and users of CDS. It looks like a normal negotiation but in fact we have a two or three sided shell game and a disproportionate share of taxpayers’ money will go to the Wall Streeters who are playing three card monte against us.
Former Treasury Secretary Paulson, who has made dozens of trips to China, knows full well what conflicted banks look like under crony capitalism. One has to believe that in setting up TARP he knew exactly how messes like Chrysler would turn out. He is familiar, for example, with the problem China’s banking system had some years ago, when big borrowers got loans by exerting political influence. But as Paulson also knows, crony capitalism works better in China than it will ever work here, because when the Chinese get it right the government decides what is good for the economy (especially the pieces of the economy that it owns) and gets it done. Here taxpayers fund failed pieces of the economy and failed businessmen continue to fail on our dime.
The very idea of banks negotiating aggressively against the government on Chrysler is Alice-in-Wonderland absurd. Existing law gives regulators plenty of authority to tell banks what to do. Bank examiners can tell banks to stop unsound practices, which gives them a great deal of latitude, even if the bank in question is thought to be sound. Besides, given that many of the majors are insolvent in substance if not in form, the FDIC could (and almost certainly, in our view, should) take over any of the insolvent or near insolvent banks. Under current conditions, with the Treasury owning portions of the large weak banks, that authority should increase. In addition, the Fed has, at least theoretically, plenty of leverage that it would not normally have, given its position as creditor to the banks through the alphabet soup of its lending facilities: TAF, TSLF, PDCF, etc.
Except the government is not about to nationalize big banks now, and the banks know it. The politics surrounding TARP suggest that it’s different this time. As James Kwak points out at the Baseline Scenario, when Paulson structured TARP he bent over backwards to give banks our money without our having much say in how they run their business because that would be “socialistic.” The current Administration has continued to run TARP the same way. That’s why Treasury used TARP to buy non voting shares in distressed banks, and doesn’t even seem to use 36% of the voting power it will soon have at, say C, when its TARP preferred converts into common.
Of course the big banks are spinning the Chrysler restructuring negotiations as if small, adamant regional banks (in other words, country bumpkins who don’t get it) and hedge funds are the creditors’ committee members who are holding out for a tougher deal. Is that true? Such things have happened before, but this scenario is almost too convenient for Chrysler lenders such JP Morgan (JPM), C, Morgan Stanley, and Goldman Sachs (GS). Either way, we don’t like it much.
Another thing we would like to know is, do any of Chrysler’s lenders own CDS on Chrysler debt? As we have noted in the past, credit default swaps (which essentially insure against the debtor’s bankruptcy) distort the bankruptcy process, providing creditors incentive to take a much tougher line against the debtor than they would without the swap. Suppose you own an issue of senior debt that the market thinks is worth 30c on the dollar (this is hypothetical). If the market is valuing the security accurately, you are likely to get 30c worth of something in Chapter 11 bankruptcy, perhaps consisting of some combination of equity and new debt. If you are about to become an equity holder you have incentive to preserve the worth of the underlying business; you might also want to give some concessions to the company (as opposed to forcing it to go bankrupt) if you think that it might have a chance to get back on its feet and pay you back in full. On the other hand, if you hold CDS, you want to push the company into bankruptcy as quickly as you can to collect the CDS insurance payout. We wonder who among the creditors own Chrysler CDS and we think that under current conditions such information should be made public. Fat chance.
Oh, and who wrote the largest amount of CDS and didn’t even bother to hedge them? None other than AIG, which is 80% owned by taxpayers but still lumbering along. Of course banks (again, largely taxpayer funded these days) also wrote lots of CDS. So if Chrysler creditors own CDS and force a bankruptcy, we might well end up footing the bill for at least part of the CDS payout too. Sweet deal for the taxpayer… NOT.
