Friday, March 13, 2009

Race At Havoc House Bank

Banks are most definitely "it" in the stock market these days. Bloodbath is too modest a description for what happened to their shares in just 18 months: at its low last Friday the KBW index of US banks (symbol: BKX) was down a massive 85% from the high reached in mid-2007 (see chart below, click to enlarge).

KBW Index of US Bank Stocks

In almost every sense, the market has already discounted a 1930's type depression for the finance industry. For some financial institutions this is entirely just and rational. Given the ridiculous risks they took in lending and the massive leverage in their balance sheets (40x was not unusual), one did not have to be a prophet to predict the outcome. The government swooped in and took them over, effectively wiping out their shareholders (note: it may now be the turn of their bondholders to also get a severe haircut).

In the age of Prof. Bernanke's Flying Fiat Circus no financial edifice is to go down in flames if it poses a threat to its neighbours - period. (Is this the regulatory equivalent of the neutron bomb - kill the shareholders, save the structure?)

But what about those banks that are somewhat better positioned, being a bit further in from the edge of the precipice? The ones that didn't dive headlong into the NINJA/CDO/CLO/SIV/CPDO smorgasbord buffet? What are their prospects?

Yesterday I talked with a banker friend who works on the trading side and asked him his opinion on bank stocks. He was very sanguine: this is a balance sheet crisis, he said. It will take time and pain for banks to work down from 40-times leverage to around 10-times on their own - if ever. The "if ever" was a clear reference to the risk of a government takeover - a very real risk, as we well know.

And yet, as with any business, there are two elements to a bank's accounts: balance sheet and income statement. We are currently focusing very sharply on balance sheets, i.e. examining assets to judge if their current and potential toxicity is poisonous enough to knock banks out for good. But what about income statements?

Banks are pretty simple businesses: what they charge for loans minus what they pay for funds and expenses is their net interest margin (NIM) and it ought to be significantly higher than losses sustained from the loan portfolio. There are other sources of income, such as fees and prop trading, but the heart of a bank beats at its NIM.

So, let's look at margins; below are charts that attempt to provide a current picture.

First, the prime rate, the yield on BAA corporate bonds and the 30 year conventional mortgage rate minus one month AA financial commercial paper (click to enlarge). After a brief period of volatility late last year, margins are healthy once again - even "too" healthy if we judge by the BAA spread. This means that banks are making good money from performing loans.

Each bank's gross interest margin spread will be some combination of the above, given its particular mix of corporate, consumer and mortgage lending plus exposure to the yield curve (borrow short - lend long).

Another factor is how long will the Fed be willing to keep short-term rates at current historicaly low levels. With Fed funds at 0.20% and the various FRB "windows" wide open, banks can fund themselves at extremely low cost against all kinds of collateral. That's another "plus" for bank income statements - a rather big "plus", to put it mildly.

Bottom line? There's a race going on at Havoc House Bank. On one side of the account ledger the Bad Loan Demolition Squad is tearing down the balance sheet, whereas on the other side the Wide Margins Repair Team is furiously trying to patch things up through the income statement.

Who will prevail? There are a couple trillion dollars (at least) riding on the outcome and we all have wager slips on our hands, want them or not. But this is not really a fair race, if you think about it. The bookie is in on the "fix" and he's not going to let his chosen team lose - unless he runs out of time, of course.


  1. Yes, tell us pls, what about those better positioned banks. Y'know, with clean books etc. New banks. They should be able to take over the market in no time, don't they. Where is the competition.

  2. China worried about safety of US debt:

    "China is the biggest holder of U.S. government debt and has invested an estimated 70% of its $2 trillion stockpile of foreign exchange reserves, the world's largest, in dollar assets.

    "We have lent a massive amount of capital to the United States, and of course we are concerned about the security of our assets. To speak truthfully, I do indeed have some worries.

    "I would like, through you, to once again request America to maintain their creditworthiness, keep their promise and guarantee the safety of Chinese assets," Wen said.

    U.S. Secretary of State Hillary Clinton voiced her appreciation during a visit to Beijing last month of China's continuing "well-grounded confidence" in U.S. Treasuries.

