Thursday, January 29, 2009
Freshwater and Saltwater: macroeconomic theory and losing money
Wednesday, January 28, 2009
Scandinavian bank collapse - not all the same
It seems that some central bankers read this blog. I got an email from a senior Scandinavian central banker following the exchanges on this blog (see this exchange for an example).
Anyway he points me to a note by P Honohanen of the World Bank (written several years ago) and which I reproduce here. I think this should close some of the debate. Either way it is useful if you wish to know what actually went on...
For several years it has been fashionable to look to Sweden as offering a policy model for recovering from a banking crisis. And your editors have to admit that, along with most other commentators, they had been inclined to assume that the Swedish case was mirrored by the roughly contemporaneous crises in the rest of Scandinavia. But the Norwegian crisis actually predated that in Sweden and, as we have discovered by reading the comprehensive volume on the Norwegian case which has just been published by Norges Bank (“The Norwegian Banking Crisis”), containment and resolution policy was quite different. Certainly the two countries both made a good recovery: on some reckonings the Norwegian government, like that of Sweden, may have ended up with a small cash profit after selling back into the market bank shares that it had acquired in the crash. Though sometimes thought of as a classic macro boom-and-bust, the Norwegian crisis may be better classified as the result of inexperienced bankers trading in a newly liberalized market with recently lowered capital requirements and a sharply reduced frequency of on-site supervisory inspection. The crisis was a big one: the three largest banks (DNB, Fokus and Christiania) all failed along with many smaller banks including sizable regional banks. The privately owned and managed deposit protection schemes were overwhelmed and had to be nationalized – illustrating a weakness inherent in what is otherwise a good idea: distancing deposit protection from the government. Government took ownership of the major banks – and retains, for strategic or political reasons, a major stake in DNB. But, and this is the first important contrast with the policy stance adopted in Sweden, in no case were shareholders bailed out. (Yes, the authorities were sued by disappointed shareholders, but unsuccessfully.) Two other key points to notice: government did not issue a blanket deposit guarantee and they did not set up Asset Management Companies. These striking contrasts certainly argue for avoiding knee-jerk application of the Swedish policy approach in these three dimensions.
The perfect appointment
What is a non-performing loan?
Turning to the consumer portfolio, we also continued to be very aggressive in restructuring consumer loans, modifying over $200 million in the quarter. We believe restructuring loans where appropriate will result in significantly greater likelihood of payment and more value ultimately received by Fifth Third. These activities are beneficial not only to our shareholders, but are also consistent with the needs of our customers. [Sheila Bair’s line precisely – are they pandering?]As of year end, we had $574 million in troubled debt restructurings and NPAs, classified that way because they hadn't met the six-month consecutive performance threshold. [Hey wow – they count restructured loans as non-performing – so they are not producing the Conseco fake numbers… My cynicism is misplaced in this instance.]Fifth Third has been among the most active of banks in the US in restructuring loans for consumer borrowers, a process we began over a year ago. We've been among the most active among our peers in these restructurings only one of the 15 largest US banks reports a higher dollar amount of restructured loans among its nonaccrual loans, according to regulatory filings.
Tuesday, January 27, 2009
Reaction to the Helicopter post
- those that didn’t get it
- those that got it but may have had ethical problems, and
- those that understood it all too well.
You only give something away when you think it is worthless and what you get is of greater worth. While seeing the riots after Bens helicopters came past I surely want buy a new car.
It won't work because immediately after the drop, Congress would arrest Bernanke along with the entire Fed board (probably replace it with a money czar)…. Politicians would be forced to promise responsibility and accountability in the face of the threat of civil unrest - don't forget, a lot of people own guns legally in this country. There will be new laws designed to keep the value of the dollar. In the end, the dollar would get stronger, not weaker…
Monday, January 26, 2009
Why the Federal Reserve should LITERALLY throw money out of helicopters
It seems to me that what we are seeing is simply the balance sheet consequences of the Fed's decision to take the wholesale money market onto its own balance sheet. Banks (and other entities) that used to lend to one another, are now lending and borrowing through the intermediation of the Fed. This is so not just domestically but also internationally (the huge swap line), since foreign banks used to fund dollar asset holdings in the dollar money market.In this view, inflation seems much less likely. Why not? If the original wholesale money market borrowing and lending was not inflationary, then why should its substitute be inflationary? Indeed, the real question is whether the expansion of the Fed's balance sheet is keeping pace with the contraction of money market credit more generally. If not, then the consequence may be deflationary.Posted by: Perry Mehrling at December 22, 2008 05:12 AM
Saturday, January 24, 2009
Felix Salmon asks the question: is nationlisation contagious?
