Friday, September 10, 2010

Where The Fed Has Led Us

Yesterday's Wall Street Journal's lead editorial on the Opinion page consisted of a number of economists' ruminations on what the Fed should do next.

First, let me note how refreshing it is to see real economists polled, rather, as often is the case, see the co-anchors on CNBC ask everybody who troops onto their set whether we'll see a double dip economy, or not?

The likes of John B. Taylor, of the famous Taylor Rule for monetary policy, Richard Fisher (Dallas Fed President), Frederic Mishkin ((former Fed Governor), Ron McKinnon, Vincent Reinhart and Alan Meltzer are an impressive group from which to read comments on the topic.

But what struck me more than any single comment from these accredited economic sages is simply the horrifying situation in which Helicopter Ben and his predecessor, Alan Greenspan, have placed the US economy.

As an adult, I lived through the Volcker years. As a very aware teen, I recall William Martin's and Arthur Burns' inept accommodations to LBJ and Nixon, then G. William Miller's hamhanded attempts at running the Fed, mercifully for only a little more than a year.

After Volcker's superb, calm reign in the wake of his bungling predecessors, you'd think we'd permanently learned some lessons about monetary policy, wouldn't you?

But, no, we haven't.

So we are now in the bizarre situation of nearly repeating the 1930s: low rates and a flat economy.

Isn't anyone besides these economist worried about the repeat of the last few years, in which banks funded lousy investments due to the absurdly low cost of capital? Didn't we learn anything from Greenspan's pumping the housing sector with ultra-low rates?

And what about the ridiculously large Fed balance sheet at a time when we're funding our government debt overseas? How's that not fungible? The Fed doesn't create money out of thin air, you know. Right now, it's monetizing bad loans like crazy. The net result is our government, whether through the Fed or Treasury, is issuing fully-valued debt overseas to buy over-valued instruments domestically.

Borrow to buy high.....sound smart to you? Me neither.

Looking beyond the trees of individual economists' advice on whither next for Ben & Co., it's scary to see that forest.

A sluggish, slowly, if at all, recovering economy, too-low rates, too large Fed balance sheet, huge Federal debt, spending and deficits, with a politically-intimidated private sector scared by encroaching regulatory and legislative actions and uncertainty.

Whatever the Fed does next probably won't be sufficient, on its own, to lead us back to healthier interest rate levels in a vibrant, growing, low-inflation economy.

Thursday, September 09, 2010

Those Pesky Bank-Held Mortgages

Andy Kessler, a periodically-published editorialist in the Wall Street Journal and former hedge fund manager, wrote a piece at the end of August entitled TARP and the Continuing Problem of Toxic Assets.

Leaving aside recent better-than-expected housing data, and Kessler's own wacky, unworkable ideas for handling the problem assets, he did a service by reminding readers that the problem remains with us.

In his editorial, he wrote,

"Home sales dropped 27% from a year ago July to a 3.83 million annual rate, which was blamed on the May expiration of the $8,000 home buyer's tax credit. Dig deeper and its even scarier. Existing home inventory (the number of homes for sale) now stands at four million units- that's a 12.5-month supply versus the average 6.2-month supply since 1999. As late as 2005, home inventory was just 2.5 million. Using that as a baseline or normal number, there are now around 1.5 million "extra" homes on the market that are not selling and either empty or soon to be foreclosed.

And those toxic mortgage assets? As far as I can tell, most are still there, valued at "mark to wish" since the Financial Accounting Standards Board's relaxation of "mark to market" accounting rules. Who knows what they're really worth? The stock market is guessing not much, sending finance stocks like Bank of America, Wells Fargo and even J.P.Morgan down close to 52-week lows.

...without a housing turnaround, jobs in construction, decoration, mortgage banking, auto sales and finance will stay in the doldrums. Delinquency rates, which are a leading indicator of foreclosures, are on the rise. According to the latest Mortgage Bankers Association survey, in the second quarter, prime adjustable-rate mortgage (ARM) delinquency rates rose to 9.3%, with prime fixed-rate mortgages seeing delinquencies up 4.75%. On the subprime side, ARM delinquencies hit 30.9% with fixed at 22.5%.

This is not good for banks that still own toxic assets of any type of mortgage, subprime or not. If home prices fall further, and I can't see too many scenarios where they won't, these toxic assets are all set to drop in value. At some point, buyers of bank debt will get nervous. If this toxic sludge were sitting on a shelf at the Treasury or Fed, it really wouldn't matter. But, instead, even a small uptick in foreclosures could take down the banking system- again."

