Preliminary Stress Tests Results - B of A and Citi Need More Capital

For those familiar with the banking system in the US it comes as no shock that B of A and Citigroup need more capital. The question is who should be added to the list. I noticed that futures are way down this morning. Why would that be? The market should already know these banks are in bad shape. Text in bold is my emphasis. From Yahoo News:

U.S. regulators have told Bank of America Corp and Citigroup Inc they may need to raise more capital following stress testing of the two banks, the Wall Street Journal reported.

The shortfall amounts to billions of dollars at BofA, the paper said on Tuesday, citing people familiar with the bank, adding it is likely the Federal Reserve will have determined other banks might also need more capital.

The report sent Frankfurt-listed shares in Bank of America and Citigroup down more than 7 percent and hit global stocks, already shaken by fears over the spread of swine flu.

European credit spreads widened, government bonds surged as investors sought safe-haven assets and the dollar hit a near five-week low against the yen.

"The U.S. stress tests are absolutely critical to where we are going. Not only are they crucial for share prices to work out how much dilution or not may come through, but the tests have also been introduced to try to improve the credibility of the system," said Huw van Steenis, Morgan Stanley banking analyst in London. . . . .

. . . . Both banks, whose officials are objecting to the preliminary findings of the tests, plan to respond with detailed rebuttals, the people told the paper, adding BofA's appeal was expected by Tuesday.

It is likely that Citigroup and BofA are not the only banks targeted by the Federal Reserve, the Journal said.

The Fed said last week the tests conducted at major banks were aimed at ensuring the institutions have enough capital in reserve to continue to lend in potentially bleaker conditions, and are not a measure of banks' current solvency.

The United States broadly outlined how it stress-tested the health of the country's top 19 banks on Friday, but disappointed investors who were looking for more details of how stringent the tests were.

"The read across for the UK and Europe is a reminder that capital concerns about banks have not gone away," said Danny Clarke at UK stockbrokers Shore Capital.

He said it was difficult for investors to judge whether shortfalls would emerge at the U.S. banks without full details of the stress tests.

The chairman of Britain's financial regulator said on Monday that industry reform would be multi-faceted and include "major changes to capital adequacy regulation," stoking worries the biggest banks will need to hoard extra capital.

The Fed has said most of the 19 banks have capital levels well in excess of the amounts required to be deemed well capitalized. However, it said heavy losses had lowered capital and choked off lending.

The results of the tests will be released during the week of May 4, and regulators hope that by outlining the methodology used, investors will have a way to gauge the results.

Some banks with too thin a capital cushion will have six months to find private funds, others may need to accept an immediately infusion of taxpayer money.

The 19 banks tested, which include JPMorgan Chase & Co and Wells Fargo & Co , hold two thirds of the assets and more than half of the loans in the U.S. banking system.

The Bank Stress Test - What We Know So Far

Let's keep a tally of the statements that have come out recently about the banking industry in the US. By the way, I omitted most of the optimistic statements (except for profit reports) due to the large fluff component:

1. Lending is down since last fall.
2. The Treasury is talking about converting the bail-out money to equity
3. The Treasury will tell the banks when they can re-pay the TARP money
4. According to the IMF the banks are still not half way through their losses
5. President of the KC Fed thinks some financial institutions should be allowed to fail
6. There is talk of the the break-up of the large banks.
7. The banks need more capital (see below).
8. Most large banks turned a profit in the first quarter
9. Foreclosures continue to grow
10. Most banks still have weakening credit card and commercial real estate loans to address

Does this sound like a healthy banking system to you? Note one thing - no helathy banking system - no recovery. Text in bold is my emphasis. From Yahoo News:

The top 19 U.S. banks need to hold a "substantial" amount of capital above regulatory requirements to weather a potential worsening of the economic recession, the U.S. Federal Reserve said on Friday.

The Fed said so-called "stress tests" that regulators conducted at major banks are aimed at ensuring the institutions have enough capital in reserve to continue to lend in potentially bleaker conditions, and are not a measure of banks' current solvency.

"It is important to recognize that the assessment is a 'what if' exercise intended to help supervisors gauge the extent of capital needs across a range of potential economic outcomes," the Fed said in a white paper outlining the methodologies regulators employed.

The concept paper is a precursor to release of the results of the stress tests on May 4. A closely-watched outcome of that exercise will be to determine which of the banks, which include Citigroup Inc, JPMorgan Chase & Co, and Wells Fargo & Co, need to raise more capital, possibly with government help.

The paper did not quantify the size of the buffers banks may need to build, or say how the results would be presented.

"The market may be disappointed by the lack of details, as there is not much new in the report, but at the margin, it does sound as if regulators will give each company a real review, rather than a rubber stamp of approval for the group," said Paul Miller, an analyst with FBR Capital Markets in Arlington, Virginia.

The White House said it expects some banks to release their own results.

"Our strong inclination is to provide transparency," White House spokesman Robert Gibbs told reporters. "I think you'll see some banks release on their own some of the results and we'll release what we deem applicable."

Most U.S. banks have capital levels well in excess of the amounts required to be well capitalized, the Fed said. However, lower overall levels of capital, especially of common equity, and the uncertain economic outlook have impaired bank lending, it added.

Officials said the size the additional capital buffer would vary, depending on the riskiness of institutions.

The paper outlined the underlying concepts or variables used in the tests of how the 19 largest banks would fare if the economy -- already in the throes of one of the longest and deepest recessions in decades -- took an even sharper turn for the worse.

A senior Fed official said on Friday that although some see signs the recession may be ending, doubts remain.

The Obama administration's goal is for the stress tests to restore confidence in the U.S. banking sector, which has been battered by losses from the collapse of the housing market, a spike in credit defaults and the painful recession.

The tests could also require some institutions to come clean about weaknesses and commit to a course of action to regain health. Those salvage plans could include seeking further government assistance and, at the extreme, result in the firing of senior managers.

Treasury Secretary Timothy Geithner announced the tests on February 10 as part of plans to purge toxic assets from the U.S. financial system and restore credit flows.

Examiners subjected banks to stresses stemming from a scenario in which the economy shrinks by as much as 3.3 percent this year and in which unemployment goes as high as 10.3 percent next year. Some analysts have criticized those parameters as not stringent enough.

The institutions undergoing stress tests also include: Bank of America Corp, Goldman Sachs Group, Morgan Stanley, MetLife, PNC Financial Services Group, US Bancorp, Bank of NY Mellon Corp, SunTrust Banks Inc, State Street Corp, Capital One Financial, BB&T Corp, Regions Financial Corp, American Express Co, Fifth Third Bancorp, Keycorp, and GMAC LLC.

This Weekend's Contemplation - Chrysler and Their Creditors, Is it "Me" or "We"?

As is to be expected the future of Chrysler is going right down to the wire and it depends on what the debt holders are going to do. The real question that requires an answer is if you took bail-out money from Uncle Sam it assumes that "we" are all in this together. If you took bail-out money from Uncle Sam and you are one of Chrysler's creditors and you are refusing to give on what is owed you by Chrysler because you are thinking of your narrow interests, you are operating in the "me" mode and not the "we" mode. You can't have it both ways! We are either in this together or we are not. Text in bold is my emphasis. From Yahoo News:

With just days to go for Chrysler LLC to reach agreements to cut labor and debt costs or face bankruptcy, members of Michigan's Democratic congressional delegation said on Saturday the onus was now on the U.S. automaker's creditors to make concessions.

"The unions have come to the table over and over and over again and have taken huge cuts," said Senator Debbie Stabenow on the sidelines of a Michigan Democratic Party fundraising event in Detroit, the heart of the beleaguered U.S. auto industry.

"It is now incumbent on the creditors, in particular those that have taken public funds, to make some concessions and be a part of the solution," Stabenow said.

Chrysler, which is about 80 percent-controlled by private-equity firm Cerberus Capital Management LP , faces a Thursday deadline by the Obama administration to reach cost-cutting deals and cement an alliance with Italian carmaker Fiat SpA.