Friday, January 23, 2009
Scandinavian bank nationalisation and due process
Amendments were also made to the banking law, enabling the government under certain conditions to write down a banks shares to zero. This ensured that share capital really was written down to the extent that capital was lost.It was soon realised that Christiania Bank and Fokus Bank had lost their entire share capital. The share capital in Den norske Bank was written down by 90% according to losses. The banks needed more capital, but private investors were unwilling to invest. All three banks thus received a substantial capital infusion from the GBIF [which was an independent but government owned bank manager] at the end of 1991. Conditions were established regarding balance sheet restructuring/downsizing, cost cuts and other measures to improve results. Share capital was written down to cover estimated losses. In both Christiania Bank and Fokus Bank the share capital was written down to zero by government decision (after shareholders had refused to do so). The existing shareholders thus did not receive anything for their shares, and the GBIF became the sole owner of the two banks. The boards and the top management were replaced. The banks received further capital support from the GBIF in 1992.
Thursday, January 22, 2009
The last bank with an antidilution clause...
Barclays has one.
Implication - either Abu Dubai waives the clause or it is confiscation for Barclays.
If I were Abu Dubai I would be waiving the clause NOW.
But then I was not long Barclays - unlike SMFG who put almost 700 billion yen in only a little while ago. (Hey what is 700 billion yen between friends?)
Zero in Japan versus zero in America
I don’t have a solid economic model of different types of zero interest rate policies. I guess the number of instances historically doesn’t give us enough material to get a classification. But this is worth stating.
Zero in Japan looks very different from how zero in America looks right now.
How Japan looks
One of the first posts on my blog was about 77 Bank. 77 is a typical mid sized Japanese regional bank. It has vast excess deposits. It has plenty of liquidity – but almost nobody to lend it to. Competition to attract worthy borrowers is intense – and is led by prices. Loans are typically made on less than 50bps of margin.
The banks are bizarrely unprofitable. At 12 times leverage and a spread after costs of about a third of a percent the return on equity – before tax and provisions – is about four percent.
Businesses – at least ones with any claim to be credit worthy – have no trouble borrowing at all in Japan.
There is however a problem with these low spreads – a very big problem. Japanese banks are vulnerable to very low levels of credit losses. A loss rate of a third of one percent wipes out profit. A loss rate of 2 percent sustained over a couple of years would wipe out half the capital.
Summary: Japan has zero rates and the banks can’t make a spread because they have no willing borrowers. The banks have no liquidity problems – but they have a capital problem whenever losses rise to merely low levels from extremely low levels. The reason banks stopped lending was that there were insufficient willing borrowers.
The broken bank in Japan is a “zombie” (living dead). It has insufficient capital and not enough spread to rebuild capital over even a decade. It has enough liquidity to limp on for many years. However it often is attracted to riskier loans in a vain effort to find some spread – and it is prone to blow ups. For a long time Nishi Nippon City bank looked like that.
Note that Japan is now facing credit losses of a couple of percent - and that is high enough to cause widespread devastation to the low-spread Japanese banking system.
How the US looks
Most US banks have spreads after costs well above two percent of assets. Wells Fargo for a long time has had an interest spread above five percent. Spreads are still that high or higher.
In the good times background loss rates were one percent or more. Indeed there were plenty of businesses in the US which worked fine with three percent background loss rates (much car lending for instance).
There is no shortage of willing borrowers. Indeed there are plenty of worthwhile projects at the moment that have a hard time being funded because the banks don’t have any money available. Banks can’t fund themselves as the market for senior bank funding has shut down. The reason banks have stopped lending is that there are insufficient people willing to provide funds to banks. In plan parlance banks don’t lend because they can’t borrow.
It is trite – but the key difference is between a current account deficit country and a current account surplus country.
The deficit country has to borrow from abroad. Banks intermediate the deficit and the banks are subject to hot money flows.
Being subject to hot money flows the banks are subject to runs – very big and destructive runs.
The banks in those countries fail fast. Japanese banks by contrast remain as zombies (living dead) with insufficient capital but enough liquidity to last decades.
In current account deficit countries nationalisation or part nationalisation is a common end-game for a financial crisis.
Lots of people talk about Sweden (or better Norway) because they did their nationalisation well. But another example is Korea – where the bank blew themselves up too – and were critically dependent on (Japanese) money which became rapidly unavailable.
I know how these things look. I don’t have a decent model grounded in facts-on-the-ground.
I am surprised at the tone of the WSJ story about Japanese regional banks needing a bailout. They don’t need it from a liquidity perspective – they need it from a capital perspective. The WSJ story does not make this clear.
