Sunday, May 10, 2009

Comments on Where the New Jobs Will Come From

The following is an excerpt from an article by John Mauldin concerning prospects for new job growth. Basically we are in for a tough slog. Text in bold is my emphasis.

. . . . As the water in our bucket seeks a new economic level, there are simply going to be fewer jobs to make "stuff," as we consume less. We can't rely on many of the old jobs and industries to come back in short order, as has been the case in the past. In order for new jobs to be created, we are going to have to create new businesses and expand current ones.

The vast majority of new job creation in the US is by small businesses and entrepreneurs. Yet today small business faces a tough environment. Banks have tighter lending policies. Venture capital is tough to find. Competition in a shrinking economy is brutal.

And the Obama administration wants to raise taxes on small businesses by raising taxes on the "rich." 75% of those rich he targets are small businesses who need capital in order to grow, but are having trouble getting it from banks.

Sure, entrepreneurs will do what they have to do, and higher marginal tax rates will typically not keep them from working as hard as possible to make their businesses successful. If the tax rates of the large majority of businessmen and women go back to the pre-Bush level, it will not make us close our businesses, but it will cut down on the capital we have available to expand. It will slow down economic growth and hinder job creation. There is just no getting around that fact.

There is a reason that high-tax states have higher unemployment rates and lower job growth. Taxes have consequences for economic growth.
(I am not sure the consequences will be that severe. Certainly lower tax rates did not help out that much.)

The sad reality is that it is going to take a long time to get back to acceptable employment levels in the US. It now takes an average of over 21 weeks to find a new job, a new record. Stories from friends in the financial services business are particularly difficult, as there are many very highly qualified people for every job that comes available. And it is not going to get better any time soon.

How could we add 120,000 new jobs while unemployment is going up? Because the number of people looking for jobs is growing far faster, as more and more young people come into the market place and couples now find they both must look for a job. And that is a trend that is going to continue.

So many bullish analysts talk about the second derivative of growth, by which they mean that we are slowing our descent into recession. But it is not the second derivative that is important. What is important is that the first derivative, actual growth, return. Until that time, unemployment will continue to rise, which is going to put pressure on incomes and consumer spending, and thus corporate profits.

Profits in the first quarter, with nearly 90% of companies reporting, are down over 50% from last year and are 18% less than estimates. Yes, inventories are down, but so is final demand from consumers and businesses. There is a reason that GM and Chrysler are shutting down for two months this summer. That will percolate throughout the economy.

As the realization that the economy is not due for a robust recovery sinks in, I think the chances for another serious bear market test of the stock market lows will become increasingly high. As David Rosenberg said in his final memo from Merrill Lynch (and good luck to him in his new position, where I hope we all still get to read his very solid analysis!), if a few weeks ago someone had said you could sell all your stocks 40% higher, most of you would have hit that bid.

Now that price has in fact been bid. Do you want to gamble on a renewed bull run in the face of a continually shrinking economy? I suggest you give it some serious thought, or at least put in some very real stop-loss protection.

This Weekend's Contemplation - Poll Indicates Social Problems Ahead for the US and Europe

The following is a summary of a poll conducted by Harris. This is the the original relaease from Harris. Otherwise this is the link from the NY Times for the article below. Text in bold is my emphasis.

A solid majority of people in the major Western democracies expect a rise in political extremism in their countries as a result of the economic crisis, according to a new poll.

Even in the United States and Italy, the two countries whose citizens are least likely to hold that view, fully 53 percent of those surveyed say more extremism is “certain to happen” or “probable” in the next three years, according to the poll, conducted by Harris Interactive for the International Herald Tribune and France 24. The number rises to 65 percent in Britain and Germany, with about 60 percent expressing that view in the other two countries surveyed, France and Spain.

“I believe there will be a rise in political extremism in the United States, particularly from the right, between now and the next presidential election,” said Robert J. Kepka of Addison, Illinois, one of the people surveyed who agreed to a follow-up interview by e-mail. He said he expected such a result, however, “not as a result of the current economic crisis, but rather the perceived erosion of conservative Christian values.”

The survey found a widespread expectation of unrest, with strikes and demonstrations forecast by 86 percent of those in the six countries. Half of those surveyed expected riots in their own countries.

Other changes forecast were “greatly increased immigration into your country” (60 percent), a “rise of religious fanaticism in your country” (45 percent) and a drop in human rights or individual freedoms (41 percent).

The one political figure that people consistently pin their hopes to is President Barack Obama. About half of all people surveyed expressed the most confidence in his ability to solve the crisis, with Chancellor Angela Merkel of Germany coming in second, with 22 percent. Only in Britain did a minority back Obama — one in three — but even there he handily outdistanced the runner-up, Prime Minister Gordon Brown.

Another person surveyed, Amanda King of Newport, Wales, said it was more important to focus on systemic change rather than looking to personalities.

“It is almost impossible for one single leader to resolve such a crisis,” she said. “Especially in today’s globalization, bringing a recession to a close requires international co-operation.”

