Death Spiral in the Banking System out of Control?

After having watched the Banking System all our adult life (and some more) we are the first to admit that managements have committed serious errors of judgement. This just reinforces our view that hiring the right people is the most important job for all those working in positions of responsibility in any bank of other financial service business.
But this particular banking crisis is characterised by certain features that have a tendency to push institutions further down the path to ultimate destruction. For instance, hardly anyone seems to focus on what proportion of the loan books are actually delinquent. Instead, there is constant talk of 'toxic assets' most of which turn out to be mortgages that just happen to be under water to different degrees. Nothing new to that. That has happened before and will happen again.
Instead, the markets, commentators and the authorities are completely enthralled by what can only be described as a 'death spiral' of weakening economic data and falling asset prices which drive 'market prices' down. The main culprit is the 'mark-to-market' rule that has been designed to keep accountants, auditors and theoreticians in academia happy. Never mind that these 'prices' are created in thin markets and pushed around by speculation. They are accepted as gospel truth even though it is a well-established fact that all markets overshoot - on the way up and on the way down.
As a result prices for so-called 'toxic' assets are divorced from reality where assets may be somewhat impaired but are still in the major part serviced by debtors. The difference between these two levels of valuation is the difference between a banking system that is in trouble but able to work its way out of a hole and a banking system destined to hit the buffers sooner or later.
In addition, respected analysts such as Meredith Whitney (CNBC, 14 Jan 2009) paint a horror picture where banks are supposed to look at economic data such as employment or home price trends and mark down their books according to some spurious economic forecast. That assumes that economic forecasting is an accurate science - a heroic assumption if there ever was one!
The latest fashion among commentators is the reference to the 'Swedish Model' of bank rescue. As no one seems to realise what is driving the death spiral they jump to the conclusion that all bad assets should be written off against shareholder equity. Given the logic of 'mark-to-market' that would mean that ever-declining 'market prices' would set the benchmark for these write-offs. Naturally, the authorities - who must share a major part of the blame (banking was always heavily regulated and the authorities were if anything supposed to prevent bank runs) have to step in and nationalise the institutions.
Ironically this outcome would not even mean that lending can resume as usual. In our impatient age politicians, the media, academics and the world of business seem to have forgotten that credit cycles are a major - maybe the major - force behind economic cycles. After an extended period of excess credit creation it is inevitable that a period of credit contraction will follow. Banks have to rebuild balance sheets and the same applies to business and consumers.

Incompetent Regulators

'Catastrophic interaction of governmental and managerial incompetence that led to the collapse of Fannie Mae and Lehman Brothers' (Anatole Kaletsky, The Times, 12 Jan 2009)

Spending no solution to debt problem

Jim Rogers - in-depth Bloomberg interview. In case you also wonder if spending more is the right way to reduce the debt mountain.

Alan Greenspan - long on Words, short on Insight

That is what he produced for years, and Media and Investors were hanging on his every uttering. It went so far that the gullible Commentariat even tried to get a glimpse of his suitcase when he walked from the Fed to Congress and tried to devine what the 'Sage' might intend to say based on correlation with previous events.
We are grateful for this gem of a quote we found on the Marketoracle: I think further comment is not required.
“Innovation has brought about a multitude of new products, such as subprime loans and niche credit programs for immigrants… With these advances in technology, lenders have taken advantage of credit scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers… Where once more marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending,… fostering constructive innovation that is both responsive to market demand and beneficial to consumers.”-- Alan Greenspan, April 2005

Alan Greenspan - long on Words, short on Insight

That is what he produced for years, and Media and Investors were hanging on his every uttering. It went so far that the gullible Commentariat even tried to get a glimpse of his suitcase when he walked from the Fed to Congress and tried to devine what the 'Sage' might intend to say based on correlation with previous events.
We are grateful for this gem of a quote we found on the Marketoracle: I think further comment is not required.
“Innovation has brought about a multitude of new products, such as subprime loans and niche credit programs for immigrants… With these advances in technology, lenders have taken advantage of credit scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers… Where once more marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending,… fostering constructive innovation that is both responsive to market demand and beneficial to consumers.”-- Alan Greenspan, April 2005

Rating Agencies - only radical reform will do

An interesting interview with the CEO of Assured Guaranty (Bankstocks.com, 24 Nov 2008) reminded me that - despite all the hot air from regulators, politicians and industry practitioners - the problem of rating agencies and their role in the financial markets is as far from solution as ever.
The Number 1, 2 and 3 Priority must be to prohibit the issuers to pay the rating agencies. That will introduce a major reality check and clip their wings substantially - apart from helping to prevent more abuse.
90% of the ratings process can be based on numbers anyway and with the ease of access to number-crunching software most investors should be able to do most of the research themselves. After all, that is what they get the management fees for in the first place and any self-respecting investment institution has a credit research department in place already to do this task.
Credit research basically follows a 'margin of safety' approach. So calculating various key rations should be a great first step to filter out suitable investments. Subjective Analysis belongs more to the equity analysts and investors.
Most current reform proposals are just a waste of time, for example registering agencies in Europe - a favourite pastime for the Commissars in the EU and their hangers-on. It suits their Stalinist mindset.

Paulson as market indicator

Paulson - A Bumbling Giant - every time he speaks it seems to pay to short the market

Dangers of Derivatives

Martin Mayer wrote this article in 1999 and it shows that the risks associates with derivatives was not only foreseen by Warren Buffet. Now it is up to the regulators to make sure that this cannot happen again.

Iceland to get $10 Billion in bail-Out loans - who is to benefit?

Only four weeks ago we learned - already in disbelief about that number - that the IMF would give a $2 Billion bail-out package to Iceland. Latest announcements in the press have - again - raised this number to an even more staggering 10 (!!) billion US Dollars. We are not surprised by anything anymore. Who said that you could never go wrong underestimating the intelligence of civil servants (especially when they spend other people's money)?
Iceland has a population of just 320,000 inhabitants. Now that the IMF has generously decided to give a $6 Billion loan to the country it is worth putting these numbers in perspective: a simple calculation tells you that every man, woman and child in the country will have to bear the burden of about $20,000 in debt which translates to around $75,000 for the average family.
Just imagine - if the United States would be the recipient of this bailout it would translate into the staggering sum of $6 Trillion - that is $6,000,000,000,000 for those not yet too familiar with trillions - as the population of the US is about 1000times larger.
Anna Schwartz just raised serious doubts about the US rescue package - in particular about its transparency and efficacy. We agree with her and would raise the same question: who really benefits from the Iceland loan? Does it benefit the country or is it supposed to bail out imprudent lenders that advanced more loans to the country than it could ever have serviced in the light of level-headed credit appraisals?

Hats off to Peter Wuffli

We salute Peter Wuffli at UBS for turning down a Sfr 12 million bonus entitlement out of solidarity with the bank's staff and shareholders. Would it not be nice if Chuck Prince and Stan O'Neal showed similar contrition?