Let's recall that major banks halted foreclosures in early 2009 due to coercion by the incoming administration. Having been forced to take TARP funds only months earlier, all the major money center banks were pretty much vulnerable to such intimidation.

That doesn't mean they don't still hold the toxic stuff, as Kessler reminds us. And that, with a continuing weak housing market, the toxic mortgages remain impaired, and could easily become worse.

At this point, I don't really think there are any better solutions than forcing banks back to "mark to market" valuations. None of Kessler's various sleight-of-hand suggestions for fixing the problem seem reasonable or feasible.

To me, this all leads back to employment. Not the construction- and housing-related employment to which Kessler referred, but the simple notion that, without an imminent, healthy expansion of non-government, non-stimulus-sourced, genuine private sector jobs, the housing sector, and toxic mortgages, will continue to ail, then grow worse.

Eventually, if that happens, it's going to affect equity values- again.

There's no long term substitute for letting asset values find their own, real, un-manipulated value. Nearly two years' worth of government subsidies, coercion and other actions to try to wave a magic wand over housing prices and related mortgage values have all failed to fix anything. For that, we'll finally have to just let housing values and their associated mortgages find real, market-based values. Until then, nobody will really believe current 'values' anyway. Certainly not as a basis for long term investments.

Wednesday, September 08, 2010

New Revelations On Lehman's Funding Tactics

Yesterday's Wall Street Journal contained an article by Peter Eavis in the Heard On The Street column entitled Lehman's Flighty Funding Lesson.

If true, what Eavis contends is that Lehman was misleading lenders and regulators for months prior to its collapse. In fact, apparently as early as February of that year, just prior to Bear Stearns' demise. Among its moves were securitizing junk collateral to pass it off as better-quality for loans from Chase, as well as the Treasury's Primary Dealer Credit Facility.

A Chase executive pointedly alleged that Lehman knew it substantially overstated the value of the illiquid, underlying instruments in the collateral securities.

The Journal article quotes from a June, 2008 email written by then-New York Fed senior official William Dudley,

"I think without the PDCF, Lehman might have experienced a full-blown liquidity crisis."

Eavis notes that the recently-passed 'Dodd-Frank' financial regulatory bill is largely silent or vague on the use of repo markets by large, highly-leveraged financial institutions.

This is particularly disturbing, since so much of what occurred in 2007 and 2008 ultimately depended upon excessive leverage in the form of short-term financing.

I've written elsewhere, for years, that the modern broker/dealer is, for all intents and purposes, merely an extension of the broker/dealer lending desk of its creditors, which are typically money center banks.

As such, since said banks all have investment banking units, the separate broker/dealers, when they still existed, were necessarily competing with lower-cost rivals who also funded them. And used less leverage, plus had access to the Fed window and insured consumer deposits.

There aren't any large independent broker/dealers anymore. In part, they failed because, to compete with their lenders, they had to take more risk, which ultimately proved lethal.

But, as Eavis notes, you'd expect the recently-passed regulatory laws to address this. They don't. They essentially allow regulators latitude in how and when to apply limits on various funding sources.

It seems almost comically narrow-minded that the FCIC is just now discovering the essentially fraudulent means by which Lehman managed to survive for its last 6-7 months, but new financial sector regulatory laws were passed months ago. And clearly missed focusing on what we are now learning were key practices which aggravated and worsened the 2007-08 financial markets crisis.

Tuesday, September 07, 2010

Apple TV Returns

Last Thursday's Wall Street Journal articles discussing Apple's return to television left me with the sense that the company is now too late with too little to make a difference as it typically does in its other specialized digital processing hardware.

When I read that the new Apple TV offering includes Netflix streaming video access, it told me that Apple is accepting the latter's dominance in television-delivered internet-based video content.

That wouldn't seem to bode well for Apple TV's ability to differentiate from other similar video content purchase/storage systems.

Perhaps it's more of a niche-filling strategy, so that the firm offers something in this increasingly hot space.

However, as I noted in this post late last month, Tivo has finally marketed a relatively inexpensive keyboard remote. This will allow viewing of virtually any website through Tivo, which also streams Netflix.

Doesn't this make Apple very late with nothing particularly unique in this product/market space?

I think it does.