Speaking of Obama, she added: “Every measure he might make in response to this financial crisis will be limited and on its own will have very little effect. Confidence and stability will only increase over a period of time.”

The survey exposed pockets of optimism amid the gloom. For instance, two in three people thought the crisis could result in reform of the worldwide economic systems. And half thought it could strengthen solidarity among people, though again half thought it would not.

Looking to neighboring nations, most people found less cause for alarm. Given four possible pessimistic outcomes (bankruptcy, coup, civil war, international war), only a minority found such a result probable or certain in their region.

The story on the home front, however, was quite different. Around half of all respondents said they worried at least somewhat about losing their job or their pension, being unable to afford medical care, or being able to afford basic utilities like electricity, water or the telephone.

And fully one in three respondents even worried about becoming homeless. Only the Germans, at 19 percent, were relatively worry-free on this score. Nearly half of those in Italy and Spain had such a nightmare, but the Italians, for one, thought it would not become a reality. When asked whether they thought such a thing could happen to them in the next three years, only 12 percent of Italians said yes — the lowest percentage of any country. The highest number, at 32 percent, was in the United States.

This poll was conducted online from March 25 to 31 by Harris Interactive, in partnership with France 24 and the International Herald Tribune, among 6,449 adults, ages 16 to 64, in Britain, France, Germany, Spain and the United States and adults, ages 18 to 64, in Italy. The data for age, gender, education, region and Internet propensity were weighted when necessary to bring them into line with the current proportions in the population. Propensity score weighting was applied to adjust for respondents’ propensity to be online.

Harris Interactive relied on the Harris Poll Online panel as the primary sample source for the survey.

The panel consists of potential respondents who have been recruited through online, telephone, mail and in-person approaches. Because the sample is not random but is based on those who agreed to participate, no statistical estimate of sampling error can be calculated.

More Opinion on the Stress Test and the Unemployment Rate

Below is an op/ed piece from Alan Abelson at Barrons that is very interesting and easy to read. Once again the Fed bank stress test is called into question. Also he tries to determine why an unemployment rate of 8.9% is good news. Text in bold is my emphasis. From Barrons:

WHAT'S ALL THE EXCITEMENT ABOUT? SIMPLE: the economy has stopped falling off a cliff and -- Glory Hallelujah! -- it's now merely rolling briskly downhill. (We couldn't resist cribbing that description from Société Générale's Albert Edwards.) No guarantee, mind you -- economies being notoriously quirky -- that on the way down, if it espies another nice-looking cliff, the blamed thing won't decide to take a leap off that one.

You doubt that's reason enough for the stock market to go racing for the moon and, in just a couple of months, rack up a 37% gain? Come to think of it, you're right to be skeptical, and we feel sheepishly negligent. For not only are things getting worse more slowly, but equally as important in the remarkable revival of euphoria is that investors en masse, taking a leaf from Federal Reserve Chairman Ben Bernanke, have become budding botanists, able to espy green shoots of recovery in virtually every compost pile.

We're also a tad remiss in not mentioning that the dread stress tests, designed by the famed financial-testing firm of Bernanke, Geithner & Co. to determine how much of a pulse the nation's 19 largest banks still have, proved not to warrant much dread after all. Just by way of example, disclosure that
Bank of America was in need of $34 billion in fresh capital promptly sent its shares soaring 17% on Wednesday. Who can blame shareholders for wistfully wondering how high the stock would have jumped had the bank needed $68 billion?

Geithner, Bernanke & Co., nothing if not adept at the care and feeding of investors, sought to take any possible sting out of what they found as they combed through the murky balance sheets of the banking behemoths (the Environmental Protection Agency might have been a better choice, considering the toxic material involved). They did so by cunningly contrived leaks, designed more for reassurance than revelation, in the weeks leading up to D- (for disclosure) Day as to the likely results of their examinations. By last Thursday, when the "scores" on the stress tests were actually released, those leaks had become veritable geysers.

As Philippa Dunne and Doug Henwood, proprietors of the Liscio Report, shrewdly observe, the highly publicized exercise made it look as if Washington's aim was "to restore confidence in the financial system before restoring the financial system." And the stress test itself struck them as being "precooked, with just enough talk of raising fresh capital to be credible, but not so much as to induce fear."

The presumed point of the two-month probe was to determine how the banks would hold up, were the economy to confound the expectations that the worst was over and, instead, suffer further declines. The "worst-case scenario," as the cliché goes, that the Fed crew was able to dream up was one in which the unemployment rate, already a hair under 9%, would rise to 10.3% next year, housing prices would fall another 22%, and the economy -- which has been shrinking at more than a 6% annual rate the past two quarters -- would contract at a 3.3% pace.

Undeniably, that represents something less than a heartening prospect. But to call it a worst-case possibility for the economy is a good deal less than a creditable postulate; rather, it bespeaks a surprising failure of imagination on the part of the same folks who've been able to spot plantlets of recovery in even the most unforgiving data.

