Mark to Market Madness … Geithner Plan Shenanigans … Economy in Crisis
Politics / Credit Crisis Bailouts Apr 03, 2009 - 03:24 AM GMT
Mike Larson writes: I've had a lot on my mind this week, and so has the market. Mark to market accounting … the Geithner plan … and the latest economic data have all been capturing the attention of investors. So I want to share my latest thoughts on all of these market drivers, and explain where we're likely headed next …
Mark to Market Accounting Mess Shows That Congress, Bankers Just Don't Get It …
This week, the Financial Accounting Standards Board (FASB) caved on the mark-to-market accounting front. Members of the board agreed to give financial institutions more flexibility in valuing assets, including the “toxic” ones that have given investors so much agita.
You could see this coming a mile away because Congress has essentially been browbeating the group into submission. Recent hearings and commentary from legislators made it clear that if FASB didn't kowtow to the banking lobby and amend mark-to-market standards, Congress would find a way to make it happen.
Where do I stand on this? I made my position abundantly clear on March 13, when I wrote the following in my Money and Markets column:
“Look, the problem isn't that there's NO market for these bad securities. The problem isn't that the prices are “artificially” low. The problem isn't how we account for these assets. The problem is that the industry doesn't want to acknowledge that today's prices are the REAL prices .
There are tons of bidders out there for this crappy paper … at the RIGHT price. Vulture funds, hedge funds, private equity investors: They're all raising billions and billions of dollars to scoop up cheap real estate, inexpensive bundles of mortgage backed securities, and distressed buyout loans.
But sellers don't want to admit reality. They're not hitting the buyer's bids. They're hanging on to the garbage securities, hoping against hope that they won't have to sell at the true market prices. And the government is busy trying to figure out ways to prop up the price of the garbage rather than forcing banks to take their medicine now, even if it means the result is that they have to temporarily be nationalized or put into receivership.”
Nothing has changed my opinion since then. The banking lobby argues that because many of these assets are still spinning off principal and interest payments, they should be able to carry them at full value or close to it — not the supposedly distressed, “false” market prices.
But look at the performance of the asset markets underlying the toxic paper! Those markets aren't getting better. They're getting worse.
The latest figures from S&P/Case-Shiller showed housing prices plunging 19 percent year-over-year in January. That was the biggest yearly drop on record. The monthly decline (2.8 percent) between December and January was the biggest ever seen. Every single market showed deteriorating prices. Heck, I've seen a few isolated examples of properties changing hands or being listed at prices they haven't seen in more than a decade — or two!
At the same time, FHA loan delinquency rates are rising. Fannie Mae and Freddie Mac 90+ day late payment rates are surging. The number of borrowers who are “upside down” — meaning they owe more on their mortgages than their homes are worth — continues to climb month after month.
All of this tells us that while some of these securities may be spinning off income NOW, the likelihood they will continue to do so in the FUTURE is going down. So while the comments that the banking lobby are making may be TECHNICALLY accurate, they certainly don't prove the “real” value of these securities should be much higher.
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| The John Hancock Tower was just sold on the auction block for 49.2 percent less than it went for three years ago. |
And it's not just residential real estate where the underlying assets are tanking. Take the John Hancock Tower in Boston. It's a prized piece of trophy real estate, the tallest building in New England, and it changed hands at $1.3 billion in 2006.
Well guess what? It was just re-sold in a foreclosure auction. The price? $660.6 million. Total decline in value? 49.2 percent in less than three years.
Meanwhile, according to The Wall Street Journal , delinquencies on commercial mortgages are soaring. The delinquency rate on $700 billion in securitized commercial real estate loans has more than doubled in just the past six months. At 1.8 percent, it's still low on an absolute basis. But it's the direction that counts, and analysts are now expecting delinquency rates to rival those seen in the early 1990s commercial real estate collapse.
So what does that say about the value of CMBS — Commercial Mortgage Backed Securities? You guessed it: The value of those securities SHOULD plunge. Yet industry lobbyists claim that it's not crappy fundamentals driving their value down, it's illiquidity — and that they shouldn't have to take big mark downs as a result. What a joke!
Geithner Plan Structured as a Blatant Wall Street Giveaway …
Let me ask you a question: Suppose you wanted to buy something that has an even chance of being worth nothing or $200 a year down the road. You might be willing to pay $100 for it, because you have a 50/50 chance of doubling your money.
Now say the government came along and said: “We're going to give you 92 bucks to buy this asset, and if you “win,” we'll only take 50 percent of your profit. If you lose, we'll eat almost all of the costs.”
Not a bad bargain, eh? You might even say it's a great one. And since you have so little money at stake (8 percent of the purchase price), you might even be willing to pay an inflated price for the asset — say, $150. In that case, you'd have to put up just $12, while the government would give you $12 in equity and a $126 guaranteed loan.
