Saturday, February 28, 2009

Kiss My Assets

One of the most fascinating aspects of a financial meltdown built on excess credit – except that I am unfortunately living through the accelerating pain – is this basic observation: when folks overvalue assets and borrow heavily against them, somehow the creditors usually wind up with those assets. When a company files for Chapter 11 reorganization under U.S. bankruptcy law, except for a rare (a very, very, rare) exception, the holders of the equity (the common shareholders) generally lose it all, and the creditors (unpaid vendors, lenders based on their seniority on the debt scale) tend to take over as the new owners of the reorganized company.

So what happens when whole countries borrow heavily from other countries? Aside from the obvious relative shift in currency values over time? Here’s a seriously pessimistic view – Harvard Professor, Niall Ferguson (quoted in the February 23nd “The world divides in two, the debtors and the creditors. The debtors … (U.S., Europe) ... are going to have to sell off their assets. Call it the global foreclosure. They're going to be selling their assets cheaply to those who have the surpluses. This is not going to be like the Chinese buying Blackstone [a large private equity firm that is famous for mega-deals] at the top of the market… It's revenge of the sovereign wealth funds [money stored by governments from economic surpluses – like oil-rich sheikdoms or massive exporting economies]. They got burned. And this time, no more Mr. Nice Guy.”

Ferguson’s core theory is that government economists have spent way too much time looking at currency inflation and very little time looking at “asset inflation,” which he claims is at the bottom of this entire meltdown. It’s hard to argue with the reality that companies have been trading at increasing multiples of the same levels of earnings – investors were literally bidding up the price of assets merely because they could borrow money very inexpensively and needed a place to put that cheap money. Too many buyers with too much money drove stock prices through the roof. Whole new economic movements – hedge funds and private equity – grew to take advantage in this shift in valuation.

The same thing happened in the real estate market. Cheap money was offered to unqualified borrowers to buy houses – supply and demand – more buyers in the marketplace for a relatively smaller universe of homes pushed real estate prices through the stratosphere. Until the subprime mortgage meltdown shoved those buyers out the door… and demand for real estate dropped, home prices plummeted, and the lenders who bought into the inflated prices died.

Simply put, it’s time to pay the piper. Assets are being looked from an entirely new perspective, and there are many economic professionals who see (i) a permanent downward adjustment in stocks and real estate values, and (ii) a whole lot of shifting of assets from Europe and the U.S. to Middle Eastern and Asian powers. If it’s any consolation, Europe is more highly leveraged than the U.S., and the very existence of the European Union is at stake.

But what we are facing as Americans is horribly worse than most of us, including the President, might have thought. The February 28th New York Times: “A sense of disconnect between the projections by the White House and the grim realities of everyday American life was enhanced on [February 27th], as the Commerce Department gave a harsher assessment for the last three months of 2008. In place of an initial estimate that the economy contracted at an annualized rate of 3.8 percent — already abysmal — the government said that the pace of decline was actually 6.2 percent, making it the worst quarter since 1982.”

Is there hope? The countervailing balance: oil exporters (like Saudi Arabia – and yes, unlike Iran, Russia or Venezuela, they still have massive wealth) and manufacturing exporters (like China) have much to lose if they nations have been their customers for decades suddenly are unable to buy their products. In short, they have a stake in supporting the Western borrowers.

But the temptation to create “buy American” programs or the equivalent “protectionist” sentiments we see in Europe (like in the automaker sector) will bring fierce retaliation from the nations we owe so much money too already. As civil disobedience turns into riots and even civil war among and within the debtor nations (we only seen a taste of what can happen), it will be interesting – in a bad way – to see whether those violent efforts are sufficient to destroy the stabilizing influence of the otherwise strong relations (call it co-dependency) between debtor and creditor nations in a global trade cabal. If that co-dependency dies, you ain’t seen nothin’ yet!

I’m Peter Dekom, and I approve this message.