Should worse come to worse, those fearless (or feckless?) forecasters allow that the major banks could take a $599 billion hit.

However, our financial guardians decided that it would be enough to dissipate any stress in banking by requiring the 10 big lenders that got less-than-passing grades to come up with a total of nearly $75 billion. That may sound like a lot of money -- because it is -- but to a populace that has become inured to seeing trillions tossed at the banks like confetti, it's not apt to cause a whole heck of a lot of angst.

While gratification at what the stress tests showed evoked widespread relief, touching on giddiness, not everyone was satisfied, much less elated. Ah well; there are always some chronic doubters in every crowd, we suppose.

Just by way of example, Barry Ritholtz, chief of the eponymous Ritholtz Capital, seems more than a tad aghast at the idea that Messrs. Geithner and Bernanke, after duly weighing the results of their not-exactly-stressful tests, have concluded that banks will be fine in the future with 25-to-l leverage (Tier 1 capital equal to 4% of risk-weighted assets).

And while 25-to-l leverage may have been appropriate for depository banks in the relatively sedate days before the Glass-Steagall Act was dismantled, it seems more than a little much to Barry in "today's toxic-asset-laden banks." As to the cause of the seemingly generous standard, he suggests it may have something to do with the Treasury's new role as "shareholder and cheerleader for bank profitability." That explains at least why Tim and Ben never leave home without their pom-poms.

And then there's Chris Whalen, who, via his Institutional Risk Analytics, keeps a gimlet eye on the banks -- big, small and in between. Institutional Risk Analytics sounds wonderfully authoritative, but it's a mouthful, so we'll content ourselves with referring to the service as IRA. By whatever name, we find it always worth perusing, not least for Chris's caustic take on the financial scene.


As it happens, IRA performs its own stress tests on some 7,600 banks using the vital statistics compiled by the Federal Deposit Insurance Corp. and it has even fashioned a stress-test index. Its latest ratings of bank safety and soundness -- the handiwork of the outfit's Dennis Santiago -- tell a much less comforting tale than does the Washington version.

More specifically, IRA's bank-stress index, which stood at 1.8 at the end of the final quarter of '08, shot up to 5.57 in the first quarter of this year (the benchmark year, 1995, equals 1). Behind this sharp increase in stress is the startling number of the nation's banks -- 1,575 -- that wound up in the red in the first quarter.

In a follow-up report, Chris comments that it's "pretty clear that the condition of the U.S. banking industry is continuing to deteriorate, and we are still several quarters away from the peak in realized losses for most banks." Indeed, he adds, "We're not even on the right block to make the turn."

And, not surprisingly, he feels strongly that this isn't the time for investors to go ga-ga over financials. In case you're wondering, there's no evidence that he's color-blind and just can't see all those green shoots littering the financial landscape.

PERHAPS THE MOST ELOQUENT expression of how delusional Wall Street has become was its response to Friday's report on what happened to employment -- or, more importantly, unemployment -- in April. Payrolls shriveled by 539,000, less than the 550,000 to 600,000 guesstimates of the seers as well as March's initial tally of 633,000. That was enough for the choristers to start humming Happy Days Are Here Again.

A slightly more careful look suggests rather emphatically that they're not. The unemployment rate extended its doleful rise, hitting 8.9%, the highest level since 1983. The jobless ranks have swollen by 5.7 million since the recession got underway in December 2007, and there are now 13.7 million people out of work.

Moreover, our favorite measure of unemployment -- favorite because we think it a truer gauge -- is the Bureau of Labor Statistics' U-6, which includes the likes of workers laboring part-time because they can't land full-time jobs, rose to a fresh peak of 15.8%. That means 24.7 million people are effectively unemployed. It's a figure that doesn't get too much notice -- maybe it's just too depressing -- but it should.

For that matter, bad as it is, 539,000 doesn't do justice to the severity of the payroll shrinkage. For one thing, it was puffed up by the 72,000 federal census takers signed on by Uncle Sam. And for another, it includes 226,000 supposed jobs, or 60,000 properly adjusted, courtesy of what David Rosenberg calls the Alice-in-Wonderland birth/death model. Ex this pair of extraordinary items, he points out, the headline number would approach 670,000.

In one of his valedictory scribblings (David's leaving Merrill Lynch and returning to the glories of his native Canada and money management), he also notes that private-sector employment sank by 611,000 in April, and did so across a wide swath. "The data," he contends, "just don't square with the conventional wisdom permeating the investment landscape."

Take the notion that we're enjoying a commodities boom; If so, it seems more than passing strange that natural resources shed 11,000 jobs last month. Or, how do you reconcile the burst of enthusiasm for leisure/hospitality stocks with 44,000 busboys, bell captains and bartenders being laid off? Or retailers' giving pink slips to 47,000 workers -- atop the 167,000 slots they let go in the first quarter -- if they thought anything more than the timing of Easter underpinned their April results?