If the Administration had any concern for taxpayer dollars it would shut down the insolvent banks and get on with the business of creating and preserving jobs in the real economy. It would also find a way to force the unwind of existing CDS and prevent new CDS from being issued, so that in the future lenders have at least some stake in borrowers’ well being. But so far it seems that Obama doesn’t understand what is at stake, has caved in to the banks, or just doesn’t care.
UPDATE: The latest from the WSJ now characterizes the planned “alliance” with Fiat as a Fiat takeover, giving the Italian automaker day to day control over the company. So… as things stand at the moment, if the deal goes through, Fiat would have to risk a cash drain to get Chrysler into good shape, they get to own 20% of Chrysler for free after the US parties haggle things out among themselves. Sweet for them… maybe…
After suggesting a couple of weeks ago that I foresaw the 875 level as a possible bounce level, we hit 875.63 before backing off the past few days. However, we haven’t had much of a pullback as the market ramped the last 30 minutes yesterday into the close.
Amazon reported better than expected, may be time to take some profits if you haven’t already done so, for those of you who followe us into that trade. MSFT was about inline. Techs continue to lead this market with some amazing moves in the sector the past week.
In other fronts, the dollar got beat up pretty good during the night, while gold hit the 911 range overnite. Gold will be coming to it’s resistance level here shortly. I took a small position in GLD yesterday thinking that we may have seen the bottom. If we break the 870ish level from which we made a double bottom last week, then I’m gone.
Where do we go from here? Our intermediate rally is getting a little long in the teeth and we’re probably due for some pullback. The question is, have we already seen it with the 50 point pullback we had earlier in the week, before we push further. In my humble opinion, earnings have held up a little better than I anticipated, though admittedly many companies are simply beating the revision, the absolute numbers still not that bad in some sectors. Forget the banks, they’re all manipulating and no one including themselves, know what they’re really worth. As you can see from the chart, some key levels to watch both upward and downward. We have a potential H&S formation forming on the SPX here that bears watching. A break below the mid 820 level sets us up for a potential pullback to 780ish range.
We don’t know about you, but we are still trying to adjust, emotionally speaking, to GM’s probable bankruptcy. It’s a shock but not a surprise, even though GM has been ripe for the plucking for decades — and they have always been quite public about it. Ever since 1964, in fact.
That year Ralph Nader worked consulted for the US Department of Labor and for a US Senate subcommittee, exposing the hazardous designs of many US built cars. Automakers claimed that driver errors caused that era’s high accident fatality rates, but Nader proved them wrong. In 1965 Nader published Unsafe at Any Speed, which made the his name and changed the country’s thinking — and its laws — regarding consumer product safety.
GM’s reaction told us all we needed to know about the company’s arrogance and inability to learn from its mistakes. Did the company invite Nader to Detroit and ask him how to improve its products and protect its customers’ lives? No, indeed. In fact the company hired detectives to trail Nader in the hopes of digging up dirt on him. Nader sued to stop the harassment, and GM Chairman James Roche admitted to the surveillance on national TV in 1966. Since that day the Big Three have done everything they could to fight government regulations on safety, pollution, and fuel economy. The Big Three held onto the right to make bad cars and lost the war for survival.
Contrast this stance with the way Johnson & Johnson (JNJ) handled its problem with Tylenol in 1982, the textbook example in corporate crisis management. When a vandal contaminated at least several bottles of Tylenol with cyanide, JNJ chairman James Burke convened a company task force to decide how to protect customers and also save the product. Unlike GM, JNJ put its customers first. They recalled and destroyed existing store inventories of Tylenol nationwide at a cost of tens of millions of dollars and actually took the product off the market, even though Tylenol was one of JNJ’s most important moneymakers. Only months later, after all the facts were in, did JNJ relaunch Tylenol in new tamper resistant bottles. The relaunch was a huge success. Surveys continue to rank JNJ among the nation’s most admired companies.