Friday, February 27, 2009

Europe Peein’

We’ve drilled down in recent blogs noting riots across parts of Europe, particularly where economic pain is greatest, and the collapse of economies like those in Iceland and Latvia, as well as the significant drop in economic stability of European household names like Spain, Ireland, Portugal, Greece, Italy and Ireland. While France and Germany feel the contraction, and England (as financial capital) is taking it on the chin, the real threat of collapse, one that threatens the very existence of the European Union and the operation of the Central Bank, perhaps even the fall of the Euro as a currency (a risk according to Bloomberg), is the general precipitous collapse of the eastern European nations.

A tiny and underwhelming solution to some of these banking woes has been a pledge by European Bank for Reconstruction and Development, the World Bank and the European Investment bank to provide up to 24.5 billion euros [almost $31 billion] to aid central and eastern European banks. But this is a drop in the bucket.

As these eastern European nations emerged from the dark ages of communism, their need to enter the 20th and now 21st century required a new financial system, massive investment and construction – and massive lending. The citizens of these nations barely qualified as “consumers” when the Berlin Wall fell almost two decades ago, but they rapidly discovered the use of credit to begin to “catch up” with the Western lifestyle. This money came mostly from the financial institutions from the rest of Western Europe, and as the European Union grew to include an increasing number of these Eastern bloc nations, the financial support of the EU’s Central Bank became their central resource too.

But we all know what rapid and vast overleveraging can produce. In Europe, some are calling the Western European nations’ support of Eastern European growth through debt as Europe’s “subprime crisis.” Which means that failing European financial institutions and frozen credit is due to a whole lot more than more than just greedy banks’ buying toxic American derivatives. Whether you call it “folly,” “humanistic,” “greed,” or some malevolent combination of these variables, Houston… er… Paris/Berlin/London… we have a problem.

The February 27th “Writing on on [February 26th], Daniel Gros of the Centre for European policy studies had this to say: ‘The EU should set up a massive European Financial Stability Fund (EFSF). Given the scale of the problem facing European banks, the fund would probably have to be of substantial scale, involving about 5% of EU GDP or around €500-700 billion [$630-$882 billion].’… And on [February 25th], former IMF chief economist Simon Johnson reiterated a proposal he made in October. He wants a European Stability Fund that is able to offer a 2 trillion euro credit line. Johnson also argued for action sooner rather than later.”

In-fighting, nascent intra-European protectionism (particularly in the automobile industry) and the vast schism of short and long-term financial interests between the “haves” (particularly France and Germany) and the “have-nots” (the nations noted above and particularly the Eastern bloc of EU nations), make what is at stake more than the stability of the euro; it is the survival of the European Union itself.

I’m Peter Dekom, and I thought you might like to know it’s not all our fault.

Thursday, February 26, 2009

Securi-tied – It’s Bound to Happen

When financial managers first contemplated selling off bundles of mortgages or other loans to investors, their goal was to bring in additional cash on to their books to make more loans. So they would create loans, based on the ability of the borrower to pay and the value of the asset being lent against, and, when they had sufficient volume of loans to entice an investor group, the banks would sell off this group of loans in the form of a “mortgage-backed” security, having made an interest mark-up in the process, and the new investors would benefit from the remaining interest rate.

These were, for the most part, good loans made to good people for good assets. They were sold to good investors at a fair price. They were the early-stage “derivatives” that wound up blossoming into bundles of debt instruments that leapt far beyond mere mortgages into every form of credit instrument imaginable (like the “corporate loan default insurance” derivative – the credit default swap).

Let’s take this model one little step further. Let’s assume that the buyer of these bundles of joy can borrow money at a very favorable rate, so instead of using equity cash to buy the bundle, they would borrow the whole or a substantial part of the cost of buying that bundle, effectively keeping as pure cash flow the difference between the average interest rate yield of that bundle and the interest cost that the investor had to pay. Sounds good, huh? So good that the buyers of these bundles of loans wanted more; they were developing a heroin addiction to the difference between the interest they were earning and the interest they were paying. They told the banks they needed more, even when the banks told them that they had lent to all the qualified buyers they could.

