Ian Welsh

The horizon is not so far as we can see, but as far as we can imagine

Category: Financial Crisis Page 11 of 12

The Chrysler Bankruptcy May Not Be As Smooth As Hoped

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On April 30, 2009

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Chrysler went into bankruptcy because creditors wouldn’t agree to be wiped out.  They may believe that they will do better in front of a bankruptcy court, or some of them may have credit default swaps (CDSs) and have wanted Chrysler to go under so they would be paid off at full dollar (which points out another problem with CDSs, that they make bondholders more willing to force companies into bankruptcy.)

The government’s plan is to have a quick 30 to 60 day bankruptcy, shed the debts, and come out of it with the United Auto Workers owning 55%, the US government 8%, the Canadian and Ontario sharing 2% and Fiat receiving 10% with the possibility of more.

But bankruptcy court is not a sure thing.  The bankruptcy judge will have discretion and there are laws to be followed.  It is by no means a sure thing that this plan will survive contact with the court.  The debt holders will go to the judge and argue that they deserve to own much more Chrysler or that it should be broken up and that their claims take precedence.

I don’t know if they’ll succeed.  Certainly the government will put all their weight behind the current plan.

The next question, then, is GM, where the same calculation is playing out: a lot of debt holders think that they can do better in bankruptcy than through the government plan.  How the bankruptcy judge starts ruling in the first days of Chrysler’s bankruptcy will have a lot to do with whether GM debt-holders crumble.  If the judge seems ready to ram through the government plan, then GM probably won’t go bankrupt.  If he isn’t, it probably will.  Assuming of course that enough debt-holders don’t have CDSs covering their GM debt.  If they do, well, it’s in their interest to crash the company no matter what.

Evaluating Geithner’s Stress Test

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On April 27, 2009

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With the release of the stress test methodology(pdf), let’s take a look at what the stress test is, what it isn’t and how it’s done.

What the Stress Test Is, is a test of the whether the 19 bank holding companies with more than 100 billion in assets have enough income and reserves to survive till the end of 2010, with enough reserves left at that time to make it through 2010. Banks were required to report their expected income for the next two years, then that was compared to their reported expected losses for the duration.

The Stress Test Is Not a test of whether or not, if a given bank holding company were liquidated right now, it would be worth more than 0 dollars. As such, it is not, primarily about mark-to-market accounting. The question is now “are the banks solvent”, the question is “can they keep operating and if not how much money do they need to keep operating?” In household terms, think of it as “can they pay their bills”, not “what is their net worth?”

The assumption is thus that all loans will be held to maturity and not sold on the market. What matters, then, is the income on those loans and how likely those loans are to default. Income is thus loan income minus defaults, taking into account any ability to recover losses. (For example, if a homeowner defaults on a mortgage, how much will the bank receive when it seizes and sells the house?)

Something over 150 people worked on the test on the government side. They were divided into teams by asset and income areas, such as “Commercial Real Estate Loans”, “First and Second Lien Mortgages” and “Credit Cards and Other Consumer Loans”. Each of these teams evaluated the submissions off all the Banks for that area.

Using the Banks Own Models

An initial criticism of the Stress test was that it used the banks own financial models-the same models which didn’t predict this mess in the first place. That’s mostly, but not entirely correct. The banks run the numbers based on their models, but they have to give the assumptions underlying those models to the supervisory teams. If the teams don’t agree with the banks model, they can insist on changes. How much they have done so, we don’t know, but there is some indication in the methodology that the teams did their own analysis of likely losses. For example, when referring to mortgages, the methodology reports that:

Certain attributes, in particular FICO, LTV bands, vintage, product type, and geography, were found to be strongly predictive of default. These attributes were used to further evaluate submissions by the firms, and where necessary, loss estimates were adjusted to better reflect portfolio characteristics in a consistent way across firms.

There are also indications that the teams found some substantial differences in underwriting standards between firms, and have taken that into account as well. Nonetheless, given that this was done in a 2 month period, with a little over a 150 people reviewing 19 massive banks, the teams would not have been able to develop their own models and could only have tweaked the bank models.