    As I mentioned yesterday, as long as the US finds suckers to buy treasuries we can proceed to bailout everything and everybody. But as with any Ponzi scheme, eventually you run out of suckers. It seems that the biggest sucker, China, gets a bit uneasy over the amount of US debt they took on. The US goverment will follow the same path as GM, CITI, WAMU, Clownifornia and home debtors. The only difference being is that they have a printing press at their disposal.
    I have to admit that the current US government debt level is still not too worrisome by international standards, but several years of trillion $$ deficits might change that. On the other hand, an eroding industiral base and an aging populations dimish our ability to service future debt payments.

  3. in a unrelated post, as I read this recent mr. Roubini ( article I felt like rereading your's early posts about this.

  4. do i smell the perfume of Sir Keynes in the house?

  5. Seems to me that among the befuddled bankers, bonuses to the talented traders, CEO's who cry too big to fail and 'victimized' homeowners, that debt does indeed equal wealth. Arrogance equals intelligence. Risk equals safety and greed equals humility.

    This must be the paradigm shift they were alluding to.

  6. I meant to say greed equals naivete

  7. Goldie- The new "paradigm shift" is the bag holder of last resort--the tax-payer.

    People get on board, the fix is in and the Ponzi game will continue after a short break.

    Us to China "We're too big to fail." US to Europe "You drank the Koolaid too so you better get on the fast easy money train because Ben is coming with his blimp of trillions."

    Woo hoo Homer Simpson is on steroids and we'll figure out the consequences later.

  8. Surely we've all seen or read about the Stewart-Cramer interview. Cramer was snivellingly disingenuous in his apologies and promises to do better in the future. But a moment of truth did escape his lips. Stewart was asking him to defend 35-to-1 leverage and Cramer shot back "How did these investors think they were averaging 30% returns from 1999 through 2006?".

    Ah, but scepticism detracts from romance. And people love romance, especially self-romance.

    I can't help to hope that journalists see Stewart's ratings and positive response and decide to start ripping into this stuff. Man, if Cramer honestly wanted to do an expose of the stuff he's seen (and done) it would be mind-bending.

  9. Just found this blog. I'm using the Letter submission below to show the first URL, in case it's new to you.

    Very instructive real asset price histories are kept little-apparent to the people. This is, effectively, book-burning. See the first chart:
    “Real Dow & Real Homes & Personal Saving & Debt Burden” at
    Here in our town, this book-burning is done by newspapers, libraries, and institutions of higher learning. And these outfits purport to be friends of “community, family, etc.”, but never purport to be friends of “fool ‘em if you can”. They are false friends. “The public’s right to know” is replaced with “What is intellectual honesty’s cash flow?”. These book-burners walk W.C. Fields’ talk: “Never give a sucker an even break, or smarten up a chump.”.

    Here is a great example of how severely the people are being suckered by this book-burning: on 3/9/2009, the Dow closed equal to its January 1966 average close, on a real basis -- both the Dow and CPI-U increased by the same factor 6.64. Zero change in the Dow’s consumer purchasing power over 43 years! See it here:

    I noted at the start “real asset price histories are kept little-apparent to the people.” At the URL there, two one-time-only precedents in major newspapers are cited, from 10. and 2.5 years ago. Get a good look at them, and see them up-to-date at the URL. Ten years ago, Real Dow was 85., it maxed at 100., and on 3/9/2009 it was ca. 46.4. Two and a half years ago, Real Homes (national index) was 99., it maxed at 100., and most recently (11/2008) it was 68. Both these subsequent histories are UNsurprising, given the two pasts -- which book-burning kept little-apparent to you. Refer to W.C. Fields quote above.

    I assume that you have now seen enough histories, with false highs subsequently reversed, to concur with “Hidden or Not: Serial Herd Behavior IS Our Track Record”. Re. the merit of Our Track Record, abetted by book-burning, I ask: Do you know folks who had kids to have someone to sell high to?

  10. Very interesting contest re GD differences than and now. Yes a major difference is the absence of the gold standard.

    But the total Debt to GDP ratio is higher now than it was then isn't it?