Enter the credit rating agencies and the theory of blended risk. As banks and real estate brokers complained that the good borrowers were gone, the statistical “experts” from the financial world told them that since they were blending so many borrowers into each bundle of joy, they would factor in an “expected average default rate” and price the bundles accordingly. The volume of loans would absorb these riskier new borrowers (the new unqualified borrowers that we have euphemistically labeled as “sub prime”), and the process could continue. Since the folks creating the bundles and trading in them got to pick the credit agency that would put its stamp on the deal – thus making the bundles marketable – they tended to pick credit rating agencies that were overly generous in their ratings.

But if the ratings on the new bundles of sub prime loans really were too high (the actual average default rate significantly exceeded what they predicted), and real sub prime defaults occurred way above expectations (late 2006 and beyond), then the bundles of loans wouldn’t generate the interest rate that the investors needed to pay the loans they took out to buy the derivatives in the first place (read: Bear Stearns, Lehman Bros, etc.).

So the question is whether we should simply ban all derivatives. Matthew Wurtzel writing for the February 26th the “Securitization is a tool banks and other financial services firms use to generate liquidity, which allows them to lend. If we simply outlawed it, we'd be rolling back the availability of credit by decades, just as the government is spending huge sums to restart student lending, credit cards and mortgages, and of course to save the car companies. Bernie Madoff was a crooked money manager. That doesn't mean we should ban money management… Outlawing securitization would mean an end to the American middle-class lifestyle. We should be careful what we wish for. ”

The answer may not be to ban the entire practice, but instead to tighten the regulatory process and the standards that credit ratings must apply, require that the originating banks keep some of the original loans on their books so that they are incentivized to vet borrowers and assets thoroughly and severely limit how much leverage (borrowing) is permitted to those who buy derivatives. We also need to clamp down on home buyers who don’t put enough down (except when they are taking distressed and otherwise unsellable properties off banks’ hands) and don’t have the necessary earning power to pay a real mortgage.

I’m Peter Dekom, and I approve this message.

Wednesday, February 25, 2009

Stressed Out!

Federal Reserve Chairman Ben Bernanke told Congress on February 24th that the feds won’t “nationalize” banks, that the worst they will do is take large minority interests in the common (voting) stock. The Fed is talking to Citigroup right now, presumably to increase its stake in this financial behemoth from 8% to 30-40%. How is this not de facto nationalization? Why are playing a game? Meanwhile, house sales continue to fall, job loss is escalating and there is no meaningful credit in the market right now. Lending between banks is virtually non-existent, and I’ve even heard stories of banks refusing to accept “normally same as cash” letters of credit from other banks! American Express is telling some of their customers that they will pay them $300 to give up their cards, and it looks like a tightening of consumer credit in general is right around the corner.

While the President and Congress cry for a loosening of the credit markets, the government bank examiners are telling banks that their balance sheets are questionable and that if they lend, the new criteria make qualifying for a loan nearly impossible. Who’s going to lend against depreciating assets, questionable payables (people and companies that might not be able to pay) and threatened pay-cuts and job losses? If you had money, would you lend it out? And if so, at what interest rate? Precisely the issue.

We all know about the “stress test” that the Federal bank examiners are applying right now to the 20 largest American financial institutions. The goal is to determine which banks can survive, how solid they are and how to deploy the next round of federal bailout money. But financial folks love to play games, and since they don’t want the stock market to write off their shares as valueless or vastly less valuable (which further impairs their ability to meet the “stress test” parameters), they need to try and convince the market that “everything is alright.” But it isn’t; banks have played fast and loose with accounting definitions and valuations for too long, and this game-playing is exactly what got us into this horrific meltdown in the first place.

The issue facing the examiners is what standards should apply to determine bank “health.” The factors which have been included in valuations in the past have included the market capitalization (the value of the company as a whole as perceived by the stock market) of the company as one of the key “tier one” factors that determine how safe and solid a bank is. Added into this “tier one” pile of values are things like preferred stock and a few other “hybrid” financial instruments that combine debt and equity. There is a “tier two category” (stuff like revalued property reserves – that’s makes me feel good… not – yet undisclosed reserves, etc.), but it would get way too complicated to delve into that mash. But how are our lovely banks doing?