Economic Scenarios

The losses taken into account were based on two economic scenarios, a scenario based on median economists forecasts at the time the Stress Test was first planned, and a more adverse scenario. The first scenario has already been superseded by events, as the economy is performing worse than mainstream economists expected. The more adverse scenario has not yet been exceeded, but, for example, it models 8.9% unemployment in 2009, and current unemployment is running at 8.5. It is highly unlikely, in my opinion, that unemployment will not rise more than .4% in the rest of 2009 unless it’s for technical reasons like people despairing so much of finding a job that they just stop looking entirely.

What this means is that even if one accepts the models might be accurate after the examiners fiddled with them, losses will probably be higher than expected.

Banks that don’t pass will be required to raise enough capital to make it through the time period. They can try and do that on private markets, or the government may step in and provide capital. In addition, they can ask the government to convert its preferred shares into common stock, which will reduce the company’s expenses.

Concluding Remarks

The stress test is flawed, but not worthless. The economic forecast used was overly optimistic, and given that mainstream economic forecasts have been consistently off throughout the crisis, this should have been expected. The staffing may be sufficient to do superficial analysis, but this is by no means a real audit, in which hundreds of examiners swarm over each bank to discover whether or not the top end numbers they are supplying are accurate or if their accounting and underwriting has been weaker than declared or if there has been outright fraud.

While examining underwriting standards is useful, examining actual random cases in a professional audit to see whether or not underwriting standards had actually been followed would have been far more useful and predictive of future losses. To some extent, looking at comparative loss rates between banks can substitute for this, but only partially, as it is backwards looking rather than forward looking.

Bank default and valuation models are highly suspect, as well. As a rule the models used during the collateralization process did not sufficiently account for default clustering (i.e. for the fact that in a recession or depression a lot of people default in a short time period) or for the fact that there were housing or securitization bubbles. Those models have to be corrected for each particular class of securitized loan, since each one had its own model. Crude approximations were no doubt put in place by the teams and perhaps by the banks, but there’s still plenty of reason to question the models being used.

Given these flaws the stress test is only indicative, not final. Certainly any bank which fails them definitely needs money, but it may need more money than indicated by the test. Likewise banks that pass will likely not be viewed as out of the jungle, unless they pass with flying colors.

Likewise, the methodological paper was quite vague. The stress test will not be trusted without more specifics, and when results are released we will need firm numbers, not just the final numbers “needs X amount of money” or “passed” but the assumptions on default rates broken down by year, location of loan, type of loan and so on so that independent analysts can come to their own conclusions. Failure to do so will mean that the banks and Treasury are saying “trust us”, and unfortunately, at this point, no one does. Given the known flaws of the stress test, independent verification will be required

4.1 Trillion of Losses?

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On April 21, 2009

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american-dollar-toilet-paper1The IMF put losses at 4.1 trillion today. As a friend noted, that needs a couple of big caveats:

  1. Losses to this point.  Not losses that are yet to occur.
  2. Losses that people are willing to admit to.

But losses should slow down now that firms no longer have to mark assets to market. Mark to fantasy is very forgiving.  As we’ve seen in the last bit, with bank after bank declaring profits, mark to fantasy can turn almost any firm around.

Bank Profits And the The Choice America Has Made

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On April 13, 2009

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Peter Morici points out something which should be obvious:

Monday afternoon, Goldman Sachs reported much larger than expected first quarter profits, and this comes on the heels of Wells Fargo’s strong earnings reported last week.

No one should be surprised.

The Federal Reserve has provided the banks with lots of cheap funds through its various emergency lending facilities and quantitative easing.

The Federal Reserve has permitted the banks and financial houses to park vast sums of unmarketable paper on its books—securities made nearly worthless by the misjudgment and avarice of bankers. In return, the Fed has provided these scions of finance with fresh funds, cheaply, that they may lend at healthy rates on credit cards, auto loans and even mortgages.

While the Fed cuts the banks slack, the bankers are busy turning the screws on their debtors by raising credit card rates and fees, and harassing distressed borrowers with all the zeal of the Roman army sacking Palestine.

Yes, well, there you go.  Morici goes on to point out that low interest rates screw over old people who have certificates of deposit, and that the banks now want to “repay” the loans because when you’re being given money for nothing, and allowed to keep bad assets on your books at whatever price you feel is ok (since mark to market is gone), well, everything is wonderful in banker land.

(Well, unless you’re so far gone, like Citi, or Bank of America, that even in fantasy land you can’t make it work.)

As Stirling Newberry has pointed out, the economy has become clearly divided into two different economies.  One for the people who have access to money cheap and whose job is to take care of foreigners, and the other one, where credit is dear and you’re losing your job.