If the automaker fails to do that, Chrysler could see further U.S. government support withheld and face potential liquidation.

Michigan Democrats said the announcement on Friday of a tentative concession deal between the Canadian Auto Workers union and Chrysler showed the unions were acting in good faith and it was now up to the creditors to follow suit.

The CAW deal would reduce hourly labor costs by C$19 ($15.70) and save Chrysler about C$240 million annually in benefits, time off, "legacy costs" and improved productivity, but not through lower base wages or reduced pensions.

That deal will be put to CAW-represented workers for ratification this weekend.

Talks on concessions between the United Auto Workers union and Chrysler continued on Saturday. UAW President Ron Gettelfinger had been due to attend the fundraising event, but canceled his appearance because of the talks with Chrysler.

The U.S. auto industry has suffered from its worst sales in decades, with the recession and the credit crunch taking a heavy toll. Like Chrysler, General Motors Corp has received government aid. Ford Motor Co, the third member of the storied Big Three U.S. auto makers, has said it can restructure its business without government help.

"The unions have made a number of concessions to ensure the survival of Chrysler," said Representative Mark Schauer. "The question now is what the company's creditors will do."

"They have to look at the broad economic impact (of Chrysler collapsing) and not just their own short-term financial interest," he said.

In an impassioned speech to cheering attendees at the fundraising dinner, Michigan Democratic Governor Jennifer Granholm criticized Chrysler creditors that had received bailout money as part of the U.S. government's efforts to prevent a collapse of the financial system.

Those same banks and hedge funds have reported profits for the past few months, she said.

"This is going to be a tough week and new battle lines have been drawn," Granholm said. "Who knew they (Chrysler's creditors) would take that bailout money and then kill this great industry?"

Although Senator Carl Levin promised the audience that "we're doing everything we can to make sure they (auto workers) don't get sold out, Michigan Democrats said bankruptcy for the automaker could not be ruled out.

"If it comes to the liquidation of Chrysler as we know it, then we will push urgently for a rapid restructuring of the company," Schauer said. "There are too many jobs at stake."

Bill Moyers Interviews Simon Johnson and Mike Perino

On the the Bill Moyer's Journal last night Mr. Moyers interviewed Mike Perino and Simon Johnson.

Mike Perino is writing a book about the Pecora Commission, which was formed in 1932 to determine the cause of the Great Depression. The Commission ultimately led to the creation of the SEC and Glass-Steagall Act.

Simon Johnson is the former Chief economist at the IMF and author of the article in the Atlantic entitled the Quiet Coup.

IMF Defines the Global Economy as Being in Recession

IMF basically states that the world is in the worst recession since the Great Depression. In addition they expect it to last well into 2010. This is part of the IMF's World Economic Outlook (click on WEO for a link to the report), which is published twice per year. Maybe someone should send this to the folks at CNBC. Text in bold is my emphasis. From the WSJ:

The global economy is in the grips of a deepening recession that isn't likely to turn around until sometime next year, the International Monetary Fund said. The IMF, which had been slow to apply the word to the current downturn, also released a new definition of global recession.
Overall, the world economy is now expected to contract 1.3% this year -- a sharp reduction from the IMF's January estimate of 0.5% growth for 2009 -- and then grow just 1.9% in 2010, well below the global growth rate before the economic crisis hit.

"By any measure," the IMF's twice-yearly World Economic Outlook concluded Wednesday, "this downturn represents by far the deepest global recession since the Great Depression."

Treasury Secretary Timothy Geithner said that "only 17 of the 182 economies followed by the IMF are expected to grow faster this year than they did last year. Some 71 -- including 30 of the world's 34 advanced economies -- are expected to shrink."

Ahead of a gathering of Group of Seven finance ministers and central bankers this week, as well as the spring meetings of the IMF and the World Bank, the IMF urged global leaders to keep up the momentum that began at the Group of 20 summit this month.

The fund is anticipating that G-20 countries will pursue fiscal-stimulus measures totaling about 2% of gross domestic product this year and 1.5% next year, but said that may not be enough.
"It is now apparent that the effort will need to be at least sustained, if not increased, in 2010, and countries with fiscal room should stand ready to introduce new stimulus measures as needed to support the recovery," the IMF said.

That's likely to be a subject of debate at the G-7 meeting; European leaders thus far are resisting U.S. pressure to pursue additional stimulus measures.

Advanced economies, which are expected to contract 3.8% this year and see no growth in 2010, should also continue to pursue rate cuts and unconventional monetary measures to support demand and counter deflationary pressures, the fund said.

The U.S., which remains the "epicenter" of the crisis, is expected to contract 2.8% this year, with no growth next year. Much of the expectation for a U.S. recovery to begin by the second half of 2010 hinges on the success of the government's plan to partner with private-sector investors to remove bad debts from bank balance sheets, the fund said.

Emerging economies overall are expected to remain in positive territory, growing at a 1.6% pace in 2009 and 4% next year as a group. But an increasing number are sliding into recession.
Informally, IMF chief economists have called global growth of lower than either 3% or 2.5% -- depending on the chief economist -- a recession. It hadn't called the current downturn a global recession yet, partly because it didn't have a good definition. Now, IMF economists have a precise way to measure global recession: a decline in real per-capita world GDP, backed up by a look at indicators such as industrial production, trade, capital flows, oil consumption and unemployment.

Under the new definition, this is the fourth global recession since World War II, and the deepest by a long shot. The earlier recessions were in 1975, 1982 and 1991. All were one-year recessions when measured by purchasing power parity, which takes into account the different cost of goods and services in different countries.

What Are the Odds of a V, L, or U-shaped Recession or a Depression

Below is an interesting article from David Wessel on the subjective probabilities of a V, L, or U-shaped recession or a Depression. I follow Mr. Wessel closely because he seems to have good foresight and tends to be fairly rational. For example, he was one of the first to point out that the US was in for a massive de-leveraging that would take years. Based on the probabilities given in the article their is a 2/3s chance of an L or U-shaped recession. With that said there is still a 1/5 chance of a Depression. Note that this flies in the face of the US media that is claiming a recovery starting in the second half. Text in bold is my emphasis. From the WSJ:

There is no doubt where the economy is now. "By any measure, this downturn represents by far the deepest global recession since the Great Depression," the International Monetary Fund declared Wednesday.

But there's more than the usual uncertainty about where it is going. The key is the U.S. Even though its slice of the world economy is smaller than it once was, it's still huge. The U.S. led the world into the abyss, and it will lead the world economy out of it.

But how fast and when?

The alphabet can help to imagine the possibilities and the path of the economy. There's the letter V: the kind of quick rebound that usually follows a deep recession. Or U: a longer recession and slow recovery. There is L: years of painfully slow growth. And W: a temporary upturn as the economy feels the jolt of fiscal stimulus that quickly wears off. Finally, there's the big D, not the shape but another Great Depression.

With history a guide, consider three starkly different scenarios.

The V

The late Victor Zarnowitz, a student of the business cycle, had a rule: "Deep recessions are almost always followed by steep recoveries." The mild recession of the early 1990s and early 2000s were followed by mild recoveries. But the U.S. economy grew faster than a 6% pace in the four quarters after the deep 1973-75 recession and faster than a 7.75% pace after the even deeper 1980-82 downturn.

The IMF says this is the worst recession that the world has seen since the Great Depression. So what will happen next? Economics Editor David Wessel discusses three possible scenarios.
"In deep recessions," says Michael Mussa of the Peterson Institute for International Economics, "there is usually a growing sense of gloom as the recession deepens." Then the forces that triggered recession -- say, plunging home prices -- abate. The adrenaline of tax cuts and government spending kicks in. With inventories so lean, the slightest uptick in demand prompts a sharp increase in production, and the natural dynamism of capitalism reasserts itself.

"Experience suggests all of this should work, and I believe it will," Mr. Mussa predicts. Governments have administered huge doses of fiscal and monetary stimulus. Home-building and car-buying are so low they can't fall much further. Many consumers shy away from buying because they're frightened, not broke, and that state of mind can change quickly and liberate pent-up demand.