In a “win” scenario (where the asset goes to $200), you pay back the government's $126 loan and you split the $74 profit 50-50. Congratulations! You just made $37 on a $12 investment. Your partner, the government, who took on $138 in risk, also made $37 — but received a much smaller percentage return.
In a “lose” scenario, you take a $12 hit. But the government gets stuck with a loss of $138.
Talk about a sweetheart deal! And I'm not pulling these numbers out of thin air. They come directly from a damning New York Times op-ed piece by Joseph Stiglitz, a Nobel prize-winning economist and professor at Columbia University. He added:
“The Obama administration's $500 billion or more proposal to deal with America's ailing banks has been described by some in the financial markets as a win-win-win proposal. Actually, it is a win-win-lose proposal: The banks win, investors win — and taxpayers lose.
“Treasury hopes to get us out of the mess by replicating the flawed system that the private sector used to bring the world crashing down, with a proposal marked by overleveraging in the public sector, excessive complexity, poor incentives and a lack of transparency.”
If you're not outraged that we're bailing out the banks in this fashion, you should be. Martin and I have advocated a much different approach, one we believe is both fairer and more effective. You can read about it in the white paper Martin recently presented in Washington, DC, to the National Press Club.
If we continue down this current path, we're going to look a heck of a lot like Japan in the 1990s. And we're far from the only ones to arrive at that conclusion. As Adam Posen, the deputy director of the Peterson Institute for International Economics, recently wrote:
“A number of major American banks have lost huge amounts of money, and clearly have insufficient capital if they are not literally insolvent. Why else would they be pushing so hard to change the accounting rules to avoid showing what they really have on their books instead of raising private capital? Why else is the U.S. government taking so long to perform “stress tests” and trying to get expectations of overpayment for some of the bad assets on the banks' books before the test results are out? In short, the U.S. government is looking to shovel capital into the banks without sufficient conditions, hiding rather than confronting the actual situation.
“That is just like the Japanese government in their lost decade, or the U.S. officials during the 1980s before they really tackled the savings-and-loan crisis. In those cases, the delay simply made the problem worse over time and in the end the government had to put more money into the troubled banks directly, taking over or shutting down the weakest of them.”
The Latest on the Economy
I read and hear a lot of talk about how the economy has supposedly “bottomed” and how we're ready to be off to the races again. To which I say “Huh?”
While I may be the first to admit we've gone from “all terrible” news to “slightly less than terrible,” I can't find any evidence of any kind of lasting, V-shaped recovery or even a dramatic turn.
Pending existing home sales? Sure they were up 2.1 percent in February. But that gain came after a 7.7 percent PLUNGE a month earlier. The sales index, at 82.1, was still at its second-lowest level on record.
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| Continuing jobless claims topped 5.72 million — the highest ever recorded in 42 years of record-keeping. |
The job market? An epic disaster according to the employment services firm ADP. The company said the economy shed a whopping 742,000 jobs last month, the biggest drop ever and much worse than economists were expecting. Initial jobless claims just climbed to 669,000, the highest since October 1982, while continuing jobless claims topped 5.72 million — the highest ever recorded in 42 years of record-keeping.
Consumer confidence? Yes, it was “up” in March. But by a lousy 0.7 points. The reading of 26 was worse than economists were expecting and the second-worst reading (after February) in the index's 42-year history.
Also worth noting: The percentages of survey respondents saying they planned to buy cars, homes and major appliances all dipped on the month. In fact, only 2 percent of those polled said they would buy a house, the lowest reading since October 1982 — when the average 30-year fixed mortgage went for 14.6 percent.
Where to from Here …
Now that the big mark-to-market change is behind us, I believe a “sell the news” reaction is possible. I wouldn't be surprised one bit if the financial stocks gave up a sizable chunk of their recent gains. Changing the way you account for losses on bad assets doesn't mean the losses have gone away. If anything, the obfuscation of those losses will drive investors away because balance sheets in the financial sector will become more opaque.
I also believe that Geithner's bad asset plan is going to see more and more resistance in Congress and the court of public opinion. As the details get fleshed out more on the airwaves, the Internet, and the pages of The New York Times , more people are going to come to the same conclusion that I have: It's a blatant giveaway to hedge funds, mutual funds, and other financiers from U.S. taxpayers.
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| Protesters at the G-20 meeting in London give a clear sign that people aren't happy with what they see going on. |
Will people really stand for that?
They're already fed up with the industry — you need only look at the protests in the streets of London during the G-20 meeting to see that. So don't be surprised at all if this plan stalls out, and if financial stocks weaken as a result.
As for the economy, I wish I could be more optimistic. But I think anyone buying into the recent stock market rally on the assumption the economy is roaring back is going to be sorely disappointed. I'd stick with hedges like inverse ETFs, because I believe stock prices are not done going down.
Until next time,
Mike
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