While Detroit’s Big Three still owned the US car markets through the 1970s, we suspect that GM’s reaction to Nader’s work told foreign carmakers that GM could be had. The first Toyotas imported into the US in 1957 flopped miserably, as the China Post recounts, but the Japanese learned from their experience:
“Used as taxis on Tokyo’s bumpy post-war roads, the Toyopet was uncomfortable, plain, and had an engine so weak it that ‘loud, threatening noises radiated from under the hood’ when it was driven up steep hills, Toyota admitted in a retrospective.
“Toyota had sold just 2,314 Toyopets when it was replaced in 1965 with the Corona, which was designed for American roads and drivers.
” The Corona was a hit, pushing Toyota into the number two spot for import cars by 1969. But import sales comprised just 11 percent of the U.S. market and remained dominated by Volkswagen, which sold nearly five times as many cars as Toyota…”
The oil shocks of the 1970s took their toll, and the government had to bail out Chrysler in 1979 with its $1.5 billion loan guarantee. Nonetheless, the Big Three continued to fight the idea that fuel efficiency could be a selling point. A strange strategy, since fuel efficiency proved to be a potent selling point for Toyota, Honda, and Nissan. When oil prices dropped in the ’80s, Detroit acted as if the reprieve would last forever. We now know it didn’t….
But given the status GM still held at the time, the company received many chances to redeem itself. What amazes us is how completely it managed to flub each and every one of them. In 1983, GM and Toyota re-opened GM’s Fremont, CA plant as a joint venture named NUMMI, New United Motor Manufacturing Inc. Under the venture, Toyota got to see what it would be like to begin operating plants in the US while GM got to look at Toyota’s now-superior technology. But did GM apply what it learned to the rest of the company? Nope, it was Not Invented Here.
Similarly GM launched its Saturn division in 1985 in the hope that it would make a home for best industry practices (including a unique agreement with the United Auto Workers) that would in turn pace innovation at the rest of GM. Although consumers liked the “no-haggle” policy at Saturn dealers and the initial product line that offered good value for the money, managers at the other divisions starved Saturn for resources during the mid-1990s. GM also succumbed to the temptation of using other GM parts at Saturn to keep costs down. The product line aged, the division lost its initial excitement, and by the time GM revamped Saturn’s offerings the division had become.. part of GM. Again, whatever learning developed at Saturn was, Not Invented Here.
How about battery technology, which many observers believe could be a key to future car technology? In 1989, as Naked Capitalism reminds us, GM produced its battery powered EV-1, which had an EPA certified range of 140 miles per charge for its then advanced nickel-hydride battery, ostensibly to comply with California’s attempts to encourage zero emission vehicles. Some people who drove the EV1, really, really liked it, some didn’t, but no one denies that it represented intriguing technology. As the Orange County Register notes, the end of the EV-1 was “controversial.” Indeed. No one disputes that GM did its level best to round up each and every EV-1 it could and scrap them after deciding to halt production. Given its other history with new technology, at least some people suspect that GM simply wanted to prove that electric cars couldn’t be made. Whatever its intent, in producing EV1 GM gave Toyota some great ideas that led to its monster hit model, the Prius. Since then the US has just about ceded the lead in battery technology to Asia, and last week Nissan announced a program to provide and produce advanced electric cars in Wuhan, China.
At this point some readers will ask us, why dredge up all this history of management blunders without mentioning the UAW? We are really glad you asked! We know very well that through the Seventies the Big Three held a dominant market share, paid generous wages and benefits to the UAW, and passed costs to consumers without having to worry about other competitors. Yet the Big Three muffed a golden opportunity to unload its costs for health care benefits in 1994 when the Clintons proposed their health care reform plan. Rather than work to improve the plan as proposed, the Republicans succeeded in their strategy to kill the plan so as to prevent the Democrats from getting credit for solving an important national problem. In our view, if the Big Three had fought for the plan, the united front of business support for the Republican position could have broken, a viable plan could have been passed, and the government would have taken over the health benefit costs. Then the Big Three would have been in the same position as its Japanese and German competitors, none of whom have to pay for workers’ health benefits because those countries have national health insurance. Instead Detroit held out for ideology rather than their own self interest (in cutting health care costs per vehicle) and … here they are.