But the Federal Reserve caused the deep recessions of the 1970s and 1980s when it put its foot on the brake to stop inflation; it ended them when it let up. This time, Fed has its foot to the floor and the economy is still slowing. And so much stock-market and housing wealth has evaporated that a quick turn in consumer spirits seems unlikely. Plus, the repair of the banks remains far from complete, restraining lending.

The odds of the V: 15%.

The Big D

If one asked a roomful of economists two years ago to put odds on a repeat of the Great Depression, nearly all would have said zero. In early March, The Wall Street Journal posed the question to about 50 forecasters -- defining depression as a decline in output per person of more than 10%, four times worse than the decline the IMF anticipates. On average, they put odds at one in seven; several put them above one in four.

"This is a Depression-sized event," says economic historian Barry Eichengreen of the University of California at Berkeley, citing the global decline in industrial production and world trade. The big difference: In 1929, governments dithered, or worse. In 2009, they've rushed to the rescue.

To go from today's deep recession to a depression something would have to go wrong. It could be a financial catastrophe on the scale of last fall's bankruptcy by Lehman Brothers or another panic-inducing event. Or a crash in the dollar, one that forces interest rates up at just the wrong moment. Or it could be political gridlock that stops governments in the U.S. or Europe from spending enough to fix the banks before a big one fails, or keeps them for doing more on the fiscal or monetary fronts as the economy deteriorates.

Or it could be virulent deflation that pulls down prices and incomes, making debts, which don't fall when prices do, a heavier burden. The textbook remedy is easy money and big government deficits. But so much of that has been tried it's easy to question its efficacy or to imagine resistance around the world to doing.

The odds of the big D: 20%.

The L

For a decade after its stock market and real-estate bubble burst in 1990, Japan bumped along at an annual growth of just 0.5%. It was dubbed the Lost Decade, and it could happen here. The recession ends but the economy plods along, growing too slowly to bring down unemployment for years.

As the IMF observed this week, recoveries following recession caused by financial crises are "typically slower." Those following recessions that occur simultaneously across the globe "have typically been weak." Back in the 1990s, as U.S. banks struggled, the Fed talked a lot about "financial headwinds." Those were zephyrs compared to the gale-force winds that the economy confronts today.

If financial markets stabilize but don't improve steadily, or if housing prices continue to drift down, or if confidence remains shaky, the U.S. economy could languish for a time. American consumers, once known for spending in the face of prosperity or adversity, could finally decide to prepare for retirement by saving more, having just learned that neither 401(k) retirement accounts nor home values rise inexorably. And the U.S. can't count on increasing exports, the solution when emerging-market economies run into financial trouble and the reason Japan didn't do even worse in the 1990s. The rest of the world is in no shape to buy.

An unfolding depression could scare Congress to act boldly, but the L is less ominous -- and perhaps more likely as a result. There would be months when the economy appeared to be strengthening so the temptation to wait-and-see would be strong.

Put the odds of the L at 55%. That adds to 90%. So put 10% odds on the U, less pleasant than the euphoric V but far less painful than a Lost Decade. That's the rough consensus of economic forecasters; it means U.S. unemployment grows for another year and a half.

More on Banks That Are Too Big To Fail

The following from the WSJ Economics Blog is a summary of comments made by the head of the Kansas City Fed. It is good to see that there are descending points of view at the Fed.

Also the post below makes reference to Simon Johnson, former senior economist at the IMF. He authored a very interesting article entitled The Quiet Coup in the Atlantic that compares the US economy with those in emerging market countries. A really good read.

Certain firms are not too big to fail and must be allowed to do so to help the U.S. economy and financial markets heal, Federal Reserve Bank of Kansas City President Thomas Hoenig said Tuesday.

Hoenig said that protecting the country's largest institutions from failure risks prolonging the current crisis and increasing its cost. Of particular concern, he said, is that financial support provided to these firms gives them a competitive advantage over other firms and subsidizes their growth and profit with taxpayer funds.

“The United States currently faces economic turmoil related directly to a loss of confidence in our largest financial institutions because policymakers accepted the idea that some firms are just “too big to fail,'” the central banker said. “I do not.”

The central banker was delivering a prepared statement before the Joint Economic Committee of the U.S. Congress. Also appearing at the hearing were former IMF chief economist Simon Johnson and Nobel laureate Joseph Stiglitz. Hoenig is currently a nonvoting member of the interest-rate setting Federal Open Market Committee.

Hoenig said that pouring more money into large firms in hope of a turnaround may be tempting, but despite record levels of spending, confidence and transparency have not returned to financial markets. Key for a full economic recovery is restored confidence, Hoenig said.
Hoenig added that in “the rush to find stability,” no clear process was used to allocate TARP funds among the largest firms. That created further uncertainty, he said, and is impeding a recovery.

The central banker said that systemically important financial firms should be triaged based on their current condition. Well-capitalized firms should be left as is. Viable firms that need more capital should privately raise the capital or seek government assistance, with the taxpayer put in the senior position and the government determining the circumstances of the senior managers and directors. Nonviable institutions should be allowed to fail.

Nonviable institutions could be put into a negotiated conservatorship, as was done in 1984 with the holding company Continental Illinois, he said.

“Such a resolution process is equitable across all firms, has worked in the past, and favors taxpayers,” Hoenig said.

Past experience also suggests the approach costs much less than the alternative of not recognizing losses and allowing forbearance, he said, as Japan initially did with its problem banks during the “lost decade” and as the U.S. initially did with thrifts in the 1980s.

In his remarks, the central banker also said that regulatory reform is key as the crisis subsides and old habits remerge. Because they are complex and politically influential, “too big to fail” firms cannot be supervised on a sustained basis without a clear set of rules constraining their actions, he said. He said history has shown strong limits on leverage ratios work.

Hoenig also noted that the structure of the Federal Reserve System is not the problem, as has been recently suggested.

Banks Still Not Half Way Through Their Writedowns

The following by the IMF indicates that the banks will need another $875 B in capital next year and that some believe that we are only 1/3 of the way through our writedown phase. This is due mostly to fact that credit card losses and commercial real estate losses are just starting. Certainly this jives with some of the comments made in the US Treasury stress test. Text in bold is my emphasis. From the WSJ:

U.S. and European banks need to raise $875 billion in equity by next year to return to levels similar to the years before the current crisis -- and twice that amount to match the levels of the mid-1990s, the International Monetary Fund said.

The steep funding requirements reflect a financial crisis that continues to deepen, the IMF said. The banking sector's woes have spread from the housing sector to commercial real-estate loans and emerging-market debt. Overall, the IMF estimates the U.S., European and Japanese financial sectors face losses of about $4.1 trillion between 2007 and 2010. Of that, banks are confronting $2.5 trillion in losses, insurers $300 billion and other financial institutions $1.3 trillion.

The banking sector has written down $1 trillion of those losses, said the IMF; it didn't estimate how much other financial firms have written down thus far.

"Without a thorough cleansing of banks' balance sheets of impaired assets ... risks remain that banks' problems will continue to exert downward pressure on economic activity," said the Global Financial Stability Report, the IMF's twice-yearly review of the financial sector. >
While problems in the U.S. mortgage sector are blamed for the financial crisis, the IMF report shows that other regions played a big role. About $2.7 trillion of the losses from 2007 to 2010 were attributable to the U.S. market, the IMF said, while $1.2 trillion came from bad loans and securities losses in Europe.

The IMF projects that 7.9% of U.S. loans will have gone bad by next year. In a report, Calyon Securities analyst Mike Mayo predicted that losses will crest at 3.5% of loans, a level that he said will slightly eclipse the peak rate during the Great Depression. Mr. Mayo estimated that U.S. banks are about a third of the way through accounting for losses on nonmortgage consumer loans, while losses on business loans "seem in the early stages."

Despite the grim message, some IMF officials said improvements in a few markets in the past month point to the possibility that write-downs could come in below the report's projections.

