Farewell Monsieur Allais

"In essence, the present creation of money, out of nothing by the banking system, is similar - I do not hesitate to say it in order to make people clearly realize what is at stake here - to the creation of money by counterfeiters, so rightly condemned by law." Maurice Allais - Nobel Prize in Economics - 1911-2010.

"In fact, without any exaggeration, the current mechanism of money creation through credit is certainly the "cancer" that's irretrievably eroding market economies of private property."

"La Crise mondiale aujourd'hui" (Éd. Clément Juglar, 1999).

also author of the "Allais paradox".

A great loss for France. A great economist and a great mind.

Resolution Trust Corporation II - the unavoidable Sequel

How to fix the US Commercial Real Estate Mess:

The US need a Resolution Trust Corporation similar to the one put in place during the Saving and Loans Crisis. The RTC was established in 1989 until mid 1995 and closed or otherwise resolved 747 thrifts with total assets of 394 billion USD.

http://en.wikipedia.org/wiki/Resolution_Trust_Corporation

"The Resolution Trust Corporation pioneered the use of so-called “equity partnerships” to help liquidate real estate and financial assets which it inherited from insolvent thrift institutions. While a number of different structures were used, all of the equity partnerships involved a private sector partner acquiring a partial interest in a pool of assets, controlling the management and sale of the assets in the pool, and making distributions to the RTC reflective of the RTC’s retained interest."

Between 1986 and 1991, the number of new homes constructed per year dropped from 1.8 million to 1 million, which was at the time the lowest rate since World War II.

Where are we now? In a worse situation than anytime between 1986 and 1991.



The hole is much deeper. We have beaten the record since the Saving and Loans crisis. Desperate times need decisive action and setting up a new RTC would definitely be the right move in the right direction.

We have a lot to learn from the Saving and Loans crisis:

http://en.wikipedia.org/wiki/Savings_and_Loan_Crisis#Imprudent_real_estate_lending

"Between 1980 and 1994 more than 1,600 banks insured by the Federal Deposit Insurance Corporation (FDIC) were closed or received FDIC financial assistance."

How many banks failure have we had so far this year? 129 banks went under and the year is not over yet.

In 2009, 140 banks failed.

Because the situation is worse than during the Savings and Loan Crisis, where 1600 closed down or received help, you can expect more bank failures in this ongoing crisis.

http://bankpred.blogspot.com/

"If you look at the most recent FDIC statistics on problem banks, you would see that there were 829 problem banks at the end of the last quarter."



Don't believe the situation is improving in the CMBS space:



This is what the banks are in fact doing with their damaged Commercial Real Estate Exposure:



B notes are comparable to Sub debt where the coupon payment is deferred (similar to Upper Tier 2 financial paper).

But it isn't only happening in the Commercial Real Estate space. Many large banks have recently suspended foreclosures, kicking the can down the road:

http://online.wsj.com/article/SB10001424052748704657304575539963605720860.html

"As of August, there were more than 4.4 million home loans that were either in the foreclosure process or 90 days past due, according to mortgage research firm LPS Analytics. Since 2006, about 6.4 million homes have been lost through the foreclosure process."

According to the article, it is due to documentation issues...I don't believe it is the real reason.

"Bank of America services 14 million mortgages, or one out of every five in the U.S., and its loan-servicing portfolio exceeds $2.1 trillion in size. Of its mortgages, 10 million came from its 2008 acquisition of troubled California lender Countrywide Financial Corp. More than 80% of its delinquent loans were acquired through Countrywide."

Given that 1 out of 4 US Household is already in negative equity, you can do the math.

The Mortgage mess:



In addition to the rising delinquencies in Mortgages, the Unsecured Home Equity Loans exposures of large US banks have not been resolved (the HELOC time bomb).



http://www.housingwatch.com/2010/04/13/the-heloc-bust-next-problem-for-big-banks/

"In an interview with Bloomberg, CreditSights' senior bank analyst Baylor Lancaster said: "While a lot of people are looking for dramatic improvement in the short term, one area that still has to be worked through in a material way is home equity." The writedowns from HELOCs are not likely to show up in earnings reports until later this year, Lancaster said."

"Together with Citigroup the banks hold about 42 percent of the $1.1 trillion in second-home liens. Unlike first mortgages, they are typically not bundled and sold off to investors but kept on the banks' books. The biggest home-equity lender in the U.S. is Bank of America, holding some $138 billion in such loans. Wells Fargo has about $123.8 billion of home-equity loans."