Looking ahead, David scoffs at the idea that the "jobs data are about to get better because the markets have enjoyed a nice two-month rally." Among the reasons he's skeptical: the still record-low workweek, at 33.2 hours; the 66,000 downward revision to the back data (which, he avers, tends to feed on itself); the 63,000 slide in temp-agency employment; and the high levels of both initial and continuing jobless claims.

All of which, he believes, foreshadow a further 550,000 payroll plunge when the May data roll out early next month.

To David, as to us, the present buoyant mood on the Street is obviously more the result of rose-colored glasses than of green shoots.

Saturday, May 9, 2009

The Value of the Stress Tests Could be Crap


Once again the value of the Bank Stress Test performed by bank regulators is in question. I don't mean to "beat a dead horse", but these issues are critical. When you reduce the equity needs of the banks a few days before the results come out it indicates that either the regulators don't know what they are doing or there were some "behind the scenes" politics. With today's modern computer facilities it is possible to state results in a number of different ways to accomodate all the different ways to look at things. Text in bold is my emphasis. From the WSJ:

The Federal Reserve significantly scaled back the size of the capital hole facing some of the nation's biggest banks shortly before concluding its stress tests, following two weeks of intense bargaining.

In addition, according to bank and government officials, the Fed used a different measurement of bank-capital levels than analysts and investors had been expecting, resulting in much smaller capital deficits.

The overall reaction to the stress tests, announced Thursday, has been generally positive. But the haggling between the government and the banks shows the sometimes-tense nature of the negotiations that occurred before the final results were made public.

Government officials defended their handling of the stress tests, saying they were responsive to industry feedback while maintaining the tests' rigor.

When the Fed last month informed banks of its preliminary stress-test findings, executives at corporations including Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. were furious with what they viewed as the Fed's exaggerated capital holes. A senior executive at one bank fumed that the Fed's initial estimate was "mind-numbingly" large. Bank of America was "shocked" when it saw its initial figure, which was more than $50 billion, according to a person familiar with the negotiations.

At least half of the banks pushed back, according to people with direct knowledge of the process. Some argued the Fed was underestimating the banks' ability to cover anticipated losses with revenue growth and aggressive cost-cutting. Others urged regulators to give them more credit for pending transactions that would thicken their capital cushions.

At times, frustrations boiled over. Negotiations with Wells Fargo, where Chairman Richard Kovacevich had publicly derided the stress tests as "asinine," were particularly heated, according to people familiar with the matter. Government officials worried San Francisco-based Wells might file a lawsuit contesting the Fed's findings.

The Fed ultimately accepted some of the banks' pleas, but rejected others. Shortly before the test results were unveiled Thursday, the capital shortfalls at some banks shrank, in some cases dramatically, according to people familiar with the matter.

Bank of America's final gap was $33.9 billion, down from an earlier estimate of more than $50 billion, according to a person familiar with the negotiations.

A Bank of America spokesman wouldn't comment on how much the previous gap was reduced, though he said it resulted from an adjustment for first-quarter results and errors made by regulators in their analysis. "It wasn't lobbying," he said.

Wells Fargo's capital hole shrank to $13.7 billion, according to people familiar with the matter. Before adjusting for first-quarter results and other factors, the figure was $17.3 billion, according to a federal document.

"In the end we agreed with the number. We didn't necessarily like the number," said Wells Fargo Chief Financial Officer Howard Atkins. He said the company was particularly unhappy with the Fed's assumptions about Wells Fargo's revenue outlook.

At Fifth Third Bancorp, the Fed was preparing to tell the Cincinnati-based bank to find $2.6 billion in capital, but the final tally dropped to $1.1 billion. Fifth Third said the decline stemmed in part from regulators giving it credit for selling a part of a business line.

Citigroup's capital shortfall was initially pegged at roughly $35 billion, according to people familiar with the matter. The ultimate number was $5.5 billion. Executives persuaded the Fed to include the future capital-boosting impacts of pending transactions.

SunTrust Banks Inc. also persuaded the Fed to significantly reduce the size of its estimated capital gap to $2.2 billion, after identifying mathematical errors in the Fed's earlier calculations, according to a person familiar with the matter.

PNC Financial Services Group Inc., saw a capital hole materialize at the last minute. As recently as Wednesday, PNC executives were under the impression they wouldn't need to find any new capital, according to people familiar with the matter. Thursday morning, the Fed informed PNC that it had a $600 million shortfall.

Regulators said other banks also were told they needed more capital than initially projected.
The Fed's findings were less severe than some experts had been bracing for. A weeklong rally in bank stocks continued Friday, with the KBW Bank Stocks index surging 10%. Investors were especially relieved by the relatively small capital holes at regional banks. Shares of Fifth Third soared 59%, while
Regions Financial Corp.'s $2.5 billion deficit led to a 25% leap in its stock.
With the stress tests, government officials were walking a fine line. If the regulators were too tough on banks, they risked angering their constituents and spooking markets. But if they were too soft, the tests could have lost credibility, defeating their basic confidence-building purpose.