Market improvements have not been significant enough to alter the overall outlook, said Jan Brockmeijer, deputy director of the monetary and capital-markets department. Some of the biggest improvement has come from emerging-market spreads. On Tuesday, Colombia became the third country, after Mexico and Poland, to seek new IMF credit lines.>
(double click to enlarge)

Economists Support the Breakup of Large Banks

I think it was a senator from NH that said, "if they are too big to fail, they are too big to exist". This is becoming a more common view. I personally believe that there is no need for a bank that handles my checking and savings accounts to also handle a large portfolio of loans or securities that could torpedo the bank. Maybe the banks that handles chekcing, savings, credit cards, auto loans, personal loans, and various types of mortgages should be more like a public utility. If you want to speculate in finance then form something other than a bank, but leave my deposits out of it. Text in bold is my emphasis. From the WSJ:

Instead of funneling taxpayer money into big financial firms, the government should take the radical step of breaking them up into smaller, more transparent companies, top economists told lawmakers Tuesday.

"We have little to lose, and much to gain, by breaking up these behemoths, which are not just too big to fail, but also too big to save and too big to manage," said 2001 Nobel Prize recipient and Columbia University Prof. Joseph Stiglitz, one of the witnesses testifying before the Joint Economic Committee of Congress Tuesday morning. He argued that big institutions are more likely to take excessive risks that backfire and distort markets.

Mr. Stiglitz also criticized the Treasury Department's $700 billion financial-rescue program for propping up large firms with subsidies, while allowing community-based banks to collapse. He voiced skepticism that the Troubled Asset Relief Program would be successful, because it paves the way for big banks to continue dominating the U.S. financial system.

Massachusetts Institute of Technology Prof. Simon Johnson argued that policy makers need to overhaul antitrust laws to prevent the development of financial firms that are too large. Banks should be sold to new private-equity owners and broken up, Mr. Johnson said, adding that banks could be divided regionally or by type of business to avoid a concentration of power.

"This may seem like a crude and arbitrary step, but it is the most direct way to limit the power of individual institutions, especially in a sector that, the last year has taught us, is even more critical to the economy as a whole than anyone had imagined," Mr. Johnson said.

Also on the panel was Federal Reserve Bank of Kansas City President Thomas Hoenig, who criticized the government's response to the financial crisis, saying the measures have focused too heavily on propping up big companies such as AIG.

"Our actions so far risk prolonging the crisis, while increasing the cost and raising serious questions about how we eventually unwind these programs without creating another financial crisis as bad or worse than the one we currently face," Mr. Hoenig said.

Was the Bank Stress Test Leaked? It Appears So.

I first heard about this Monday morning that the bank stress test being conducted by the Treasury was leaked on Sunday. The AP released a story Monday evening basically stating that they received the stress tests results on Sunday. Below is a summary of their comments.

By the way if you are interested in a much more inflammatory version of the stress test try TRN. I do NOT support many of the views given on their site and I do not know how reputable their stories are but it is another version.

Text in bold is my emphasis.

The government is giving Wall Street banks a helping hand. But this time it's not a handout.
The federal bank "stress tests" rate the individual loans held by big regional banks as riskier than the complex troubled assets held by the industry titans, according to a Federal Reserve document obtained by The Associated Press.

That approach could threaten some major regional banks while making the national banks appear in better shape when the government releases the results of the tests next month.
Regulators are administering the tests to 19 large financial firms to determine which banks are healthy, which need more help and which might fail if the recession worsens.

Under one scenario, the tests assume banks will see "no further losses" on the complex securities, according to the document obtained by AP. By contrast, it estimates that individual loans will lose up to 20 percent of their value.

Regional banks are holding more individual loans and fewer of the securities Wall Street giants specialize in — complex derivatives backed by huge pools of mortgage-backed loans and other debt.

Analysts say regulators are probably favoring the largest banks because if even one failed, it would pose a grave financial risk. Banks that deal in securities are more connected to other corners of the global financial system.

Regulators also face pressure to highlight the weaknesses of some banks. Otherwise, critics will dismiss the tests as a whitewash. That could undermine one aim of the tests — restoring confidence in the banking system.

The approach spelled out in the Fed document "certainly penalizes those banks that are more involved in traditional banking, which frankly have been performing better in recent months," said Wayne Abernathy, a former Treasury Department official now with the American Bankers Association.

He said banks' loan portfolios have lost only about 5 percent of their value so far, while the values of complex securities are down 30 to 40 percent.

The securities are held mostly by banking titans like Citigroup, JP Morgan Chase, Bank of America and Goldman Sachs. Their value is based on the performance of vast pools of underlying loans.

As defaults on the underlying loans spiked last year, investors lost confidence in the value of the assets. Individual loans have lost less value because their prices are tied more closely to actual defaults.

A Treasury Department spokesman referred questions to the Fed. A spokesman for the Federal Reserve declined comment.

Scott Talbott, a banking industry lobbyist with Financial Services Roundtable, said it's hard to conclude that the method discriminates because there are vast differences among all the companies on the list, regardless of size.

Regulators are administering the tests to all financial institutions with assets of at least $100 billion. The 19 institutions on the list include an insurer, Wall Street brokerages and regional banks, such as Cincinnati-based Fifth Third Bancorp and Cleveland-based Keycorp.

A spokeswoman for Fifth Third Bancorp said the bank would not comment. Keycorp did not respond to requests for comment. The bank said Tuesday it lost $488 million in the first quarter, partly from a large increase in what it sets aside to cover loan losses.

Some other regional banks on the test list also reported disappointing quarterly earnings Tuesday, reflecting steeper losses as people fell behind on loan payments. U.S. Bancorp's profit fell 61 percent, Regions Financial's 92 percent.

The Fed document obtained by AP doesn't mention any bank by name. And no sources or regulators would discuss any bank's performance on the tests. But some analysts have said a poor showing on the test could hammer a bank's stock or the broader market.

"The market is now pricing in an expectation that these reports are going to be pretty good," said Lawrence Brown, an accounting professor at Georgia State University. "So I think the downside risk is bigger than the upside potential."

Douglas Elliott, a former investment banker at JPMorgan now at the Brookings Institution, said only test results that reveal "substantial capital needs" will have credibility.

Once the results are announced May 4, regulators are expected to put the firms into three groups: those that are healthy, those that need more money to stay healthy and those at risk of failure.

The approach in the Fed document could help keep the largest banks out of the weakest category. That would avert the risk that bad news about the biggest banks could set off a market panic.

But it won't help the banks lower on the list. They could face pressure from speculators using share prices, futures and options to set off a wave of selling. Investors "already are preparing their strategies," Abernathy said.

Treasury Secretary Timothy Geithner told a congressional panel overseeing the federal bailouts that "the vast majority" of banks have more capital than they need. He said regulators would decide when banks will be allowed to pay the government back.

In the stress tests, regulators are putting banks through two scenarios. One reflects forecasters' expectations about the recession. The other assumes a more severe recession than expected.

Both tests measure losses that banks could face over the next two years against the cash cushions they hold to protect against those losses.

For the test that uses current expectations for the recession, banks can value securities as they have in recent filings. But losses for loans are estimated to range between 5 and 12 percent for mortgages and as high as 17 percent for credit cards.

Under the test that assumes a more severe recession, loan losses are projected at 7 to 20 percent. Securities in that test would be marked down based on market disruptions during the second half of 2008.

The Treasury May Convert TARP Loans to Equity to Shore Up Banks

Converting TARP bail-out money (loans) to equity is a quick way to help shore up the banks without being forced to go back to Congress and ask for more bail-out money. This is a simple process. Instead of carrying the bail-out money as a liability on the balance sheet, it is now carried as stockholders equity (or net worth). This immediately improves the capital ratios of the banks and lessens the amount of additional bail-out money required by the banks. Of course the downside is the US Treasury is now your largest stockholder. That means they have a lot of say in how the bank is run. Is that so bad? Obviosly the bank could not manage itself or it would not need bail-out money.

