BAC: 'Extremely Difficult Challenges'
A: About to head out for a few days, but hopefully Jeff will publish some articles he has been working on the past week or so. Before I go I just want to re-iterate the nature of this recession, debt deflation, and that with unemployment levels rising the way it is we must expect consumer credit quality to deteriorate as well. This is not an environment we should want banks to aggressively lend into and certainly we don't want lending standards to be loosened just to 'get things going' again. It seems we have become a society that fears recessions, instead of embracing them for what they are: healthy and normal disruptions of economic growth (normally brought on by tighter monetary policy to cool overheating economies) necessary to ensure longer term sustainable growth. We must purge the excesses, reform the system that allowed the excess to occur, write down the bad debts that came out of the old system/boom, restructure the bad companies that no longer are viable without the old system, allow poorly managed firms to fail, and see risk capital take haircuts - not pass on all the crap to the taxpayer. Because of the nature of the parabolic credit boom that we experienced and the excess that came out of it, this purging/deleveraging process will take longer than most think. Lets just be prepared for that.
This is an overall debt problem in a society that has become very comfortable with buying now & worrying later. Lets face it, Americans tend to live above their means and use credit like it was an endless luxury. Not so. As we all have learned, when the party stops it is not so much fun anymore to realize how much debt we actually built for ourselves.
A week ago I discusses whether or not we were "Out of the Woods - Loan Loss Provisions Being Taken":
A few questions we must ask ourselves: are defaults starting to decelerate - are defaults spreading to higher quality debt classes - are banks taking the proper loan loss provisions to cushion against future losses?This is why I think the markets got the severity of this crisis right, but not the duration of it right.
Lets take Bank of America's latest earnings report, which comfortably beat estimates. Did you know that they set aside an additional $5Bln in loan loss reserves from the 4th quarter of 2008 to cushion against what they see coming? The Wall Street Journal reports, "BAC Posts Profit, Says Credit Quality Still Weakening":
Chairman and Chief Executive Ken Lewis said that the company welcomed the profit amid the harsh economic environment, adding that "we continue to face extremely difficult challenges primarily from deteriorating credit quality driven by weakness in the economy and growing unemployment."Right there, "...deteriorating credit quality and weakness in the economy & growing unemployment" + "...Credit-card losses increased to 8.62% from 5.19% and total nonperforming assets jumped to 2.65% from 0.9% in the prior year and 1.96% in the fourth quarter". Non performing assets jumped big time, and is something to watch as time goes on.
Credit-loss provisions more than doubled to $13.38 billion and climbed from the prior quarter's $8.54 billion, while the net charge-off rate rose to 2.85% from 1.25% a year earlier and 2.36% in the fourth quarter. Credit-card losses increased to 8.62% from 5.19% and total nonperforming assets jumped to 2.65% from 0.9% in the prior year and 1.96% in the fourth quarter.
Banks are hesitant to lend to a consumer that is experiencing deterioration in credit quality and already laden with debt. As unemployment rises, savings will increase and consumers will work to pay down debts and repair their balance sheets. Not the American way, is it? After all, we are a spend spend spend economy, not a saving one. This is debt deflation, a contraction of credit, all occurring at the same time that banks balance sheets are in complete disarray after suffering ginormous losses in the shadow banking system. This is why the fed is gaming the system to help the banks recapitalize - and leading many to worry about the future unintended consequences of such policies on the broader economy. It's an adverse feedback loop in which one stage feeds on the another.
But what about the PPIP plan which uses FDIC powered leverage to get private investors to participate in the market for toxic assets? Well, I am hearing rumors of VERY LITTLE INTEREST in this program. Add that to little interest in the TALF program and we have two huge programs that may not work at all! Besides, even if the PPIP turns out to be a big winner, it does NOT change the fact that there are still good assets on the books of financials that are quickly turning bad; that is, starting to non perform! As the economy continues to struggle, it is clear that what started out as subprime is now spreading to higher quality debt classes; proving the broad nature of this crisis.