Guess which economy you live in?

This isn’t just going to be about employment, though that is going to suck for the forseeable future, and will, in effect, never recover.  It is also going to be about real income.  Forget the headline CPI, the costs you pay are going to go up faster than your wages (which are probably going to deflate), and your assets are going to deflate.  Riptide inflation, which catches you on both the up and downsides.

Real standards of living for median Americans are going to drop.  It’s just that simple.

In 4 to 8 years, the Republicans will probably get back in again.  They will do stupd things again.  By the end of their orgy of looting and warring (which will be even worse than Obama’s) the country is going to be extremely damaged.  Right now things could be fixed.  They probably won’t be, because Barack Obama has no intention of fixing main street, but they could be.  By the time the US gets its next real chance, well, this hole is going to be mighty mighty deep.

The US has made the choice of continuing to put its primary efforts into pursuing a chimerical paper economy which promises easy alchemical gold, rather than fixing the real economy.

But there’s no such thing as free money, not on aggregate over the long run.

And the long run is here, and by “aggregate” I mean “you aren’t an executive with the power to pay yourself millions in bonuses for destroying the US’s economy.  But you will have less money because of them.”

(Note: quote from an email from Morici, article does not appear to be online)

WTF!? Stress Tests Prove that Banks Fine, Just Need More Bailouts

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On April 9, 2009

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You can’t make up stupidity like this.  The Onion must be in despair, because there’s no way to satirize something so mind-numbingly moronic.  In reference to the “stress tests” of the banks:

What they are discovering may come as a relief to both the financial industry and the public: the banking industry, broadly speaking, seems to be in better shape than many people think, officials involved in the examinations say.

That is the good news. The bad news is that many of the largest American lenders, despite all those bailouts, probably need to be bailed out again, either by private investors or, more likely, the federal government. After receiving many millions, and in some cases, many billions of taxpayer dollars, banks still need more capital, these officials say.

So, to summarize. The banks are fine, but they still need to be bailed out?  IE., they’re effectively bankrupt, but it’s not as bad as we think?

Did I wander into the twilight zone?  Just how stupid do they think we are?

(Answer: it doesn’t matter, because they’ll give the banks as much money as they feel like, whether we like it or not, because that’s job 1 for the Obama administration—to bail out the masters of the universe at taxpayer expense).

In the immortal words of George H. Bush “Who cares what you think?”  Who cares what any of us think?

IMF Now Estimates Losses To Grow To 4 Trillion

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On April 7, 2009

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The odd thing about this is that 4 trillion is the number I’ve been hearing as the banks own estimate of their losses for a few months now, I even mentioned it back in February.

If the banks think their losses are 4 trillion, that means the total losses are higher, and the worldwide losses are much, much higher.

Numbers are still being lowballed.  Now that doesn’t mean that 4 trillion will necessarily have to be spent by the federal government, the move to mark-for-market accounting, which allows banks to keep assets on their books until marutity at calculated prices, for example, will reduce how much money the government has to spend to keep banks from actually going under.  The Geithner plan, if it works, is likewise intended to inflate asset prices through the miracle of leverage, and that will reduce perceived losses.  If lucky, it might even reduce eventual nominal losses, by holding the assets to maturity and praying really hard that they don’t default, and that by maturity the market and economy are a lot stronger.

Still, all in all, my guess is that the IMF is still underestimating the issue.  In fact, it’s not even clear if there’s enough free money in the world to absorb all the real losses, but I suppose if everyone keeps printing enough money, we can get there.

Calculated Risk via Atrios

Elizabeth Warren: Finally someone with a clue how to handle the financial crisis

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On April 5, 2009

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Warren’s the chief watchdog for the 700 billion TARP fund.  Unfortunately, she has no real power, but it’s still nice to see a government official say not just some of the right things, but almost all of the right things.  Talk of how the US is following Japan’s path is finally everywhere (myself and a few others have been talking about it for years, and started really beating the drums last year).  Here’s Elizabeth:

Warren, a Harvard law professor and chair of the congressional oversight committee monitoring the government’s Troubled Asset Relief Program (Tarp), is also set to call for shareholders in those institutions to be “wiped out”. “It is crucial for these things to happen,” she said. “Japan tried to avoid them and just offered subsidy with little or no consequences for management or equity investors, and this is why Japan suffered a lost decade.”…

… Warren also believes there are “dangers inherent” in the approach taken by treasury secretary Tim Geithner, who she says has offered “open-ended subsidies” to some of the world’s biggest financial institutions without adequately weighing potential pitfalls. “We want to ensure that the treasury gives the public an alternative approach,” she said, adding that she was worried that banks would not recover while they were being fed subsidies. “When are they going to say, enough?” she said.