Don't get hung up on ideology like "nationalization". Without a functioning banking system we have no recovery and make no mistake we do not have a functioning banking system. People that worry about bank "nationalization" remind me of people that are picky about who they ride in a life boat with. When the ship is going down survival is the only issue.

Text in bold is my emphasis. From the NY Times:

President Obama’s top economic advisers have determined that they can shore up the nation’s banking system without having to ask Congress for more money any time soon, according to administration officials.

In a significant shift, White House and Treasury Department officials now say they can stretch what is left of the $700 billion financial bailout fund further than they had expected a few months ago, simply by converting the government’s existing loans to the nation’s 19 biggest banks into common stock.

Converting those loans to common shares would turn the federal aid into available capital for a bank — and give the government a large ownership stake in return.

While the option appears to be a quick and easy way to avoid a confrontation with Congressional leaders wary of putting more money into the banks, some critics would consider it a back door to nationalization, since the government could become the largest shareholder in several banks.

The Treasury has already negotiated this kind of conversion with Citigroup and has said it would consider doing the same with other banks, as needed. But now the administration seems convinced that this maneuver can be used to make up for any shortfall in capital that the big banks confront in the near term.

Each conversion of this type would force the administration to decide how to handle its considerable voting rights on a bank’s board.

Taxpayers would also be taking on more risk, because there is no way to know what the common shares might be worth when it comes time for the government to sell them.

Treasury officials estimate that they will have about $135 billion left after they follow through on all the loans that have already been announced. But the nation’s banks are believed to need far more than that to maintain enough capital to absorb all their losses from soured mortgages and other loan defaults.

In his budget proposal for next year, Mr. Obama included $250 billion in additional spending to prop up the financial system. Because of the way the government accounts for such spending, the budget actually indicated that Mr. Obama might ask Congress for as much as $750 billion.

The most immediate expense will come in the next several weeks, when federal bank regulators complete “stress tests” on the nation’s 19 biggest banks. The tests are expected to show that at least several major institutions, probably including Bank of America, need to increase their capital cushions by billions of dollars each.

The change to common stock would not require the government to contribute any additional cash, but it could increase the capital of big banks by more than $100 billion.

The White House chief of staff, Rahm Emanuel, alluded to the strategy on Sunday in an interview on the ABC program “This Week.” Mr. Emanuel asserted that the government had enough money to shore up the 19 banks without asking for more.

“We believe we have those resources available in the government as the final backstop to make sure that the 19 are financially viable and effective,” Mr. Emanuel said. “If they need capital, we have that capacity.”

If that calculation is correct, Mr. Obama would gain important political maneuvering room because Democratic leaders in Congress have warned that they cannot possibly muster enough votes any time soon in support of spending more money to bail out some of the same financial institutions whose aggressive lending precipitated the financial crisis.

The administration said in January that it would alter its arrangement with Citigroup by converting up to $25 billion of preferred stock, which is like a loan, to common stock, which represents equity.

After the conversion, the Treasury would end up with about 36 percent of Citigroup’s common shares, which come with full voting rights. That would make the government Citigroup’s biggest shareholder, effectively nudging the government one step closer to nationalizing a major bank.
Nationalization, or even just the hint of nationalization, is a politically explosive step that White House and Treasury officials have fought hard to avoid.

Administration officials acknowledged that they might still have to ask Congress for extra money. Beyond the 19 big banks, which are defined as those with more than $100 billion in assets, the Treasury has also injected capital into hundreds of regional and community banks and may need to provide more money before the financial crisis is over.

Treasury officials say they have more money left in the rescue fund than might be apparent. Officials estimate that the fund will have about $134.5 billion left after the Treasury completes its $100 billion plan to buy toxic assets from banks and after it uses $50 billion to help homeowners avoid foreclosure.

In practice, the toxic-asset programs are not expected to start for another few months, and it could be more than a year before the Treasury uses up the entire $100 billion. Likewise, it will be at least a year before the Treasury uses up all the money budgeted for homeowners.

But the biggest way to stretch funds could be to convert preferred shares to common stock, a strategy that the government seems prepared to use on a case-by-case basis.

Ever since the Treasury agreed to restructure Citigroup’s loans, officials have made it clear that other banks could follow suit and convert their government loans to voting shares of common stock as well.

In the stress tests now under way, regulators are examining whether the big banks would have enough capital to withstand an economic downturn in which unemployment climbs to 10 percent and housing prices fall much further than they already have.

As their yardstick, regulators are expected to examine a measure of bank capital called “tangible common equity.” By that measure of capital, every dollar a bank converts from preferred to common shares becomes an additional dollar of capital.

The 19 big banks have received more than $140 billion from the Treasury’s financial rescue fund, and all of that has been in exchange for nonvoting preferred shares that pay an annual interest rate of about 5 percent.

If all the banks that are found to have a capital shortfall fill that gap by converting their shares, rather than by obtaining more cash, the Treasury could stretch its dwindling rescue fund by more than $100 billion.

The Treasury would also become a major shareholder, and perhaps even the controlling shareholder, in some financial institutions. That could lead to increasingly difficult conflicts of interest for the government, as policy makers juggle broad economic objectives with the narrower responsibility to maximize the value of their bank shares on behalf of taxpayers.

Those are exactly the kinds of conflicts that Treasury and Fed officials were trying to avoid when they first began injecting capital into banks last fall.

This Weekend's Contemplation #2 - Is This the New Consumerism?

I don't know if this is exactly where we are headed, but it certainly worth considering. Make no mistake the world that I worked in, the Boomer world, is coming to an end. Text in bold is my emphasis. From the WSJ:

A small sign of the times: USA Today this week ran an article about a Michigan family that, under financial pressure, decided to give up credit cards, satellite television, high-tech toys and restaurant dining, to live on a 40-acre farm and become more self-sufficient. The Wojtowicz family—36-year-old Patrick, his wife Melissa, 37, and their 15-year-old daughter Gabrielle—have become, in the words of reporter Judy Keen, "21st century homesteaders," raising pigs and chickens, planning a garden and installing a wood furnace.

Mr. Wojtowicz was a truck driver frustrated by long hauls that kept him away from his family, and worried about a shrinking salary. His wife was self-employed and worked at home. They worked hard and had things but, Mr. Wojtowicz said, there was a "void." "We started analyzing what it was that we were really missing. We were missing being around each other." So he gave up his job and now works the land his father left him near Alma, Mich. His economic plan was pretty simple: "As long as we can keep decreasing our bills we can keep making less money."

The paper weirdly headlined them "economic survivalists," which perhaps reflected an assumption that anyone who leaves a conventional, material-driven life for something more physically rigorous but emotionally coherent is by definition making a political statement. But it didn't look political from the story they told. They didn't look like people trying to figure out how to survive as much as people trying to figure out how to live. The picture that accompanied the article showed a happy family playing Scrabble with a friend.

Their story hit a nerve. There was a lively comment thread on the paper's Web site, with more than 300 people writing in. "They look pretty happy to me," said a commenter. "My husband and I are making some of the same decisions." Another: "I don't know if this is so much survivalism as a return to common sense." Another: "The more stuff you own the harder you have to work to maintain it."

To some degree the Wojtowicz story sounded like the future, or the future as a lot of people are hoping it will be: pared down, more natural, more stable, less full of enervating overstimulation, of what Walker Percy called the "trivial magic" of modern times.

The article offered data suggesting the Wojtowiczes are part of a recent trend. People are gardening more if you go by the sales of vegetable seeds and transplants, up 30% over last year at the country's largest seed company. Sales of canning and preserving products are also up. Companies that make sewing products say more people are learning to sew. I have a friend in Manhattan who took to surfing the Web over the past six months looking for small- and farm towns in which to live. The general manager of a national real-estate company told USA Today that more customers want to "live simply in a less-expensive place."