All the back-and-forth is typical of the way regulators traditionally wrap up their examinations of banks: Regulators often present preliminary findings to lenders and then give them time to respond. The process can result in changes to the regulators' initial conclusions. Some of the stress-test revisions, for instance, were made to account for the beneficial impact of the industry's strong first-quarter profits.

On Friday, some analysts questioned the yardstick, known as Tier 1 common capital, that regulators chose to assess capital levels. Many experts had assumed the Fed would use a better-known metric called tangible common equity.

According to Gerard Cassidy, an analyst with RBC Capital Markets, the 19 banks' cumulative shortfall would have been more than $68 billion deeper if the government had used the latter metric, which accounts for unrealized losses.

Federal officials said their projections reflected the most comprehensive analysis ever conducted of the industry.

The test results showed that the 19 banks faced a total of $599 billion in losses over the next two years under the government's worst-case, Depression-like scenario. The Fed directed 10 banks to add a total of nearly $75 billion to their capital buffers to insulate themselves from potential losses.

Banks pressed ahead on Friday with plans to fill their capital holes by tapping public markets. Wells Fargo raised $7.5 billion in stock through a public offering. The bank originally planned to raise $6 billion, but expanded the offering, which was valued at $22 a share, due to robust demand. Shares of Wells Fargo rallied $3.42, or 14% to $28.18.

Morgan Stanley, which is facing a $1.8 billion capital hole, raised $4 billion by selling stock. Shares of Morgan rose $1.06, or 4%, to $28.20.
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The Bank Stress Test - Maybe Another $0.6 T To Go

Below is a summary of the bank stress test performed by various bank regulators. As is to be expected the results are controversial at best. The optimists have found reasons to be happy, the pessimists have found reasons to be unhappy, and the people familar with the banking industry understand how flawed the analysis was. Both President Obama and Secretary Geithner may not appreciate how much of their reputation is riding of these types of tests. Be careful the American people are watching and they are not happy.

A couple of things I find interesting about this: 1) everyone is mad at B of A because they need relatively large equity injections, but evryone forgets that B of A came to the rescue of the finacial system twice: once when they picked-up Countrywide and a second time when they picked-up Merrill Lynch. Both these companies were in really bad shape and needed to be absorbed. 2) Wells Fargo needs more money, but they in turn picked up a really sick bank in Wachovia. Same issue as B of A. 3) another bank (un-named) comes out clean in this process in part because it received part of the AIG bail-out money, when AIG paid off some of their obligations. And 4) Most of the commercial real estate loans in this country are made by the small local and regional banks. This portion of the economy is just starting to unravel. Obviously, with only 19 banks tested this portion of the industry was not even addressed with this stress test.

Text in bold is my emphasis. From the WSJ:

The federal government projected that 19 of the nation's biggest banks could suffer losses of up to $599 billion through the end of next year if the economy performs worse than expected and ordered 10 of them to raise a combined $74.6 billion in capital to cushion themselves.

The much-anticipated stress-test results unleashed a scramble by the weakest banks to find money and a push by the strongest ones to escape the government shadow of taxpayer-funded rescues.

The Federal Reserve's worst-case estimates of banks' total losses and capital shortfalls were smaller than some had feared. Optimists interpreted the Fed's findings as evidence that the worst is over for the industry. But questions remain about the stress tests' rigor, in part since the Fed scaled back some projected losses in the face of pressure from banks.

The government's tests measured potential losses on mortgages, commercial loans, securities and other assets held by the stress-tested banks, ranging from giants Bank of America Corp. and Citigroup Inc. to regional institutions such as SunTrust Banks Inc. and Fifth Third Bancorp. The government's "more adverse" scenario includes two-year cumulative losses of 9.1% on total loans, worse than the peak losses of the 1930s.

Treasury Secretary Timothy Geithner said Thursday that he is "reasonably confident" that banks will be able to plug the capital holes through private infusions, alleviating the need for Washington to further enmesh itself in the banking system.

Banks also said they will consider selling businesses or issuing new stock to meet the toughened capital standards.

The information provided by the stress tests will "make it easier for banks to raise new equity from private sources," Mr. Geithner said. Still, he added, "We have a lot of work to do...in repairing the financial system."

Some of the banks told to add capital raced to accomplish that by tapping public markets. On Thursday, Wells Fargo & Co., which the Fed said needed to raise $13.7 billion, laid plans for a $6 billion common-stock offering. Morgan Stanley, facing a $1.8 billion deficit, said it will sell $2 billion of stock and $3 billion of debt that isn't guaranteed by the U.S. government.

If successful, the offerings "should be a meaningful step in restoring a modicum of confidence to the banks," said David A. Havens, a managing director at Hexagon Securities. "It indicates that even the big messy banks are able to attract private capital."

Shares of more than a dozen stress-tested banks rose in after-hours trading as the government's announcement soothed jitters about the industry's immediate capital needs. Bank of America shares climbed 3.6% to $13.99, while Citigroup was up 6.3% to $4.05. Fifth Third jumped 19% to $6.35. SunTrust fell 2.5% to $18.05, and Wells Fargo slipped 0.9% to $24.54.