In an interview on CBS’ Early Show on February 24th, FDIC head, Sheila Blair stated: “All these large banks exceed regulatory standards for being well capitalized, so for right now, they’re fine.” The fact that the federal government invested a lot of money into the “preferred” stock, which gave the banks that measurement, should give us all pause for concern. Take that money out of the mix, and banks might not look so good. That “tangible equity capital” measurement – looking at the common stock alone – becomes increasingly important as this economy continues to free fall. Another huge downturn and some of those bigger players could easily become worthless without more federal intervention. But the government has already said that they are prepared to invest in the lowly common stock of appropriate banks, less than a controlling interest, to shore up the system. Isn’t that enough?

But what are these examiners looking for in this stress test? The February 25th NY Times: “According to the new Treasury Department guidelines, the banks would have to assume that the economy contracts by 3.3 percent this year and remains almost flat in 2010. They would also have to assume that housing prices fall another 22 percent this year and that unemployment would shoot to 8.9 percent this year and hit 10.3 percent in 2010.” Although the government thinks these numbers are pessimistic, there are many serious economists who think they fit.

In any event, the rules for lending are clearly tightening just as the fundamentals required in order to get a loan are deteriorating. The Feds are going to make sure that enough solid banks survive (with all this bailout money, there will be several de facto nationalized banks no matter how they sidestep the label), but… What’s wrong with this picture?! Nobody has yet to explain how solidifying banks is actually going to generate loans to the businesses and people who need it most. While the government is “stress testing” away, the passing of every day eliminates another vast category of possibly qualified borrowers.

Bottom line: the government is going to have to give the banks the direct lending capital with lower qualification standards (but not too low to precipitate another subprime collapse) at first to jump start the moribund credit market. The President told us that we will get out of this mess, and they will unfreeze the credit markets. But no one, I mean no one, has explained to the American people exactly how that is going to work. As time passes, as we play with labels, we die a slow death. I am so stressed out!

I’m Peter Dekom, and maybe I just worry too much.

Tuesday, February 24, 2009

A "rapid and sudden collapse" – Part 2

When the U.S. Marines banned their soldiers from taking leave in Tijuana, Mexico, it was one of those little symbols that suggested the tempest of modern Mexico, a nation engaged in a brutal civil war pitting often corrupt government officials against major drug cartels seeking free passage and safe haven in that border nation. The above headline, taken from a recent Pentagon report, is the worst-case, but very possible end-game for Mexico’s government if it is unable to stem the tide of this drug war. The recent headlines are filled with horrific stories; a recent story depicted one “cleaner” who apparently disposed of over 300 cartel murder victims in vats of acid. With new information available, it’s time to take another look at this peril beyond our southern border.

The cartels have their fingers in almost every Mexican state, almost all police departments and at the highest levels of government everywhere. Estimates place the actual leadership of over 8% of the Mexican municipal governments directly in the hands of cartel leaders. Murder is as common as traffic accidents – 2008 saw 6,000 drug-related killings (many brutal torture-slayings or beheadings), double the rate of the previous year. The battle is over control of the lucrative supply routes into the U.S., where the Mexican cartel have links to over 230 American cities, according to a federal report issued in December.

Some states are dirtier than others, but none can compete with the vile corruption of Sinaloa, a state that rests on the Pacific. The December 28, 2009 Los Angeles Times presented this little vignette: “Yudit del Rincon, a 44-year-old lawmaker, went before the state legislature this year with a proposition: Let's require lawmakers to take drug tests to prove they are clean. Her colleagues greeted the idea with applause. Then she sprang a surprise on them: Two lab technicians waited in the audience to administer drug tests to every state lawmaker. We should set the example, she said. They nearly trampled one another in the stampede to the door, Del Rincon recalled.”

The escalation in this drug war, which has decimated tourism and made life or ordinary citizens living hell, was precipitated by a crack-down initiated by Mexico’s President Felipe Calderon; Mexico’s cartels retaliated with their own militias, getting tip-offs of raids and strategies from their huge cadre of well-paid and highly corrupt officials within the government. Violence exploded, making much of Mexico too dangerous to travel.