Some of this—the desire to live less expensively, and perhaps with greater simplicity—seems to key off what I am seeing in Manhattan, a place still generally with more grievances than grief, and with a greater imagination about how badly things are going to go than how bad it is right now. Many think that no matter how much money is sloshing through the system from Washington, creating waves that lead to upticks, the recession is really a depression. We won't "come out of it," as the phrase goes, for five or seven years, because the downturn is systemic, global, and because the old esprit is gone. The baby boomers who for 40 years, from 1968 through 2008, did the grunt work of the great abundance—work was always a long-haul trip for them, they were the first in the office in 1975 and are the last to leave the office to this day—know the era they built is over, that something new is beginning, something more subdued and altogether more mysterious. The old markers of success—money, status, power—will not quite apply as they have. They watch and work as the future emerges.

In New York some signs of that future are obvious: fewer cars, less traffic, less of the old busy hum of the economic beehive. New York will, literally, get dimmer. Its magical bright-light nighttime skyline will glitter less as fewer companies inhabit the skyscrapers and put on the lights that make the city glow.

A prediction: By 2010 the mayor, in a variation on broken-window theory, will quietly enact a bright-light theory, demanding that developers leave the lights on whether there are tenants in the buildings or not, lest the world stand on a rise in New Jersey and get the impression no one's here and nobody cares.

The New York of the years 1750 to 2008—a city that existed for money and for all the arts and delights and beauties money brings—is for the first time going to struggle with questions about its reason for being. This will cause profound dislocations. For a good while the young will continue to flock in, for cheaper rents. Artists will still want to gather with artists—you cannot pick up the Metropolitan Museum and put it in Alma, Mich. But there will be a certain diminution in the assumption of superiority on which New York has long run, and been allowed, by America, to run.

More predictions. The cities and suburbs of America are about to get rougher-looking. This will not be all bad. There will be a certain authenticity chic. Storefronts, pristine buildings—all will spend less on upkeep, and gleam less.

So will humans. People will be allowed to grow old again. There will be a certain liberation in this. There will be fewer facelifts and browlifts, less Botox, less dyed hair among both men and women. They will look more like people used to look, before perfection came in. Middle-aged bodies will be thicker and softer, with more maternal and paternal give. There will be fewer gyms and fewer trainers, but more walking. Gym machines produced the pumped and cut look. They won't be so affordable now.

Hollywood will take the cue. During the depression, stars such as Clark Gable were supposed to look like normal men. Physical perfection would have distanced them from their audience. Now leading men are made of megamuscles, exaggerated versions of their audience. That will change.

The new home fashion will be spare. This will be the return of an old WASP style: the good, frayed carpet; dogs that look like dogs and not a hairdo in a teacup, as miniature dogs back from the canine boutique do now.

A friend, noting what has and will continue to happen with car sales, said America will look like Havana—old cars and faded grandeur. It won't. It will look like 1970, only without the bell-bottoms and excessive hirsuteness. More families will have to live together. More people will drink more regularly. Secret smoking will make a comeback as part of a return to simple pleasures. People will slow down. Mainstream religion will come back. Walker Percy again: Bland affluence breeds fundamentalism. Bland affluence is over.

This Weekend's Contemplation - IMF Sees Risk of Depression

The IMF and the Europeans continue to be much more pessimistic about our economic future than views expressed in the US. Let's face it between the US and European views of the economy one of them is wrong. The IMF site gives the actuals chapters referenced below. Text in bold is my emphasis. From the UK Telegraph:

This recession is likely to be "unusually long and severe, and the recovery sluggish," said the Fund, releasing two advance chapters from its World Economic Outlook. However, it warned there is a risk that it could spiral down into a full-blown slump (European word for Depression) unless further action is taken to stop "feedback effects" gathering force.

Dominique Strauss-Kahn, head of the IMF, said millions of people risk being pushed back into poverty as the economic storm ravages the most vulnerable countries. "The human consequences could be absolutely devastating. This is a truly global crisis, and nobody is escaping," he said.

Mr Strauss-Kahn called for a urgent action to "cleanse banks" of toxic assets and for further fiscal stimulus beyond the 2pc of global GDP already agreed. The snag is that high-debt countries may have hit the limits already.

"The impact becomes negative for debt levels that exceed 60pc of GDP," said the Fund.

While no countries were named, this would raise questions about Japan, Germany, France, Italy and ultimately Britain and the US after their bank rescues.

The IMF said the US is at the epicentre of this crisis just as it was in the Depression, setting the two episodes apart from normal downturns. However, the risks are greater this time. "While the credit boom in the 1920s was largely spec­ific to the US, the boom during 2004-2007 was global, with increased leverage and risk-taking in advanced economies and many emerging economies. Levels of integration are now much higher than during the inter-war period, so US financial shocks have a larger impact," it said.

The IMF said the global financial system is still under acute stress, with output tumbling and inflation falling towards zero in key nations. "The risks of debt deflation have increased," it said.

Abrupt halts in capital flows can have "dire consequences" for emerging economies, it said. Eastern Europe has already suffered the effects, with a 17.6pc fall in industrial production in February. The region is highly vulnerable to the credit crunch since it owes more than 50pc of its GDP to Western banks.

Synchronised world recessions striking all major regions are "historically rare" events, the Fund said. They last one and a half times as long typical downturns, and are followed by painfully slow recoveries.

Industrial Production Down 13%, Worst Since the End of WWII

Once again show me how the US media is going to get us from our current level of industrial production to recovery within the next 6 months. Text in bold is my emphasis. From Market Watch:

As businesses struggle to work down their inventories of unsold goods, the output of the nation's factories, mines and utilities fell 1.5% in March, retreating in spite of higher production of motor vehicles and a boost from utilities, the Federal Reserve reported Wednesday.

Industrial production is down 13.3% since the recession began in December 2007, the largest percentage decline since the end of World War II, when production of military equipment ground to a halt and production fell 35%.

In the past year, industrial production has fallen 12.8%. Output fell at a 20% annualized rate during the first quarter, and it's now at the same level as December 1998, the Fed's latest data showed.

Factory production dropped 1.7% in March. Factory output has fallen 15.7% during the recession, also the largest decline since 1945-1946.

Underscoring the trend in manufacturing, factory output has dropped 15% in the past 12 months and has fallen for five consecutive quarters.

"The huge declines in industrial production in the past two quarters reflect very aggressive cuts in inventories by businesses," wrote Nariman Behravesh, chief economist for IHS Global Insight. "We expect industrial production to contract 10.2% this year -- the biggest drop in the postwar period -- before bottoming in early 2010."

The pace of decline could be easing, though, judging from another economic indicator released Wednesay.

The Federal Reserve Bank of New York said its Empire State index improved markedly in April, to a reading of negative 14.7 from negative 38.2 in March. The reading under zero shows most manufacturers say business is still getting worse, but at a slower pace.

In the March industrial production report, the Fed said capacity utilization fell by a full percentage point, to 69.3%, the lowest since the data series began in 1967. In manufacturing, capacity utilization fell to 65.8%, which means a third of the nation's manufacturing capacity is idle, cutting into profits and reducing companies' pricing power.

"These results are additional signs of growing slack throughout the economy that are very deflationary," wrote Lori Helwing and David Rosenberg, economists for Bank of America's Merrill Lynch.

In a separate report, the Labor Department said consumer prices fell 0.1% in March after seasonal adjustments. Prices have dropped 0.4% in the past year, the first time since 1955 that prices have decreased on a year-over-year basis. The core CPI rose 0.2% in March.

Details of industrial production

Overall, industrial output for last month was much lower than expected by economists surveyed by MarketWatch, who had been looking for a smaller 0.8% decline.

In March, mining output fell 3.2%. Utility output increased 1.8%.

In the factory sector, output of business equipment fell 2.8% and is down 14% in the past year.

Output of consumer goods fell 0.3% in March and is down 8% in the past year.

Output of motor vehicles increased 1.5% in March after a 9.4% jump in February. Vehicle assemblies rose to a seasonally adjusted annual rate of 4.84 million, up from 4.65 million in February and 3.72 million in January.

By contrast, 8.45 million cars and light trucks were produced in 2008.
Vehicle output is down 34.5% in the past year.