The Obama Administration clearly has to save GM; letting it go would cost hundreds of thousands of jobs at the company and its suppliers. Furthermore, lots of people here in the Midwest, are irate about how the Administration has been tough on Detroit and very, very soft on Wall Street, particularly Goldman Sachs (GS). But as we suggested a month ago, just bailing out Detroit while leaving them to make the same old product, would accomplish nothing other than to kick the can a year or two down the road. So if we want to make this one count, maybe Obama should make sure that America’s smartest energy specialists — people from, say, the Rocky Mountain Institute or the Los Alamos National Laboratory — have alot to say about GM’s future products. In other words, we can’t leave GM’s current crew to the mercies of the market. We have to care about GM’s success as much as the Chinese care about the success of their own auto industry. Or we can kiss it goodbye.
After rallying an additional 80 points the past week or so, the market finally gave up up some serious gains today. It peaked right in the middle of it’s resistance area at 864. Financials were the big losers today led to the downside by GS which gave up nearly 15 points despite doing a good job of beating its numbers.
Most of the major indexes dropped considerably, with Dow giving up 1.7%, the SPX -2%, and the Russell 2000 slightly over 3%. The SOX held up relatively well dropping only a slight .24%. Think this may change based on INTC’s release after hours tonight. Though the earnings were okay after heavy revisions down, the outlook was not pretty and INTC was down about .50 in after hours trading. This could weigh on the sector in tomorrows trading.
As stated earlier, financials, after being the leaders in the recent up move, took a pounding, coming in for some serious profit taking. It’s notable that SKF was up almost 10% today and FAZ nearly 20%. In other markets oil was slightly lower, as were the precious metals while the dollar was mixed, though it seems to be rallying some here overnite. Don’t forget we have the Beige Book release tomorrow after lunch. Usually good for some fireworks.
Where do we go from here. I think we’re in for a small pullback and have drawn some natural support levels seen on the chart below. I ‘ve also included the most recent video from Market Club which shows possible fibonacci retracement levels. If you noticed the VIX today, was down slightly, even as market dropped. Hmmmm
Positions in stocks mentioned – long FAZ, SKF
This past Monday, April 6, two heavyweight bank analysts made extensive, and negative, comments on the sector. Steve Forbes interviewed Meredith Whitney for his magazine’s online feature, Intelligent Investing. Also Mike Mayo hosted a conference call (sorry, no transcript link) from his new perch at Hongkong based broker CLSA along with CLSA economist Eric Fishwick and veteran independent accounting analyst Robert Willens. Willens stepped out of his restrained accountant’s demeanor to term the new mark to market accounting rules “awful,” and an “unmitigated disaster.” We’re glad to have Willens’s company in the opinion we expressed in our “April Fools” editorial last week.
We understand that bank stocks have continued to move higher since last Monday when the analysts spoke. The Bank Stock Index (BKX) soared 5.66 on Thursday to close the holiday shortened week at 33.81 based on Wells Fargo’s (WFC) preannouncing better than expected Q1 earnings. Our take: based on their track records, Mayo and Whitney are worth listening to, but as any trader knows, you can be right on the fundamentals and look very bad short term. Furthermore, value investor Whitney Tilson thinks that WFC made the number by charging off less than it should have, and will have to increase reserves to cover higher charge-offs in the future. He notes that Wells charged off only $3.3 billion in 2009Q1, while in 2008Q4, WFC and Wachovia, which then reported separately, charged off $6.1 billion combined in Q4. In addition, economic conditions got worse in the first quarter, which would lead one to expect greater loan losses than in last year’s fourth quarter. We agree with Tilson and, as noted in past columns, we think the banks and the Treasury are doing what they can to push bank stocks up artificially. But the tape is the tape.