In America and the UK the banks have (serious) liquidity problems. I am not sure they have capital problems. Indeed my view is that there is no capital problem in the system – but the banks individually might have issues. The reason there is no capital problem in the system is that the underlying pre-tax pre-provision profitability is about 400 billion per annum.
Am I right that the system has adequate capital?
This view looks really controversial. It is just assumed – more or less by all pundits – that the banks are insolvent. Krugman’s latest piece on zombie banks is just one of many.
But the pre-crisis net tangible capital of the US banks was about 1.4 trillion. About 500 billion has been raised or defaulted since the crisis began. So call it 1.9 trillion. The pre-tax, pre-provision profitability has added another 400 billion per year to the pool – so we are at 2.3 trillion or more. A few hundred billion of the losses are borne outside the banking system.
If total losses get to the 3 trillion numbers that Roubini talks about. the system will get to neutral capital in two years and be fully recapitalised in five. If those numbers are right this is not a capital problem – it’s a liquidity problem.
The problem is serious though – and nationalisation may be the right prescription. It appears – as a matter of fact – to be the end game in countries which have current account deficits and banking crises (see Korea, Sweden, Norway). I am just not sure how to do it right – and when people (like Krugman) borrow the expression “zombie banks” from Japan I think they are substituting words for clear thinking.
I guess the thinking is hard though. If I thought all this stuff through clearly enough I would have that Nobel Prize in economics. Alas I did my last academic economics twenty years ago.
Decline and fall of the British Aristocracy
Wednesday, January 21, 2009
Buiter's Modest Proposal
He also advocates the scrapping of anything that looks like process. Here is his “modest proposal”:*
(1) Take into complete state ownership all UK high street banks. This has to be mandatory, even for the banks that still like to think of themselves as solvent.
(2) Fire the existing top management and boards, without golden or even leaden parachutes, except those hired/appointed since September 2007.
(3) Don’t issue any more guarantees on or insurance for existing assets - regardless of whether they are toxic, dodgy or merely doubtful. Issue guarantees/insurance only on new lending, new securities issues etc. A simple rule: guarantee the new flows, not the old stocks. This will reduce the exposure of the government to credit risk without affecting the incentives for new lending.
(4) Transfer all toxic assets and dodgy assets from the balance sheets of the now state-owned banks (or from wherever they may have been parked by these banks) to a new ‘bad bank’. If possible, pay nothing for these toxic and dodgy assets. Since the state owns both the high-street banks (I won’t call them ‘good’ banks) and the bad bank, the valuation does not matter. If the gratis transfer of the toxic or dodgy assets to the bad bank would violate laws, regulations or market norms, let an independent party organise open, competitive auctions for these assets - auctions in which the bad bank, funded by the government, would be one of the bidders. Whatever price is realised in these auctions is paid by the new bad bank to the old banks.
My only real problem here is in step 1. It is spoken with the true arrogance of someone who has never traded markets for a living.**
Now I am as sure as anyone about the parlous state of UK banking. Here are two very early posts on this blog about the state of UK banking – see this post on Royal Bank of Scotland and this one on Barclays. These posts were over six months ago. (I declare victory on them.)
Bethany McLean did a story in Fortune magazine about Royal Bank of Scotland. The story looks fantastic now – have a look. Although I was anonymous at the time (the story pre-dates this blog) I was one of the people she spoke to for that story.
But I wasn’t absolutely sure then that the banks were insolvent and I am not absolutely sure now. Indeed whilst I thought that Barclays would probably fail but that Royal Bank of Scotland might survive. The pair – long RBS, short Barclays was one I talked about but (fortunately) did not do.
The problem. There is no way that I am buying a bank stock – any bank stock – unless I know the new rules. I have no problem with nationalisation – indeed I blogged about it in the context of Norway as early as July– and the feedback was all negative – with the general view being “that it is unrealistic for America”. What I would like however is process for dealing with the residual rights of shareholders and preference share holders. [There was such a process in Norway - and one bank was only ninety percent nationalised...]
Sure: guarantee new funding. You don’t want to guarantee old funding because that increases contingent state liabilities to some enormous level. This buys you time. Use that time for a process to determine (fairly and with a right of refusal to old shareholders) the situation for new shareholders. The sort of idea that I have is that shareholders should be able tip in new capital in exchange for government guarantees on the new funding. There should be substantial new capital required (perhaps an amount determined by a third-party independent accounting structure) in exchange for these guarantees. Moreover the government should be paid an amount for the guarantees. Taxpayers take risk and should be compensate for that risk.
My guess – is that faced with a true accounting – there will be no new capital. But I really am not sure. HSBC probably could raise some. Barclays I doubt. RBS – well – it is too late for them.
A six week process which leads to nationalisation is not a major change to Professor Buiter’s modest proposal – and it can be made to fit centuries of thinking about what constitutes good government.