In addition to these unresolved issues:

"Fannie and Freddie are "actively exercising their right to put back to the original lenders a considerable amount of the troubled mortgages in their portfolios," write analysts Tom Abruzzo and Christopher Wolfe. The agencies have a right to require lenders to buyback delinquent mortgages, if it is determined the mortgage loan did not meet GSE investor underwriting or eligibility standards."

http://www.housingwire.com/2010/08/19/fitch-big-four-banks-face-180bn-in-buybacks-from-fannie-and-freddie?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed:+housingwire/uOVI+(HousingWire)

"Under a moderate loss scenario, in which the banks buyback 35% of delinquent loans and recover 55% of the money, Fitch expects losses around $27bn."

http://www.benzinga.com/10/09/485561/%E2%80%9Cthe-giant-elephant-in-the-room%E2%80%9D

"“Home equity is the giant elephant in the room and everybody knows it,” said Anthony Sanders, a finance professor and director of the Center for Real Estate Entrepreneurship at George Mason University."

"“If 25% of mortgages are underwater, [the second liens on those homes] should be classified as nonperforming loans, which would require a 50% reserve,” said Rebel Cole, a finance and real estate professor at DePaul University in Chicago and a former Federal Reserve Board economist."

"The four institutions now hold at least $423 billion of home equity loans, including $151 billion of loans to borrowers who are either underwater or close to it, according to data provided to the House Financial Services Committee in April."

You need to watch very closely the delinquency rate for second liens loans.

"Banks are required by regulators to charge off loans after 180 days of nonperformance, according to the Fed and the Office of the Comptroller of the Currency, which supervises large banks that service 65% of all mortgages.

A bank does not have to classify a home equity loan if the value of the property has dropped, said Bryan Hubbard, an OCC spokesman.

But Cole and others argue that banks ought to reassess the underlying credit quality of loans and account for problem credits if the collateral has changed. “Regulators have the power to force the banks to reserve against these loans, but choose not to do so,” he said."

"Gerald Hanweck Sr., a finance professor at George Mason and a former visiting scholar at the Federal Deposit Insurance Corp., agreed that banks are loath to take losses on performing loans even if the value of the home has dropped 30% or more and a default is likely."

"“The banks have been accounting for [home equity loans] at par and the reason is that supervisors won't force the writedowns,” Hanweck said. “If the loan is performing, that's their fallback, but the underlying value of the property is still less and is insufficient to support the valuation.”

But forcing writedowns would have negative consequences for capital positions, which banks have spent the last few years rebuilding and will have to further buttress in coming years under the new Basel III standards."

Allowing banks to repay TARP money early was not a smart move:

"Lenders Balk at Buying Back $11 Billion in Bad Loans from Fannie Mae and Freddie Mac"

http://www.realestatechannel.com/us-markets/residential-real-estate-1/real-estate-news-fannie-mae-freddie-mac-edward-j-demarco-federal-housing-finance-agency-bad-home-loans-loan-default-rates-home-foreclosures-fhfa-3266.php

"Banks that sold bad mortgages to Fannie Mae and Freddie Mac promised to buy the loans back, according to their regulator. But many of the nation's largest institutions aren't living up to their end of that commitment, reports DSNews.com."

http://www.thestreet.com/story/10865656/1/mortgage-buybacks-hit-profit-not-capital.html

"Miller's assumptions for a "base case" scenario show that Bank of America stands to lose $9.1 billion, or 34 cents per share, on both Fannie-Freddie and private-label buyback demands. JPMorgan Chase stands to lose $8.7 billion, or 27 cents per share; Citigroup stands to lose $3 billion, or 5 cents per share; Wells Fargo $2 billion, with no per-share loss estimate provided; SunTrust $1.05 billion, or 31 cents per share; Morgan Stanley $948 million, or 44 cents per share; and other lenders less than $500 million."

Setting up a new RTC would alleviate the burden face by banks. Until all the toxic assests have been dealt with, the crippled financial sector will not function properly. The banks are hoarding cash due to these issues and cannot participate in a sustained recovery through lending and enabling investment. It will take a very long time to clean up all the mess. By not appropriately dealing with these toxic assets issues today via a new RTC means it will take a much longer period for the economy to heal. We will see more bank failures in the process.

Hemingway: Kicking a can down the road illustrated...

Analyze this

Allied Irish CDS Sub, you know the score from the previous post (Source CMA DataVision):



Anglo Irish CDS Sub on the 6th of October, can you spell default? (Source CMA DataVision):



and on the 7th of October, this is how it looks like for Anglo Irish Sub...2743.85 bps on the 5 year CDS...300 bps wider!