Excluding vehicles, industrial production fell 1.9% in March. Factory output fell 2.8% excluding vehicles.

Production of high-technology equipment fell 3.1% for the second month in a row, putting the cumulative drop at 22.6% in the past year. Excluding high-tech, industrial production for March fell 1.4%.

Building Permits and Housing Starts are Down and the Number Collecting Unemployment is Up - So Where is the Recovery?

The US Media keeps calling a bottom with a recovery starting in the second half of the year. With the building permits and housing starts down and the number collecting unemployment up someone needs to point out how we get to the recovery in 6 months or so. Text in bold is my emphasis. From Market Watch:

Building permits fell to a record-low level in March and construction on new homes dropped sharply again after a big gain in February had raised hopes of a recovery, the Commerce Department estimated Thursday.

Housing starts fell 10.8% in March to a seasonally adjusted annual rate of 510,000 from 572,000 in February. It's the second-lowest rate since the 1940s. January's 488,000 pace remains the post-war low.

Barron's Senior Editor Steven M. Sears examines why "April is the cruelest month", as certain popular sentiment indicators are declining even as some of the macro-measures that drove the rally - like good earnings clarity and guidance - seem to be fading away.It was much weaker than the 550,000 annual rate expected by economists surveyed by MarketWatch.

Meanwhile, building permits dropped 9% to a 513,000 seasonally adjusted annual pace, the lowest on record. Permits for single-family homes fell 7.4% to a 361,000 annual rate, the second-lowest on record.

"The drop in permits takes some luster off the relatively better news we had been seeing in housing, but a bottom may still be near," wrote Adam York, an economist for Wachovia. "We think a bottom for construction activity could come by summer, near or just below the half-million unit mark."

Starts are down 48% in the past 12 months and are down 78% from the peak three years ago. Starts are down 51% in the first three months of the year compared with the same period last year. In all of 2008, 905,000 homes were started.

Building permits are down 45% in the past year.

The large increase in housing starts in February, which has now been revised down to 17% from the 22% gain originally reported, was lauded by policymakers from Ben Bernanke to Barack Obama as a tentative sign that the pace of economic decline might be easing.

In a separate report, the Labor Department said initial jobless claims plunged by 53,000 to 610,000 last week, the lowest since January, potentially another "green shoot" of hope.

However, the number of people collecting unemployment checks surged by 172,000 to 6.02 million, another record high.

The drop in housing starts in March was entirely due to the volatile multifamily sector, which fell 29% in March after rising 62% in February. Starts for single-family homes were unchanged in March at a 358,000 rate, just above the record-low of 356,000 set in January.

With single-family starts steady at a very low level over the past three months, "the residential real estate sector may be starting to stabilize," wrote Michelle Girard, an economist for RBS Securities. "Of course, a meaningful upturn in home building will not be seen until inventory levels (which remain bloated) have been significantly reduced."

The inventory of homes on the market is likely to rise in coming months, as lenders have resumed foreclosures, said Richard Moody, chief economist for Forward Capital. "Any rebound in new residential construction will remain muted into 2011," he said.

The mood of home builders improved in April, but remained gloomy. The National Association of Home Builders reported Wednesday that its sentiment index rose from 9 in March to 14 in April on a scale of 1 to 100. See full story.

The government cautions that its monthly housing data are volatile and subject to large sampling and other statistical errors. In most months, the government can't be sure whether starts increased or decreased. In March, for instance, the standard error for starts was plus or minus 11.6%. Large revisions are common.

It can take four months for a new trend in housing starts to emerge from the data. In the past four months, housing starts have averaged 532,000 annualized, down from 568,000 in the four months ending in February.

Housing completions rose 3.5% in March to an annual rate of 824,000.

The number of new single-family homes under construction fell to a record low 351,000.
Housing starts rose 6.3% in the Northeast, rose 15.9% in the Midwest, fell 16.8% in the South and fell 26.3% in the West.

Japanese Economy Continues to Decline

The Japanese economy continues to weaken along with many other economies throughout the world. The question that has to be asked is whether or not the US will follow in their footsteps. Text in bold is my emphasis. From Market Watch:

Bank of Japan Gov. Masaaki Shirakawa said Friday the Japanese economy is worsening and the downturn has yet to run its course, according to reported comments.

Shirakawa, speaking at the central banks' quarterly branch managers' meeting in Tokyo, warned employment and wage conditions would deteriorate further and that company earnings and the ability to raise funds remain under intense pressure.

"Under these circumstances, the possibility is high that the nation's economy will continue deteriorating for the time being," Dow Jones Newswires quoted Shirakawa as saying.

The tone of the comments reflected a deep sense of gloom, raising the likelihood the central bank would revise down its growth outlook when it releases its semiannual outlook report on the economy April 30.

In January, the central bank said in its interim report that the economy would suffer its worst contraction since World War II. It lowered its outlook for real gross domestic product growth in the fiscal year begun in April to a 2% contraction, down from the 0.6% rise it had forecast in October.

"It's necessary to pay careful attention to the possibility that, due to worries over falls in stock prices as well as the worsening economy, [conditions] may start affecting the stability of the financial system," Shirakawa said.

The central banker also raised the deflation alarm, saying wholesale prices are likely to keep trending lower as commodity prices continue to cool amid weak global demand.

Japan's wholesale prices fell 2.2% in March from the year before, data released earlier this week showed. The rate of decline was the sharpest in nearly seven years, and is believed to reflect softening global demand.

The data were also viewed as showing demand in Japan had yet to show much signs of life after months of gloomy news flow on the state of the economy.

Big Surprise - Lending by the Banks That Received TARP Decreased in February

Lending by the larger banks that received TARP money is actually declining. This should come as a big surprise. Banks are under a lot of pressure to both lend and improve their capital positions. The only way to improve their capital position is to turn a quarterly profit which increases retained earnings. Furthermore, why lend in a bad ieconomy with increasing unemployment. Text in bold is my emphasis. From the WSJ:

The largest bank recipients of U.S. government aid are offering less credit to businesses and consumers, the Treasury Department said Wednesday, reflecting and exacerbating the tenuous state of the current economic environment.

In a monthly snapshot of lending by the 21 largest banks receiving Troubled Asset Relief Program funds, the Treasury said credit being offered fell 2.2% across all commercial-lending and consumer-lending categories in February, compared with the prior month.

Particularly problematic: continued deterioration in commercial real estate and general business lending, as well as the credit being made available for student and auto loans.

The lone bright spot remained home loans, with consumers eager to take advantage of record-low interest rates to refinance their mortgages.

The Treasury said 16 of the 18 banks surveyed increased mortgage originations in February, resulting in a 35% increase in mortgage lending from January levels.

The February decline in lending adds to pressure on the Obama administration's efforts to restart the still-fragile credit markets.

The Treasury has committed $95 billion in TARP funds for new programs to boost consumer and business lending, though they are either just getting started or are still in the development phase.

The report suggests that jawboning by federal officials for banks to use TARP funds to boost lending is having a limited effect.

The Treasury blamed the decrease on the broader economic weakness, including low consumer confidence, high unemployment and a decrease in U.S. exports.

It also said lending would have been lower absent the nearly $200 billion in capital injections the government has provided to about 550 banks.

Banks' diminished appetites for lending are forcing businesses and consumers alike to curb their spending, which risks prolonging the U.S. economic recession.

Dan Carl, who owns a handful of businesses including several car dealerships in Michigan, said Fifth Third Bancorp, Cincinnati, refused to renew some of his company's credit lines when they came due earlier this month. On other loans, Fifth Third raised interest rates and demanded Mr. Carl's firm put up additional collateral.

The lack of affordable credit was one factor prompting Mr. Carl's company to recently lay off 20% of the work force and close at least one dealership.

Lenders such as Fifth Third are punishing "the good customers to make up for the banks' mistakes," he said.

Fifth Third received $3.45 billion through TARP.