Only the bottom of the 4th Inning? So says ZeroHedge based on a Ken Rogoff / Carmen Reinart report:
This epic report examined 15 other credit contractions and asset deflations in the past, and found that the bear markets in equities last an average of 3-1/2 years, with the bear market in house prices lasting an average of roughly six years. So, when asked “what inning are we in?”, the answer we’ve been giving, on this basis, is “the bottom of the fourth”.Time, good policy that removes future unintended consequences from occurring, corporate restructuring, letting bad firms fail, letting risk capital take haircuts, writing down of bad debts, is what we need to get through this. Band-aiding over every new laceration that is revealed will only defer the recovery and prolong the recession because it prevents the natural forces from doing what needs to be done. I don't think the administration understands this, or it is just not politically correct to see America go through pain; even if that means we end up in better shape in the long run.
Posted by Azret
Mon Apr 20th, 2009 12:30 PM
"This is not an environment we should want banks to aggressively lend into and certainly we don't want lending standards to be loosened just to 'get things going' again. It seems we have become a society that fears recessions, instead of embracing them for what they are: healthy and normal disruptions of economic growth (normally brought on by tighter monetary policy to cool overheating economies) necessary to ensure longer term sustainable growth. We must purge the excesses, reform the system that allowed the excess to occur, write down the bad debts that came out of the old system/boom, restructure the bad companies that no longer are viable without the old system, allow poorly managed firms to fail, and see risk capital take haircuts - not pass on all the crap to the taxpayer."
I have been saying this since the beginning, it is just sad that our government and our economists feel that feeding the system with tax payer dollars is beneficial. I think from the beginning it was necessary to let those who did not use discretionary tactics to prevent failure fail, and those that did leverage themselves properly survive. The notion of "too big to fail or to connected to fail" is going to be a cop out in the next bear cycle. I think it is a good thing that from this debacle of our near failing traditional institutions (C, JPM, BAC); new venture capital firms, smaller finance firms, newer education, and financial innovation will be created. Capitalism's roots are not about big business, it is about the small guy making his way through innovation and hard work. If we were a true capitalist society like our government would like us to be, then the answer would be simple, those that are failing will need to fail and those that are not will survive. New opportunities are created when we break away from the old.
Posted by jeff
Mon Apr 20th, 2009 12:50 PM
My feeling has been that the Brits and Irish were doing the right thing in aggressively nationalizing banks and working to remove toxic assets from bank balance sheets. Read Paul Krugman's Op Ed today "Erin Go Broke" about the unfortunate side effects being felt in Ireland, where in order to fund the bank restructurrings, they are having to cut back on government spending and raise taxes, further depressing the economy. I fear that this is the box we are in.....we don't have enough equity capital available to de-lever everything that needs to be de-levered and the government pursuing stalling tactics because there just isn't the capacity to recognize the losses quickly. There has been some noise in the blogosphere that leaked results of the bank stress tests show the majority of big banks are insolvent.....were gonna find out sooner or later.
Posted by Former Seller
Mon Apr 20th, 2009 06:41 PM
"Band-aiding over every new laceration that is revealed will only defer the recovery and prolong the recession because it prevents the natural forces from doing what needs to be done. I don't think the administration understands this, or it is just not politically correct to see America go through pain; even if that means we end up in better shape in the long run."
Please allow me to take a moral tack from the usual market based discussion here. In just about every other aspect of life I prefer the holistic approach of solving problems, whether they are health, societal or economic. In principle I also believe that true economic recovery would happen sooner if the government would not intervene, and allow natural market forces to weed out the bad actors and reward the good ones. I also read 'Meltdown' and really get the point.
But Noah, it's unfair to characterize the justification of government intervention as simply "politically correct". If we've learned anything from the current crisis it's that America hasn't exactly been a meritocracy over the past few years.
The laissez-faire argument seems to assume that only the bad actors will be punished and the good ones will be spared. That's fine if the actors are whole corporate entities. The problem is that they were individuals *in* corporate entities, or in the case of borrowers, individuals that did so irresponsibly while their neighbors were responsible.