Now the problem is spilling into the U.S., particularly the border states of Arizona and New Mexico. The February 24th NY Times: “The Phoenix police regularly receive reports involving a border-related kidnapping or hostage-taking in a home… The Maricopa County attorney’s office said such cases rose to 241 last year from 48 in 2004, though investigators are not sure of the true number because they believe many crimes go unreported.” High grade weapons smuggling, into Mexico, is often launched from the American side of the border. New Mexico is struggling with mega-wealthy Mexican drug lords who have bought homes for their wives and children but continue to ply their violence south of the border.

Shortly before his inauguration, President Obama met with Calderon to explore America’s involvement in solving this very threatening situation. We already supply over $400 million for equipment, software and training for use in this drug war, but Mexico wants to step-up the intelligence-sharing, direct cooperation and financial aid from the U.S. Given the potential consequences, I can’t disagree, bad economy notwithstanding. It is vastly less expensive to stop this drug war on the other side of the border.

I’m Peter Dekom, and I approve this message.

Monday, February 23, 2009

Bank to the Future

For reasons that escape some of the most sophisticated financial analysts, the government is seemingly praying that with enough “stimulation,” the big banks will find the capital they need to recover in the private sector. But since no one in the private sector has evinced the slightest inclination to help those “too big to fail behemoths,” the Obama administration is still side-stepping the “n” word (“nationalization”) with assurances like: "the strong presumption of the Capital Assistance Program is that banks should remain in private hands."

Yet on February 23th, as the feds began a massive drill-down examination of the 20 largest banks (politely called the “stress test”), a process that could take weeks and will undoubtedly lead to many unpleasant surprises, the government is beginning to show signs that it too understands that more than incented private capital is necessary.

From the February 23 “A joint statement from Treasury, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the Federal Reserve released [Feb. 23rd] said: ‘[w]e reiterate our determination to preserve the viability of systemically important financial institutions so that they are able to meet their commitments. ... Should [the stress test] assessment indicate that an additional capital buffer is warranted, institutions will have an opportunity to turn first to private sources of capital. Otherwise, the temporary capital buffer will be made available from the government.’

“The ‘temporary’ buffer will come in the form of convertible preferred shares and are intended to act as a ‘cushion against larger than expected future losses, should they occur due to a more severe economic environment.’ The government's preferred shares from prior TARP investments will also be eligible to be exchanged for the mandatory, convertible preferred shares.” In English? The government will sequentially add more money to the pot, but if we have to go all the way, we (the government) are not letting these big boys fail.

Stocks plunged in morning trading on the 23d at the very notion that there is a stimulus formula that could make skittish investors jump off the fence and shore up a problematic financial sector. The February 23rd L.A. Times quoted Joe Saluzzi, a partner at Themis Trading in Chatham, N.J. on Wall Street’s clear “no confidence” vote: “Investors… simply see no incentive to buy, with the economy still sinking and no sense that the banking system’s deep troubles will be resolved any time soon -- despite the government's latest attempt to boost confidence.”

The main focus of the business press is the Bank of America, made worse by the government’s shoving a very sick Merrill Lynch down the bank’s throat last year… and Citigroup. As share prices in the financial sector reflect investor discomfort at both the likelihood of finding out exactly how bad the hidden and toxic assets are on the books of these (and many more) banks and the perceived inadequate level of government intervention that most economists now believe is necessary to save the banking process itself.

Don’t expect an easy credit market any time soon…. The clock ticks, businesses fail, unemployment rises and homes fall into foreclosure. We are nowhere near bottom, and waiting for “sequential” action from the government should simply prolong the pain. A 7,000 Dow may look really good in a few months, if the government doesn’t recognize the futility of “stimulating the private” sector to do what investors have clearly said they will not do!

I’m Peter Dekom, and I approve this message.

Sunday, February 22, 2009

A Lost Decade?

That’s what they called the 1990s in Japan, as one stimulus after another failed to reignite that economy after its late 80s real estate bubble burst, sinking Japan into a long, deep recession. So in these horrific days, what do you call an “optimist”? One who thinks that what Congress has passed to date is the only stimulus injection we need to right this economic ship – even if it takes a few years to “take.” A realist, after we have sunk $700 billion under TARP and $787 billion from ARARA? Someone who thinks there will be another trillion dollars needed to bring back our financial and real estate sectors. A pessimist? Hey! Enough already!