Having said all that, Mayo thought on Monday that the banks should sell stock to raise capital, given that their share prices had already moved up dramatically from the March bottom. He thinks bank stock investors (presumably as opposed to traders) should demand a substantial margin of safety because of the weak economy and asset quality concerns. In his view bank shares got down to “reasonable” percentages of tangible book at the March lows, and he thought that the shares were too rich on Monday at about 80% of tangible book. In any event he initiated coverage of eleven banks at “underperform” on arrival at CLSA while Whitney said she is “staying away from bank stocks still.” Going forward Mayo states that banks will no longer be able to post high teens returns on equity because they will need to reduce leverage and because revenue streams from securitization are not coming back anytime soon, but given a proper margin of safety he insists that the sector remains “investable.”
Mayo is also wary of “partnering with the government” as a shareholder because TARP and PPIP do not preclude some move that might dilute or even wipe out shareholders down the road, if these programs fail to clean up the banks’ balance sheets. He also thinks current programs are a risky approach for President Obama, who in his view would do better if he cleans house now. If Obama waits longer, Mayo says, the bank crisis Obama inherited, could become his problem. We agree and remember that the first President Bush cleaned house effectively on the S&L crisis by tackling the problem early in his term.
Both analysts say the economy’s weakness will continue to hurt the banks. Whitney says that banks value their loan books based on assumptions that underestimate this recession’s severity, and as the banks catch up with reality they will increase reserves and charge-offs accordingly. The major banks call for unemployment rates of 7.5-8% and house price declines of 31%, peak to trough. As many readers know, the most recent non farm payrolls report (NFP) put unemployment at 8.5%. Similarly, the Case- Shiller index of house prices has already dropped 30% for the top ten Metropolitan Statistical Areas (MSAs). Whitney says futures markets are forecasting a 37% drop from peak to trough. Therefore, although many banks are posting reasonable pretax earnings before loan loss provisions, Whitney doubts that banks can earn enough to maintain adequate capital; the loan losses will overwhelm them in her opinion. She expects the major banks to sell their crown jewels eventually to raise funds. She also thinks that as banks cut risk by reducing consumers’ credit card lines, that could feed back into additional economic weakness. That problem is just getting started in her view.
We can see that one, and we note that prudent consumers who might not ordinarily carry large credit card balances, might use a credit card to tide themselves over during bad times. On the other hand, we are not going back to an economy where consumers spend beyond their means. Ultimately job creation, and not increased use of credit, will be needed if the economy is to recover.
Whitney notes that loan losses are largely a function of “distance from the borrower” and that smaller community banks who know their customers will have a better future eventually. In this scenario sales of assets from the majors will eventually give community the scale they need to compete. Right now, though, the top five banks account for a majority of total US deposits and hold dominant shares in business lines like credit cards. Her thinking makes sense to us, but we note that lots of smaller banks that never got caught with exotic investments like CDOs, could get hurt by loans to real estate developers.
Fishwick’s picture of economic conditions get Mayo to the same place. Fishwick notes that in most recessions unemployment rises about 2.5% from peak to trough and we are already past that. Mayo’s base case predicts loan losses of 3.5% of total loans and his worst case predicts 5.5%, which would exceed loan losses during the Great Depression. He also noted that many banks are effectively valuing loans at about 98c cents on the dollar, and therefore, like Whitney, expects increased loan loss provisions in the future.
Willens explained the new mark to market accounting rules. They provide tests to determine if an asset trades in an inactive market. If a security passes these tests, the reporting entity (that is, the bank filing its annual report) will presume that transactions in an inactive market, reflect distressed sales rather than accurate values. Therefore instead of using market prices to value tradable securities, the bank will use the income approach. That is, the bank will estimate future cash flows of principal and interest they expect the security to yield over its lifetime and then determine the present value of these cash flows. He notes that under this approach, banks can move securities from Levels One and Two (where market prices are used) into Level Three (mark-to-model or mark-to-whatever-management-wants) once they are shown to trade in “inactive” markets under the new rules. During the Q&A one participant observed that he had recently seen very large transaction volumes in asset backed securities (that is, bonds backed by assets such as credit card receivables and auto loans), and wondered how the banks would be able to justify moving such assets to Level Three.