Debase this! Check out the evolution of the USD since 1971 against:

Japanese Yen:



Have a look at 1985 on the Graph and the huge rise in the Japanese yen following the 1985 Plaza Agreements which spelt economic disaster for Japan and the crash of the Japanese economy and the Nikkei index at the same time. 1985 to 1990, 240 to 120, bring it!

At around 82 JPY per USD I don't expect the BOJ to stay idle...

Swiss Franc:



and the evolution of the US dollar versus the Euro since 1999:



An interesting view of the evolution of Fed Funds Rate since 1950:



And the evolution of Oil prices since 1940:



Gold is continuing its steady rise:



At the same time we have Secretary of Treasury Timothy F. Geithner still gesticulating around China and the ongoing Debasing game taking place. Pathetic...

http://www.treasury.gov/press/releases/tg894.htm

"The Framework, called the "Framework for Strong, Sustainable and Balanced Growth," was designed to create stronger incentives for rebalancing growth, as the world recovered from the crisis, with higher savings in countries like the United States, complemented by reforms to strengthen domestic demand in surplus countries like China, other emerging economies, Germany, and Japan.

Alongside this "Framework" we agreed to give emerging economies a greater stake in the most important institutions for economic and financial cooperation, to increase the resources available to the international financial institutions, and to make the G-20 the centerpiece of cooperation, replacing the role traditionally played by the G-7."

Dear Tim, I don't think you have a choice in relation "to give emerging economies a greater stake in the most important institutions for economic and financial cooperation." Guess it is a done deal with China, India and Brasil...

"We have moved aggressively to do our part to help bring the world out of crisis. We are working very hard to repair our financial system, to fix what was broken, and to reduce the future risk of financial crises here at home. We have seen a very significant increase in private savings by households. Our external deficit has fallen sharply, and we are financing at home a much larger share of the fiscal deficits we inherited."

Wow!
Who in the first place put us ALL in this mess? Was letting Lehman Brothers going down a wise decision? I don't think so. In relation to reducing the future risk of financial crisis, I disagree, banks are still too big to fail. Fannie Mae and Freddie Mac are a joke and should be gradually winded down. The commercial real estate disaster is still an ongoing concern: 129 banks down this year so far and counting.

Hey Tim, where were you working before taking up the role of Secretary of the Treasury? Weren't you president of the New-York Fed from 2003? Were you not in charge of supervising and regulating financial institutions? Great work!
In May 2007, did you not work on reducing the capital needed to run a bank? Great timing! Was the "excellent" Lawrence Summers your mentor previously? It would explain a lot...

Nice one Tim, just like you tried to talk to the Chinese about how safe it was to invest in the US...
"On June 1, 2009, during a question-and-answer session following a speech at Peking University, Geithner was asked by a student whether Chinese investments in U.S. Treasury debt were safe. His reply that they were "very safe" drew laughter from the audience."



Tim, you can always send your CV to your buddy Hank Paulson, I am sure he can help you land a good job at Goldman Sachs...

Tim also added in the same speech:
"That brings me to the second policy challenge: we believe it is very important to see more progress by the major emerging economies to more flexible, more market-oriented exchange rate systems. This is particularly important for those countries whose currencies are significantly undervalued.

This is a problem because when large economies with undervalued exchange rates act to keep the currency from appreciating, that encourages other countries to do the same.

This sets off a damaging dynamic, described first by my former colleague Ted Truman, as "competitive non appreciation." Over time, more and more countries face stronger pressure to lean against the market forces pushing up the value of their currencies. The collective impact of this behavior risks either causing inflation and asset bubbles in emerging economies, or else depressing consumption growth and intensifying short-term distortions in favor of exports.

This is a multilateral problem. It is unfair to countries that were already running more flexible regimes and let their currencies appreciate. And it requires a cooperative approach to solve, because emerging economies individually will be less likely to move, unless they are confident other countries would move with them.

This problem exposes once again the need for an effective multilateral mechanism to encourage economies running current account surpluses to abandon export-oriented policies, let their currencies appreciate, and strengthen domestic demand."

The message is that the US is concerned that everyone is devaluating at the same time and they would like to be the only one playing this game to restore competitiveness. Tim would also love China to explode like Japan did after the 1985 Plaza Agreement. Unfortunately, dear Tim, Chinese are not stupid and are well aware of the risks. If the US hadn't based 70% of its GDP on Consumption and was actually producing more and exporting more, they would not be in such a difficult situation.