The Federal Reserve revised its 2009 numbers recently, knowing that $787 billion more would be injected into the economy, suggesting that the current direct unemployment rate of 7.6% would climb to 8.8% (I actually think that’s “optimistic” – but there’s always 2010) and that our overall economy would contract by 1.3% this year. If you haven’t noticed recently, except for mostly lower-end foreclosure sales, real estate isn’t selling, there are almost no business loans and our main banks are still a mess.

This is a long term mess that requires a long term solution, a reality that has not escaped our President’s notice. In his Denver speech on February 17th, as he was about to sign the American Recovery and Reinvestment Act into law, he stated: "We will need to do everything in the short term to get our economy moving again, while at the same time recognizing that we have inherited a trillion-dollar deficit, and we need to begin restoring fiscal discipline and taming our exploding deficits over the long term.. None of this will be easy."

The really expensive part of the fix is clearly the repair of the almost mortally wounded financial sector, the prodigal son who just happens to be the life blood of the entire economy. From the February 22nd L.A. Times: “‘The upfront costs are going to continue to rise,’ said Adam Posen, deputy director of the Peterson Institute for International Economics, who predicted at least $1 trillion more will be needed. ‘They're going to have to buy a bunch of bad assets from the banks in one form or another, and they're probably going to have to put more capital into the banks.’”

We have different ways of saying the same thing – nationalization, creating a “bad bank,” having the government provide the loan money that they want to see back in the credit market, insuring against loss, helping lenders with mortgage adjustments – it all comes down to the government providing survival cash to unfreeze the credit markets. So far, they haven’t remotely come close to the tipping point.

In the end, this all will end. We will be “Americans” again… new folks living in many of the old houses, a different array of job choices and probably a more conservative, less debt-driven lifestyle… but we will be back. Think of this as a war, one where we have to throw all of our resources to fight a powerful enemy, but a war we know we can win. We also know that we probably will hit some real bottom (maybe with some bad employment numbers continuing for a bit beyond – employment is a trailing economic indicator) within the next 12 months. What we don’t know is how fast or when we will rise from that bottom, but we need to let our government be the stimulator it appears it really must be.

I’m Peter Dekom, and my wrists are still intact!

The Other Liquidity Crisis Revisited Yet Again – Newer, Drier and Scarier

On February 20th, farmers in California’s Central Valley learned “that federal officials anticipate a ‘zero allocation’ of water from the Central Valley Project, the huge New Deal system of canals and reservoirs that irrigates three million acres of farmland. If the estimate holds and springtime remains dry, it would be first time ever that farmers faced a season-long cutoff from federal waters… The state has put the 2008 drought losses at more than $300 million, and economists predict that this year’s losses could swell past $2 billion, with as many as 80,000 jobs lost.” NY Times, Feb. 21. Hundreds of thousands of acres of once rich farmland will lie idle as this incredible, multi-year drought continues to strangle California in the midst of the worst economic downturn since The Great Depression. on December 11: “At least 36 states expect to face water shortages within the next five years, according to a report from the U.S. Government Accountability Office. According to the National Drought Mitigation Center, several regions in particular have been hit hard: the Southeast, Southwest and the West. Texas, Georgia and South Carolina have suffered the worst droughts this year, the agency said.” While the battle rages over why – climate change as the possible accelerant is the venue for the contest – no one disputes that population growth and wasteful water-usage policies are primary drivers that threaten a return of the infamous “Dust Bowl” scenario to many regions in the U.S. – ironically that first infamous Dust Bowl also occurred during the “depressed” 1930s.

"The demand for water has gone up," noted John R. Christy, a professor of atmospheric science at the University of Alabama in Huntsville in the above-noted CNN piece, "The demand has skyrocketed in places like California and New Mexico because they've tried to grow crops in deserts." Even where there has been sufficient rainfall has been sufficient, the complacency about the availability of “cheap water” has de-prioritized water storage, conservation and movement systems. But when a region runs out of that precious commodity, immediate solutions often result in desperate actions.