If banks move many assets to Level Three, that will make bank balance sheets less transparent, and Mayo believes that bank stocks will trade at a discount for that reason. Not exactly what the American Bankers Association had in mind when they lobbied for this rule change. Nonetheless, Mayo implied that banks expended alot of energy over this rule, since only about 15% of most banks’ assets are tradable, and only tradable assets are normally considered eligible for mark to market accounting. Most banks value loans at 100c on the dollar until and unless they are found to be impaired, at which time banks take provisons for loan losses. Loans make up the bulk of banks’ assets. Of course that is different for investment banks, and for banks’ off balance sheet entities such as structured investment vehicles (SIVs), which usually own securities.
Finally, we think Whitney made a fascinating point regarding the financial crises of last summer. There were, she says, runs on the bank at Indymac, NatCity, Wachovia, and some others. At that time FDIC insurance covered depositors up to only $100,000 per account. Therefore corporations with large uninsured deposits, used for purposes such as cutting payroll checks, fled en masse once they felt they had reason to fear they’d lose their money. The government intervened to find buyers for these banks. Because these banks got merged out, the public never saw financial reports that would have told us just how severe the outflow of funds got during the third quarter of 2008. Yet another why Treasury and the Fed had to “do something” at that point; we just wish they had done something other than TARP after rescuing these failed institutions.
The market recorded another up week this week, marking its 4th in a row. After a strong sell-off Monday to pull back to the S&P 780 level, we now stand at the 840 level with another positive week behind us. Of course this just puts us back to where we were in mid February, but it’s a welcome relief.
Today was one of the choppiest days we’ve had in awhile, rallying into the close to finish up only +39 on the Dow. Techs, other than MSFT, were leaders, led by RIMM which reported much better than anticipated after the close Thursday and managed to hold it’s after market gain today to finish up over 10 points for the day. KLAC, GOOG,IBM and NSM did their share too. The SMH closed at 20 even, up over 20% the past 3 weeks. The Q’s finished at their highest level since the end of October.
Other stocks of note today were AMZN, which broke above some horizontal resistance in the 77 range and closed over 78, not that far from its high of the past year. When everything else is still trying to regain lost ground, AMZN is now up over 100% from it’s low at 35 in November. The financials had another good day, especially in the last few minutes when JPM surged over a point in the last 30 minutes of the day. The exchange stocks did well today with CME and NDAQ doing well. GS surged another 5 points+.
Ag stocks were up slightly today, while solar was pretty much a mixed bag even though energy stocks had a good day led by the oil service sector. OIH gained 3.72. Real estate stocks did well as witnessed by the nearly 10% move in IYR, the DJ Real Estate Index. The weak group today were the metals as gold and silver both continued their drop. Gold was off another 12.90 to close under $900 at 896. The result was continued pullback in the precious metal stocks. The dollar made an important breakout above the 100 range against the yen today and was basically flat against the Euro.
So where do we go from here? It’s starting to look a little toppy short term, but not extremely so. Everyone is talking about the 850 level being an important resistance point, but I feel we could push higher than that to maybe the 875ish range before we hit too much resistance. With the incredible move we’ve already had, it’s hard to get excited about chasing anything here, but as we know the market can keep climbing on weak volume. There doesn’t seem to be much selling coming into any pullbacks. Everyone is giddy over the Feds recent moves and the worldwide monetary expansionist policies. Even a terrible jobs number was met with the refrain that the worse is over. All I can say is keep tight stops but don’t get caught trying to pick the top either.