Nine of the stress-tested banks -- including titans like J.P. Morgan Chase & Co. and Wall Street's Goldman Sachs Group Inc. as well as several regional institutions -- have adequate capital. That finding essentially represents a seal of approval from the Fed.

The others need to raise anywhere from about $600 million for PNC Financial Services Group Inc. to $33.9 billion for Bank of America. In between are several other regional lenders: Fifth Third, which needs to raise $1.1 billion; KeyCorp, $1.8 billion; Regions Financial Corp., $2.5 billion; and SunTrust, $2.2 billion.

Experts warn that the tests could have a serious unintended consequence: Loans could be harder to come by for consumers and businesses. That's because the government's intense focus on thicker capital cushions might prompt banks to hoard cash and further curtail lending, said Jim Eckenrode, banking research executive at TowerGroup, a financial consulting firm. He said banks will have less room to offer consumers low interest rates, while corporate customers may have a tougher time getting financing for commercial real-estate and property development.

That would undercut a key goal of the Obama administration, which has been pushing banks to lend more in order to jump-start the economy.


The test results were vigorously contested by some banks, which argued they were superficial and didn't reflect significant differences in the health of various banks' loan portfolios.

In a news release Thursday, Regions publicly criticized the testing process. The Birmingham, Ala., bank said the Fed's loss assumptions were "unrealistically high." Regions said it "questions whether it should be required to raise additional capital now to provide for a two-year adverse economic scenario," given recent hints that the economy may have hit bottom.

With the tests complete, Washington's effort to clean up the banking system now shifts into a new, potentially messy phase. While most of the banks that need capital are likely to be able to find it, analysts and bankers say a few others are likely to end up being largely owned by the U.S. government due to their inability to raise capital from private investors.

Meanwhile, the tests don't address a sea of problems confronting many midsize and smaller banks.

Federal officials have repeatedly vowed to support the 19 banks, which essentially have been labeled too big to fail. Those reassurances have propelled the companies' shares to their highest levels in months. The White House, Treasury Department and Fed hope that by restoring confidence in the industry, private investors will help troubled banks shore up their finances, eliminating the need for taxpayer-financed rescues.

There are some encouraging signs. In recent weeks, a handful of healthy banks -- ranging from giants like Goldman Sachs to Denver's 34-branch Guaranty Bancorp -- have raised money by selling stock in public offerings. That represents a seismic shift from earlier this year, when many investors refused to touch any bank stocks.

"What we're starting to hear from investors is a view that these companies were oversold and, although things are bad, they're not as bad as was baked into the assumptions," said Brian Sterling, co-head of investment banking at Sandler O'Neill & Partners in New York.

Some Fed-blessed banks are likely to pursue public equity or debt offerings to flex their financial muscles and help pay back the funds that the government invested in them.

State Street Corp. Chairman and Chief Executive Ronald E. Logue said the government's conclusion that the Boston company needs no additional capital puts it "in a position to consider repayment of the TARP preferred stock and warrants under the appropriate circumstances."
State Street, one of the largest managers of index funds, got a $2 billion taxpayer-funded infusion under the Troubled Asset Relief Program, or TARP. On Wednesday, The Wall Street Journal incorrectly reported that State Street had been told to come up with more capital.
Bankers acknowledge that investors' appetites are limited. Investors say not enough private funds are available to fill the big banks' financial holes.


"I think there is some demand in the market to raise a certain amount, but whether you could find $60 billion of capital in the next couple of months is highly unlikely," said Joshua Siegel, managing principal at StoneCastle Partners LLC, a New York firm that invests in banks.

Banks that can't coax private investors have some other options. They can sell assets or business lines, a strategy already under way at Bank of America and Citigroup. They can push investors to swap so-called preferred shares for common stock, padding a measure of capital known as tangible common equity.

During a Thursday conference with investors, Bank of America Chief Executive Kenneth Lewis said, "Our game plan is designed to help get the government out of our bank as quickly as possible," and vowed to abandon a loss-sharing agreement with the U.S. on $118 billion in assets.

But bankers and analysts say at least a few lenders are in a vise. Too weak to lure investors, and lacking a large pool of privately held preferred stock, these banks likely will have to turn to Washington for help. Fifth Third and Regions both said in statements Thursday that they hope to raise private funds.


The 19 tested banks, which all have at least $100 billion in assets, accounted for most of the industry's total loans. But the companies represent a sliver of the roughly 8,000 banks nationwide.

Among that vast field, many banks -- from regional institutions to tiny community lenders -- are holding huge portfolios of rapidly souring loans. Unlike their larger rivals, these banks lack the diverse income streams to overcome the brutal operating environment.

Analysts at RBC Capital Markets estimate that 60% of the top 100 U.S. banks that weren't included in the stress tests would need to raise new capital based on the Fed's loss assumptions.