It made $634 million of new commercial and industrial loans in February, down from $785 million in January and $1.3 billion in December, according to the bank's filing with the Treasury Department.

"Demand for Small Business credit is still relatively stable but showing signs of weakening as application volume is starting to slow," Fifth Third said in its filing.

Fifth Third spokeswoman Stephanie Honan said the bank won't comment on specific customers.
In reviewing loans, she said, Fifth Third considers overall economic conditions and "any changes to the customer's business environment."

Overall, she said, the bank tries "to balance our commitment to our customers with safe and responsible lending practices."

The banking industry's lending pullback was particularly severe with consumer credit.

In February, according to the Treasury report, originations of new U.S. credit-card accounts fell 2.7%.

That number likely understates the magnitude of the retrenchment. Many banks have been slashing borrowing limits on cards, especially for customers who rarely approach their limits.

By reducing the credit lines, the banks can free up space on their balance sheets. But the move risks infuriating consumers.

Bank of America Corp., which received $45 billion through TARP and has the industry's largest U.S. card portfolio, said in its submission to the Treasury that credit-card loan balances and new account originations declined in February "due to continued reduction of exposure on long term inactive customers and line reductions on high risk accounts."

Bank of America recently informed longtime customer James S. Jensen that the interest rate on his credit card would leap into the double-digits, even though he had never been late on a payment.

"I could borrow on the street for less than this," says Mr. Jensen, a 61-year-old vice president at Navistar Truck Group in Warrenville, Ill.

Mr. Jensen says he is canceling his Bank of America card as a result.

Bank of America spokeswoman Betty Riess said the Charlotte, N.C., bank is "taking a more aggressive look at accounts to control risk given the current environment."

Summary of the “The Global Financial Crisis, A Great Depression?” Discussion

If you want to believe what the US media puts out, namely, that the US is at the bottom and it is all up from here, that is up to you. The comments below give a more realistic summary of the current state of affairs. Text in bold is my emphasis. From the WSJ Economics Blog:

Former World Bank chief James D. Wolfensohn and historian Niall Ferguson gave a gloomy assessment of the world economy and said that while the outlook for the U.S. is dim, that for Europe is far worse.

In a discussion Tuesday at the New-York Historical Society with Richard Sylla, a professor at New York University’s Leonard N. Stern School of Business, Messrs. Wolfensohn and Ferguson indicated the U.S. downturn will persist through next year, and expressed little confidence that stimulus packages or financial-sector restructuring are working yet. The jury is still out on whether this is “a pause or a permanent breakdown” in the globalized economy, Mr. Ferguson said.

In the talk – titled “The Global Financial Crisis, A Great Depression?” – Messrs. Wolfensohn and Ferguson didn’t cite any bright spots around the globe but noted that China’s economy is relatively well positioned to ride out the slump, thanks to its trillions of dollars in reserves—which Beijing is tapping for its $585 billion stimulus plan. India also has some resiliency, Mr. Wolfensohn said, because its relatively stable economy doesn’t hinge on exports and its banks have expanded conservatively. “The main point, he said, “is this is a very much deeper downturn than anything that we’ve seen.”

Europe’s economic plight is far more dire than the U.S.’s, Mr. Ferguson said, because it has critical cases in Eastern Europe, such as Hungary, and because “it lacks the institutional framework to do what the U.S. is doing.” Given Germany’s highly leveraged banks, he added, it wasn’t surprising to see Chancellor Angela Merkel work during the recent Group of 20 meeting to shift the burden of Eastern Europe’s economic rescue to the International Monetary Fund from the European Union.

Mr. Ferguson, who teaches at Harvard, is a scholar of the downward spiral, having charted collapses on a grand scale in his books, “Empire: The Rise and Demise of the British World Order and the Lessons for Global Power,” as well as “Colossus: The Rise and Fall of the American Empire.” His most recent book is “The Ascent of Money: A Financial History of the World.”

For decades, Mr. Ferguson said, China and America have been locked in “a bad marriage”—with China saving too much and the U.S. overspending. To begin to right the economies of both countries, there has to be a cultural shift, with those patterns reversing he said.

Mr. Wolfensohn, who headed the World Bank from June 1995 through May 2005, went on to become a special envoy to Gaza and now is a consultant. During the discussion, he singled out Africa as a special case during the crisis, and warned that Western governments “are ignoring that part of the world.” Although economic growth will slow or even contract over the next few years, Africa’s population will continue to expand, Mr. Wolfensohn said. Without assistance, education levels are likely to decline and child mortality rates are likely to rise.

“There is a crying need for us to really sit down with the Africans and look at how much more can be done,” Mr. Wolfensohn said in an interview after the discussion. The situation will need “leadership from the G-7, the G-20 and the African countries.”

Foreclosures Up 46% from March 2008

Foreclosures are up significantly as the foreclosure "moratorium" comes to an end now that the banks have a better idea what the Obama housing stimulus plan looks like. Wait about one or two quarters and losses should be up significantly at the banks as the losses from the foreclosures hit the bank income statements. Text in bold is my emphasis. From Yahoo News:

U.S. foreclosure activity leaped 46 percent in March from a year earlier, hitting a record high as programs stunting the torrid pace of failing mortgages expired, RealtyTrac reported on Thursday.

A temporary freeze on foreclosures by major banks and government-controlled home finance companies Fannie Mae and Freddie Mac ended before President Barack Obama's massive housing stimulus, unveiled on March 6, could take root.

Filings, which include notice of default, auction sale or bank repossession, jumped 17 percent in March from February.

Filings for the quarter also marked a record high, jumping 24 percent from the same period a year ago.

The March and first-quarter totals were the highest since RealtyTrac began tracking them in January 2005, even as bank repossessions declined.

One in every 159 U.S. households with mortgages got a foreclosure filing in the first three months of this year, RealtyTrac said. Filings were reported on more than 803,000 properties in the quarter.

California, Florida, Arizona, Nevada and Illinois accounted for nearly 60 percent of U.S. foreclosure activity in the first quarter, with a combined 479,516 properties receiving filings.

In the transition from industry freeze to new government rescues, the foreclosure filing floodgates reopened.

After the moratoriums ceased, "we saw an onslaught of notices of default, which is the first stage of foreclosure," Rick Sharga, senior vice president at RealtyTrac, said in an interview.

The rise in filings suggests a backlog had built up due to the moratoriums. The success of the Obama mortgage bailout may not be seen until the autumn, Sharga added.

Activity should peak near year-end. "But unfortunately, these well-intentioned delays in the processing might have the unintended consequence of extending the housing downturn," and further dragging down home prices, he said.

"We still anticipate that we'll see upward of 3 million households receive a foreclosure notice this year, up from 2.4 million last year," Sharga said.

For all of 2005, the last year before the foreclosure spike started in earnest, RealtyTrac reported about 800,000 filings.

Loan servicers are overwhelmed with the volume of failing home loans and many are understaffed to handle modifications.

One national servicer that foreclosed on 2,000 properties in 2006 handled about 21,000 the next year with similar staffing levels, Sharga said. The servicer expects a 50 percent spike in 2008, without approval to increase staff.

Nevada, Arizona and California had the highest foreclosure rates in the first quarter.

Homes prices and sales soared in these states during the boom years earlier this decade, and now suffer the biggest losses on overbuilding and abandoned investment units.

Nevada led the ranks in the quarter, with one of every 27 households with loans getting a filing, more than five times the national average.

Florida, Illinois, Michigan, Georgia, Idaho, Utah and Oregon were the other states with the highest foreclosure rates.

Households with loans in California represented almost 29 percent of the quarter's total filings, up about 35 percent from last quarter and from a year ago. Nearly 231,000 units received a filing, the state's highest-ever quarterly total.

One silver lining is the growing demand from first-time buyers and investors for these distressed homes, which is helping put a floor under the worst housing market since the Great Depression.

"But it's unlikely that this increased demand will be enough to offset the growing number of foreclosures in the pipeline, accelerated by rising unemployment rates," James J. Saccacio, chief executive of RealtyTrac, said in a statement.