So the Financial Accounting Standards Board (FASB), pressured both by the banks and their supporters on Capitol Hill, caved in on mark to market accounting. Appropriately enough they did so yesterday, on April Fool’s Day. It’s bad enough that the old version of FAS 157 allowed the notorious mark to model, or “mark to fantasy,” standard for infrequently traded financial instruments, where there are no reliable price quotes. That standard caused plenty of confusion about the real value of assets held by banks, such as collateralized debt obligations (CDOs). In the case of CDOs and other derivative securities, the true asset values had to be falling along with the value of the residential real estate that served as the underlying collateral, but the banks got to choose their assumptions about what the assets were worth. Objective analysts relied on their own work, or on indices published by firms such as markit.com. That way a few alert observers estimated reasonable values and forecast the trouble in the banking sector accurately enough. Banks did their best to fudge and keep marks on bad assets as high as possible until they were forced to take write-offs, usually when they filed their annual 10-K reports.
But the old form of FAS 157 was defensible in one respect. If you don’t have a price quote, you do need something else to value an asset. It’s just a matter of whether you are sincerely trying to estimate the most accurate value — or if you’d rather defend a value that you wanted to put on your books before your did your analysis in the first place.
Now, if we understand the first reports on the new FAS 157, banks are actually getting latitude to disregard current market prices of assets if they deem that such assets are trading in a temporarily distressed, “fire sale,” market. Gee, I wish my broker would let me do that, and take cash out of my account on that basis too.
Without having actually seen the new guidelines, it would seem that unless the security actually stops paying interest, a bank can value it at 100 cents on the dollar even if that same security or substantially similar ones are trading at significant discounts in the markets. If you think we had a transparency problem before, we’ll now have to read bank 10-K’s as if they were written by the old Soviet press agency TASS. Will banks even have to write footnotes telling us which assets would sell at a discount in the current market, and for how much? And how detailed would those disclosures have to be? Inquiring minds would really like to know. At least under the old system banks and their auditors felt they had to ‘fess up at year-end about a fair portion of the bad stuff, and give us some hints about where other problems might lie.
Now it appears that nearly all banks get to claim that their problems are a near term, liquidity issue (their assets are good but can’t be sold into a panic) rather than a solvency issue (many assets permanently impaired). We think the latter is true for at least some of the major banks, and as stated in previous columns, we’d expect the bad assets to drop in value as a weakening economy forces additional borrowers to default.
The banks of course are arguing that they can all earn their way out of their problems, we illustrated in our column on the Bank of America — all we have to do is let them tell lies for awhile. We’d better hope so. The truth is, we don’t know if the borderline institutions can earn their way out, we won’t know for several years, and during that time anyone trying to understand the balance sheets of many banks might be even more clueless than they were under the previous rules.
We also have to think back to the money market panics of 2007 and 2008, where credit froze up because people didn’t know which banks were safe to lend to. If bank balance sheets become even less believable than they are now, the only thing making it safe to lend to a US bank, is the implicit guarantee from the Treasury and the Fed. The Government will continue to have to support weak institutions that no one understands, for an indeterminate time, rather than liquidating the weak institutions. We have taken a giant step toward semi permanent bank nationalization (in fact but not in name) and seem poised to repeat the mistakes of the Japanese.
We also agree with independent accounting analyst Robert Willens, who says that the new accounting standard will conflict with the Treasury’s PPIP program, whose objective is to get the banks to sell their bad assets. While PPIP is a taxpayer rip-off, at least before the April Fool’s Rule PPIP would have induced banks to sell off weak assets (by offering banks more than the weak assets are worth), even if the price paid might be less than 100 cents on the dollar. But under the new rule, why sell anything if you can avoid taking a writedown at all… unless of course… in several years the borrowers default and the asset goes to pennies on the dollar….
But the market loves it. Banks lead the DJIA to a gain of 245 as we write, an hour and 45 minutes into the April 2 session. So for now April Fools remain that way. At least on New Year’s Day you know if you’ve drunk too much the night before.