America’s long nightmare of bold and decisive government is over – Mr Buiter’s suggestion is so yesterday...
It is time for a nightmare of due process.
*For those of a less literate bent the phrase “modest proposal” has form. Jonathon Swift circulated a straight faced pamphlet (titled “A modest proposal”) that described – in harrowing terms – poverty and starvation amongst the Irish. He then – with an equally straight face – advocates that the solution is for the Irish to eat their own children. Is Buiter’s modest proposal a suggestion that the British eat their own (banking) children. If so then I have misunderstood Willem Buiter completely.
**I used the phrase “with the true arrogance of someone who has never traded markets for a living”. The people who are really good at trading markets are firm but modest. They are prepared to admit that they are wrong – and will always entertain the possibility. There is a stereotype of the blindingly arrogant bond trader – someone from Bonfire of the Vanities – or more colloquially the “big swinging dick”. Those people are dangerous in markets – and I suspect they are also dangerous giving policy advice too.
Obama: hotter than sex
Whitehouse.com was a pornography site – selling photos of hot teen sex.
But now it feeds news related to Barrack Obama.
Conclusion: there is more money in politics than pornography.
Stock conclusion: avoid all listed pornography companies.
Tuesday, January 20, 2009
Luigi Zingales has it right
He may be a little too jaundiced about nationalisation - but here is the money quote:
Get a strategy
To begin, you (Mr Geithner) need an overall strategy. Even a mediocre strategy is better than an ad hoc approach that confuses markets and fuels the perception of playing favorites. Legendary portfolio manager David Swensen (who in 23 years transformed the $1 billion of Yale endowment into $23 billion) in reference to the government intervention in this crisis commented “the government has done it with an extreme degree of inconsistency. You almost have to be trying to do things in an incoherent and inconsistent way to end up with the huge range of ways they have come up with to address these problems.”
The cost of ad hocery
The cost of this inconsistency is that it has forced the private capital to stay on the sideline. Short of a complete nationalization of the financial sector (which we hope is not in the plan), the problem cannot be resolved without the help of private capital. But a necessary condition to attract private capital back is a consistent and predictable strategy by the government. Without it any other effort is in vain.
I should note I disagree with a lot the rest of Zingales paper - and will explain why in a later post.
I do not oppose nationalisation - but I would prefer that private money came to the fore. Private money will not pony up if they do not know the rules.
The way to do nationalisation is nationalisation AFTER due process. Due process (anywhere) does not seem to have been a hallmark of the Bush administration.
Confiscation without process (WaMu springs to mind) guarantees that there will be a private capital strike.
With a private capital strike everything eventually needs the government to bail it out. Everything - JPM and Goldies included.
Lest you think I disagree with Krugman too much
A slogan for the new administration: nationalisation after due process
Monday, January 19, 2009
Voodoo maths and dead banks
On paper, Gotham has $2 trillion in assets and $1.9 trillion in liabilities, so that it has a net worth of $100 billion. But a substantial fraction of its assets — say, $400 billion worth — are mortgage-backed securities and other toxic waste. If the bank tried to sell these assets, it would get no more than $200 billion.So Gotham is a zombie bank: it’s still operating, but the reality is that it has already gone bust. Its stock isn’t totally worthless — it still has a market capitalization of $20 billion — but that value is entirely based on the hope that shareholders will be rescued by a government bailout.
Sweden, Norway and a request for some decent macroeconomic models
Friday, January 16, 2009
HSBC are thugs (sorry “partners”)
Thursday, January 15, 2009
Riots in Riga
Book review – Gerald Stone’s Who killed channel 9?
- Budget and artistic (and even commercial) relevance are only weakly correlated, and
- Actors, mid ranking staff and all sorts of other people when working collaboratively in an atmosphere of trust can make fabulous decisions which add to the bottom line.
Channel Nine's brilliant head of entertainment, Peter Faiman, remembered that the hardest thing he ever did in his career was to try to tell Kerry he intended to resign to work for Rupert Murdoch. Packer kept demanding to know what Murdoch at Channel Ten could do for him that Channel Nine couldn't.At every excuse - more money, wanting to do something new, establishing his own business - Packer kept hammering away with just one powerful line: "I can fix it."Faiman felt more and more desperate until Packer, the master negotiator, finally brought the tense confrontation to a head."So son, what do you want to do now?""Oh, Kerry, please, I feel like shooting myself."Faiman will never forget the next moment. Packer reached into a drawer, pulled out a huge western-style six-shooter and slammed it down on the desk in front of him."Well, I can fix that, too," he smiled.
Tuesday, January 13, 2009
How diabolically desperate are the oil exporting states?
The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.