    And how can the FED "print" the amount of money that is required to "beat" the rate at which credit money is being destroyed?

    I'm sure there are complex forces at work and the out come is far from certain. I take it that you are tending towards giving the FED a chance in the race.

    I guess its a bit like paddling a kayak near the edge of a waterfall at some point the current will become swifter than you are able to paddle meaning that unless you can make it top the side of the river no matter how hard you paddle you will be going over. That point would be the tipping point.

    Have we already reached it or not?

  11. Using the river analogy the FED in this case has slowed the current as much as it can by lowering interest rates to near to zero.

    The challenge then is can the FED keep the interest rates that low?

  12. This may or may not be related to this post.
    I should tell y'all that when I was in college, I took one semester of economics.
    In the first few weeks I panicked : my God, I couldn't understand a fucking thing, and nevertheless what I babbled on the weekly spot quizzes received a grade of B or A.
    Five weeks into the course, I THOUGHT I started to understand something and guess what ?
    My grades plummeted.
    I don't know whether this experience is more revelatory of ME or of the subject "economics"...
    I should specify that economics was the ONLY college course in the United States that I experienced this way.
    I have drawn my conclusions.
    I will let you draw yours...

    Seven years ago my husband and I pulled our money out of the BNP, the Banque Nationale de Paris (now Paribas) because I already saw (or thought I saw...) the writing on the wall.
    A bank owned up to 40 % by American pension funds.
    Well, I figured out then that a bank that had that kind of an interest group wasn't really interested in ME as a client (my husband and I had professional accounts, not just individual accounts...) they were interested in, and beholden to, their shareholders.
    We found a SMALL, not globalized bank that is more interested in CLIENTS, and in investment, I should say, than in SHAREHOLDERS.
    It is a mutualized bank. We are all owners (lol) of the bank since we are all investing in it.
    But not as globalized shareholders.
    Those kind of investments DO exist.

    And another point :
    A quick look at the editing business makes it evident that new ways of doing business that skirt traditional globalized investment structures are being invented.
    Subscription to publish books.
    Direct investment.
    I like knowing PERSONALLY the people who I'm banking on. LOL

    Feel free to point out to me where my analysis is totally wacky and/or off topic.
    I like learning.

  13. Looking at the chart "US Bank Margins" I couldn't help but notice how remarkably stable the Prime spread was compared to the other two spreads. Interfluidity had a post a couple of years ago which strongly suggested that in 1989 Greenspan coordinated the collusion between the major banks to fix the Prime-FedFunds spread at 3%:

    This was done after major corporations had migrated to LIBOR (usually lower) and only credit card users were left to pay higher Prime-plus-spread rates but perhaps that would be too conspiratorial for Thai's taste.

  14. This is decidedly off topic but I can't resist.
    I will be thinking of you all tonight while I savor a small glass of the 1995 Ch√Ęteau de Planques Monbazillac that a friend brought over for dinner last night in an incredibly generous gesture.
    The wine is (almost) worth dying for...
    An incredible experience.
    It makes you grateful that you are alive just to TASTE IT.

  15. I think this sacrifice of the public for the sake of banking is sick. There is never a free lunch. The public is being screwed royally because there is no return on their savings and the banks can turn around and lend it at high interest rates back to the public.

    If they are successful at inflation, then the banks will once again screw the public because they take advantage by being on the front end. We have lost our Democracy to the banksters, not the terrorists.

    I wonder if they blow the system up this time because they keep using the old ways of fixing the system and this time around it creates a destructive feedback loop. I wouldn't be that surprised considering ignorance and/or stupidity of the government and FED officials. These people are incapable of thinking outside the box and therein lies the real danger.

  16. This morning the woman who reviews the press on my classical music station (the only one I listen to faithfully...) announced that two people have set up a store in ground zero of the World Trade Center wreckage where they GIVE AWAY stuff instead of selling it.
    Well, well, well, guess what's next ?
    I'm licking my mustaches (when I'm not a dog, I'm a cat, of course...)
    When are you coming back, Hell ? : )