She also calls for the resignation of the CEOs of the worst firms.

One thing I’m tired of hearing though is the phrase “lost decade”.  Japan didn’t just lose a decade, it has never really recovered.  The good times have never come back.

I also think that bondholders need to take a haircut as well, not just shareholders, though they may not need to be wiped out in all cases.  However, if the value of a company if it was liquidated is less than zero, then yes, non-secured bondholders (those whose bonds aren’t attached to specific assets with value) should be wiped out.

I’m Sure There’s a Difference Between the Bush/Paulson, Obama/Geithner Approaches to Bailouts

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On April 4, 2009

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I’m just not sure what:

The Obama administration is engineering its new bailout initiatives in a way that it believes will allow firms benefiting from the programs to avoid restrictions imposed by Congress, including limits on lavish executive pay, according to government officials.

Administration officials have concluded that this approach is vital for persuading firms to participate in programs funded by the $700 billion financial rescue package.

The administration believes it can sidestep the rules because, in many cases, it has decided not to provide federal aid directly to financial companies, the sources said. Instead, the government has set up special entities that act as middlemen, channeling the bailout funds to the firms and, via this two-step process, stripping away the requirement that the restrictions be imposed, according to officials.

At this point in time, there seems to be no significant functional difference between Paulson/Bush and Geithner/Obama.  Both intended to give a ton of money to financial firms, either directly or by buying up crap at prices higher than justified.  Both opposed any meaningful restrictions on how they spent the money or who they gave it to.

Actually, I take it back, one difference is that when Paulson wanted 700 billion, he went to Congress.  When Geithner made up his plan he just had the FDIC and the FED pony up most of the money, because he knew Congress wouldn’t give him the money.

Some wonder if this is legal:

Although some experts are questioning the legality of this strategy, the officials said it gives them latitude to determine whether firms should be subject to the congressional restrictions, which would require recipients to turn over ownership stakes to the government, as well as curb executive pay.

Me, I don’t know if it’s legal.  What I do know is that they plan on giving money away in a manner which clearly intends to end-run Congress’s clearly legislated mandate for how it be given away.  What I know is that they are bypassing Congress when they can, because they know that the elected body which is the only one supposed to be able to pass spending bills wouldn’t give them all the money they want to spend and won’t let them spend what money it does give as freely as they want to.

Of course, that money will still have to be paid back by taxpayers, even if Congress never approved the spending.

But back to the TARP restrictions:

Congress drafted the restrictions amid its highly contentious consideration of the $700 billion rescue legislation last fall. At the time, lawmakers were aiming to reform the lavish pay practices on Wall Street. Congress also wanted the government to gain the right to buy stock in companies so that taxpayers would benefit if the firms recovered.

The requirements were honored in an initial program injecting public money directly into banks. That effort was developed by the Bush administration and continued by Obama’s team. The initiative is on track to account for the bulk of the money spent from the rescue package. All the major banks already submit to executive-compensation provisions and have surrendered ownership stakes as part of this program.

Yet as the Treasury has readied other programs, it has increasingly turned to creating the special entities. Legal experts said the Treasury’s plan to bypass the restrictions may be unlawful.

The problem is that while Geithner’s plan takes money from the FDIC and the Fed, it still uses some TARP money as seed money, and that money carries the restrictions.

I thought it wasn’t the executive’s job to decide that Congress is wrong and then deliberately end-run it.  I thought we had an election to stop this sort of thing.

This is one of the things we spent the last 8 years blasting Bush for doing. But in this particular case, the new administration is being less compliant with Congress’s will than the Bush administration was!

Less!

I don’t know whether to spit or cry.  I’ve always had my doubts about Obama, but in my worst dreams I didn’t think he’d try and end run Congress even more blatantly than Bush, in order to give even more money away to the richest Americans with even fewer restrictions and less protection from the taxpayer in terms of ownership stakes.

It’s going to be a long 4 years.

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