Everyone would like to see a healthy economy without anomalies or government meddling but this idea is so often promoted as if it doesn't carry tremendous moral hazard for a crisis this size. I'd bet my next paycheck that if you could draw a line between every person in the country who wants government to intervene and those who don't, the overwhelming majorities of individuals on either side would benefit if they have their way- or suffer if they don't, such is human nature. Unfortunately, the problem is that such a division is completely different from the line between good and bad actors- they're all interspersed.
Perhaps government intervention will make a recovery take longer. But in my opinion, in a correction this size it's necessary to protect a huge number of responsible individuals from suffering unduly (and severely) for to the actions of the irresponsible.
I'll probably get pounced on for making an argument for government intervention in this case, but it's just my humble intent to keep things honest.
Posted by away-noah
Mon Apr 20th, 2009 07:25 PM
former seller - just a great comment. I will respectfully stay on my side of the argument. There are two main paths to go:
1. Government Intervention, bailouts, rescue packages, massive printing, unintended consequences, bankruptcies, zombie banks, pain for common, loss of confidence in banking sector, longer period of deleveraging
2. fierce, quick purge, shoter deleverage phase, let mis-aligned corporations fail, write down the bad debts, bankrputcies, risk capital takes the pain, restructure, insolcvent too big to fail banks into receivership with risk capital taking haircuts/wipe out, fierce recession, fewer unintended consequences
etc..I can go into way more detail but wife us yelling at me to sit by fire instead of by computer. I agree. Basically you get my point. Both paths are BAD! Real BAD! but one will make the pain last a LONG TIME, and the other will be more fierce, more painful, but protect the taxpayer and lead to fewer unintended consequences. Sure we dont know the side effects if a CITI goes into receivership, but after Lehman, we know it would be painful yet manageable. Dont you think? Lets get this over with and prevent a 7-9 year lost period with waves of recessions from unintended consequences, zombie banks, and a future of higher taxes and rates.
Posted by MeekSheep
Mon Apr 20th, 2009 08:47 PM
This is how the argument is shaping, those that believe in interventionist activities and those that don't. Is it basic Keynesian economics which will prevail and save us from the terrible decisions that we made? While I agree in almost all ways with things said in the post about the credit markets (CMBS market) and the public servant's desire to stop the pain now (rather than let the cure work its way through) I have to disagree with your assertions that 1 and 2 are mutually exclusive arguments/approaches/outcomes. Those banks that need to undergo #2 will... eventually, when all other options have been depleted.
Posted by Former Seller
Tue Apr 21st, 2009 11:09 AM
I'd have to think that a pure 2. approach would just be devastating to millions of people who didn't contribute to this crisis- people who've worked hard for many years, paid their bills on time, carried reasonable or no debt. They would lose their jobs, their retirement nest egg, their home values, just because they happened to work for or be invested in a failed company or the industry it supports. Millions of others who were not so responsible would go unscathed if they happen to be employed, invested or located differently.
In any milder recession, I would be all for 2. but what's happening now is some really scary s**t and I think the idea of social-economic justice has to trump pure economic policy in this unusual case.
I agree with MeekSheep that 1. and 2. are not mutually exclusive; no matter what actions are taken, things are and will continue to be ugly. However, there must be some potion with the 'optimal' ingredients. One can only hope the new administration is getting closer to, rather than further from figuring that out. Maybe the pain will be prolonged substantially, but it hopefully will at least provide a cushion for responsible folks who need time to adjust to what's going on.
Just for disclosure (since I've been making a somewhat off topic moral argument here): I don't understand local and macro forces well enough to know whether I'd personally be better off long term with an extreme 1. or extreme 2. On the RE side I've moved back into the apartment I had been trying to sell, like living there and will be around for a while so I'm not really concerned about market prices at the moment (but am concerned about the city budget/service reduction).
Posted by denver real estate
Sun Apr 26th, 2009 11:47 AM
It is really a very good blog. It is very easy to buy, but face problem later. So, we have to take proper decision before and at the time of purchasing.