Tuesday, May 5, 2009

Bankers Gloomy About 2009

The conclusion is the article below result from the quarterly Fed survey of senior loan officers. If you ever get a chance you should read this. It is not as boring as it sounds. By the way, my contacts in the banking industry would not argue with the conclusions below. Text in bold is my emphasis. From the WSJ Economics Blog:

New loans may be profitable, given how cheaply banks can borrow today. But many banks are still worrying about whether they’ll get paid back on old loans.

The latest Federal Reserve
survey of senior loan officers finds very few shoots of green in that garden. The Fed asked senior loan officers: What is your bank’s outlook for delinquencies and charge-offs on existing loans of various sorts in 2009, assuming that “economic activity progresses in line with consensus forecasts?” Short answer: Gloomy. Or as the Fed put it: “A significant majority of banks reported that credit quality for all types of loans is likely to deteriorate over the year” — and that’s assuming the economy doesn’t take another turn for the worse.

The specifics:

Commercial and industrial loans: Of 52 banks responding, none said they expect improving quality, but seven said they expect delinquencies and charge offs to stabilize at current levels.

Commercial real-estate loans: Only 1 of 51 banks (the other doesn’t make such loans) sees improving quality, and three see quality stabilizing at current levels. Of the 47 who see a worsening picture, 13 expected a substantial deterioration in 2009.

Prime residential mortgages: Only 1 of 50 banks sees improving quality, and seven see quality stabilizing at current levels.

Subprime mortgages: No bank sees improving quality, and only two see quality stabilizing at current levels.

Home equity lines: No bank sees improving quality, though nine expect quality to stabilize around current levels.

Credit card loans: None of the 31 banks who make such loans expects improvement, and three expect stabilization.

Other consumer loans: Only one of 50 banks expects improvement, though 12 see loan quality stabilizing around current levels.

Stress Test Indicates That About 10 Banks Will Need Additional Capital

More is being leaked about the stress tests. Now it appears that 10 of the 19 banks subjected to the stress test will need additional capital. The final results are due out Thursday so we will be able to see for ourselves at that time. Text in bold is my emphasis. From the WSJ:

The U.S. is expected to direct about 10 of the 19 banks undergoing government stress tests to boost their capital, according to several people familiar with the matter, a move that officials hope will quell fears about the solvency of the financial sector.

The exact number of banks affected remains under discussion. It could include Wells Fargo & Co.
(after swallowing Wachovia I am not surprised they need more capital), Bank of America, Citigroup Inc. and several regional banks. At one point, officials believed as many as 14 banks would need to raise more funds to create a stronger buffer against future losses, these people said, but that number has fallen in recent days.

Representatives from Wells, Bank of America and Citi declined to comment.

The Obama administration announced the stress tests -- a process of examining banks' ability to withstand future losses -- back in February. At the time, the news sparked concern among investors and depositors that the results would be used to shut down or nationalize some of the country's weaker institutions. But Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner assured investors that none of the banks undergoing stress tests would be allowed to fail and that all would have access to government funds if needed.

In fact, the stress-test regimen appears so far to have eased some of the fears that swept through financial markets in February, just as President Franklin D. Roosevelt's bank holiday did in 1933. He shut down the nation's banks for several days during a banking panic and only reopened those the government deemed safe. One possible explanation for the recent, calmer state of affairs: The problems the tests appear to be uncovering aren't as bad as some analysts' worst expectations.

Also, if multiple banks are being directed to boost their capital, that could make the process seem less daunting than if it were singling out a few companies as weak.

In a sign of how much the doomsday scenario has faded, bank stocks surged Monday despite reports that Wells Fargo was identified in an initial review as one of the financial institutions needing a stronger buffer.

The San Francisco bank's stock jumped 24%, or $4.64, to $24.25 in New York Stock Exchange composite trading at 4 p.m. Bank of America shares rose 19% on Monday, while Citigroup was up 7.7%.

The stock prices of all three banks, which may need to raise tens of billions in new capital as a result of the stress tests, have tripled since early March.

It's possible Wall Street is being overly optimistic about the impact of the results and the resulting dash by banks to bolster capital. One big risk worrying industry officials is that the market will view banks on the list as insolvent when the official results are announced Thursday, even though Fed officials have repeatedly said that's not the case.

Several banks are expected to already have enough capital to weather a worsening economy, including Goldman Sachs Group Inc. and J.P. Morgan Chase & Co.
J.P. Morgan Chase Chairman and Chief Executive James Dimon expressed confidence Monday that the banking system can withstand losses from the recession, even though it will take years for the industry to recover.

"The banking system can handle an awful lot of stress and be OK," he said in a Monday conference call sponsored by Calyon Securities Inc., a unit of Credit Agricole Group.

Mr. Dimon also reiterated J.P. Morgan's goal to repay the $25 billion the New York bank received from the government last year "as soon as possible," saying company officials plan to discuss details of the potential repayment after the stress-test results are announced.

An initial stress test identified Wells Fargo as among the banks needing a bigger buffer, said a person close to the company. It is unclear whether Wells would be forced to raise fresh capital or if regulators would accept the bank's argument that it can earn its way through the losses in future years. Wells expects more clarity Tuesday.

Any bank holding company with more than $100 billion in assets was required to undergo the tests, which were largely conducted by the Fed. Their purpose was to ensure that major financial institutions had enough capital to continue lending if the economy worsened through 2010. Government officials are expected to meet with banks beginning Tuesday to go over final results. Banks directed to raise more capital aren't necessarily in trouble today, but regulators think they don't have enough of a buffer against potential future losses.

Administration officials believe many banks will be able to raise capital without tapping the Troubled Asset Relief Program's remaining $109.6 billion. They're optimistic the bulk of the money will come from private investors made more confident by the glut of information provided by the tests. Banks could sell assets and stakes in their companies, a move that could accomplish another government goal of shrinking some of the country's largest banks.

Officials say banks that can't tap private markets will be able to raise capital by agreeing to convert some of the government's existing preferred shares into common equity, a move that would leave the government owning chunks of the nation's largest banks.

"There undoubtedly will be banks that need more capital," White House spokesman Robert Gibbs said Monday in a news briefing. He said he didn't believe the Obama administration would need to ask Congress for more money. "I think everyone involved will be looking for banks to raise this through either private means or the selling of some assets that they have or that they control."

The tests have set off some tense exchanges in private between Treasury officials and bank regulators at the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency, who worried that disclosing too much information publicly could threaten the health of banks that are trying to repair themselves.

The Fed plans to release the results of the stress tests on Thursday after U.S. stock markets close. Anticipating the test results, McGraw-Hill Cos.' Standard & Poor's Ratings Service unit put on watch for downgrade the credit ratings of 22 banks and one thrift.

The affected companies face at least a 50% chance of being downgraded by at least one notch in the next 90 days.

Sunday, May 3, 2009

Obama Sees a Smaller Financial Sector

People want to know when things are going to return to normal. Normal being defined as the period before the recession. Things are not going to return to "normal". They may be returning to normal if you you are talking about the that period from about 1950 to 1980. But, we will not return to an economy driven by consumer spending and fueled by debt. One key in this is going to be the structure of the financial system going forward. Below are some comments made by President Obama indicating that returning to normal is probably not in the cards. Text in bold is my emphasis. From Yahoo News:

The financial sector will make up a smaller part of the U.S. economy in the future as new regulations clamp down on "massive risk-taking," President Barack Obama said in an interview published on Saturday.

Obama, whose young administration has spearheaded a raft of reforms in the banking sector as part of efforts to tackle the financial crisis, said the industry's role in the United States would look different at the end of the current recession.

"What I think will change, what I think was an aberration, was a situation where corporate profits in the financial sector were such a heavy part of our overall profitability over the last decade," he said told the New York Times Magazine.

"Part of that has to do with the effects of regulation that will inhibit some of the massive leveraging and the massive risk-taking that had become so common."

Obama said some of the job-seekers who may normally have gone to the financial sector would shift to other areas of the economy, such as engineering.

"Wall Street will remain a big, important part of our economy, just as it was in the '70s and the '80s. It just won't be half of our economy," he said.

"We don't want every single college grad with mathematical aptitude to become a derivatives trader."

The Obama administration in March proposed sweeping reforms to curb risk-taking on Wall Street and close regulatory gaps to prevent the kind of excesses that led to the worst financial crisis since the 1930s Great Depression.

The president said in the interview that better regulation would help restore confidence in the U.S. financial system.

"A more vigorous regulatory regime, I think, will help restore confidence, and you're still going to see a lot of global capital wanting to park itself in the United States," he said.

Obama expressed optimism that the market for securitized products would pick up, though he said that could take time.

The Federal Reserve, with taxpayer capital from the U.S. Treasury, is supporting consumer and real estate lending markets through a loan facility that could reach $1 trillion.

Holders of existing asset-backed and commercial mortgage-backed securities can get loans from the Fed by putting up their securities as collateral.

The facility aims to unclog frozen credit markets and jumpstart securitization.

"We're going to have to determine whether or not as a consequence of some of the steps that the Fed has been taking, the Treasury has been taking, that we see the market for securitized products restored," Obama said.

"I'm optimistic that ultimately we're going to be able to get that part of the financial sector going again, but it could take some time to regain confidence and trust."

Part of Obama's regulatory reforms include the creation of a new "systemic risk regulator" with broad powers to seize large non-bank financial firms, such as insurers, hedge funds or private equity companies, if they are deemed to threaten the stability of the financial system.

Large, "systemically important" firms would be required to hold bigger capital cushions.

Obama also said financial rules should be crafted according to what an institution actually does to avoid a regulatory gap in areas such as commercial and investment banking.

"Other countries that have not seen some of the problems in their financial markets that we have nevertheless don't separate between investment banks and commercial banks," he said, citing Canada as one example in that area.

"The experience in a country like Canada would indicate that good, strong regulation that focuses less on the legal form of the institution and more on the functions that they're carrying out is probably the right approach to take."