Here’s a little example with an historical twist. When a surveyor plotted the precise border between Tennessee and Georgia back 1818, he seems to have missed the Tennessee River (in Tennessee, of course) by a mile. They call it a “flawed survey,” but it didn’t seem to matter until Atlanta, in northern Georgia, began to run completely out of water. The Georgia State Legislature has often tried to fix this anomaly by legislative force, but the border is the border. Northern Georgia didn’t get a break even as to its own local reservoir: a federal appellate court ruled in February of 2008 that the state could not withdraw as nearly much water as it had planned to from the reservoir that supplies the city. Seems that to fill northern Georgia’s reservoirs and to keep a good chunk of Florida out of recent droughts, they need lots of nasty tropical depressions and hurricanes, stuff that tends to kill folks and destroy property on the coast.

The above map and this little summary come from the University of Nebraska, Center for Agricultural Meteorology and Climatology: “The Ogallala Aquifer underlies approximately 225,000 square miles in the Great Plains region, particularly in the High Plains of Texas, New Mexico, Oklahoma, Kansas, Colorado, and Nebraska.” In short, if your farm isn’t on the Mississippi or Missouri Rivers (or one of their tributaries), and you are a farmer near this giant underwater lake (once the size of Lake Huron of the Great Lakes), this aquifer is your lifeline. When they didn’t have pumps modern enough to pull enough water out of this aquifer – and excessive grazing blended with a drought – the great depression era Dust Bowl was the result. We’re pumping a lot now, and there has been some heavy rain in the region, but...

Water expert Marc Reisner (who wrote a great book about water and American policy: Cadillac Desert: The American West and Its Disappearing Water) still thinks there’s pretty good chance the Ogallala Aquifer could run basically dry in a quarter of a century (or less). I am so glad that we have finally reversed the trend of growing subsidized corn in the area served by that aquifer – to burn as ethanol – because corn, with its fat, juicy and water-filled kernels, uses water at an alarming rate!

So what else is around that could supply water to America’s heartland? Maybe the Great Lakes? They provide 20% percent of the world's fresh surface water and supply eight states and two Canadian provinces – home to roughly 40 million people. On October 3, the President signed into law (the “Great Lakes Compact”) a federal statute that bans virtually any attempt to divert water from the Great Lakes to any outside region. Hmmm? We’ll just have to get it somewhere else. The oceans – minus the salt?

Moving water uphill – a necessity given America’s topography – is a very expensive solution (read: a huge energy requirement – just think how heavy a bucket of water is – although you can pick up some electricity from the downhill flow). That means even with cheap desalinization (it isn’t yet; still takes lots of energy to covert salt water into fresh water), just getting water to where it needs to be is not cheap or easy.

As a part of America’s going-forward rebuild of her infrastructure and focus on alternative energy, we also need to prioritize maximizing our water resources, conservation and new methods for pulling potable water out of the oceans and even thin air (yes, the technology exists!). Water conservation technologies just moved way up in the list of “projects” that the American Recovery and Reinvestment Act should address as soon as possible.

I’m Peter Dekom, and I approve this message.

Saturday, February 21, 2009

The Garbage Collectors of the Future

Robert Teitelman, editor-in-chief of, often presents some intriguing if not difficult questions that lots of folks just plain miss. In his February 19th editorial, he asks a very simply question, which I will take the liberty of paraphrasing: since all the traditionally conservative bankers (who really asked borrowers the logical and tough questions) have long since been pushed out of the system to be replaced with aggressive MBAs looking for ways to package new debt instruments (the folks who got us into this mess), just exactly who is left to separate the good debt from the bad?

It seems that Washington has been assuming that these evaluations will be done in the private marketplace, creating jobs from the ranks of Wall Street’s unemployed financial community. But do folks who have spent their lives looking for ways to avoid analyzing the borrowing ability of potential debtors and have depended on a false marketplace to place value on collateral actually have the skill-set to get it real? And if it is not this cadre of experts, who will need to step up and fill the shoes of the valuation experts? The Obama administration hasn’t even really begun to fill the ranks of the more junior political appointments – those who will be charged with implementing the American Recovery and Reinvestment Act expenditures – so this expertise appears to be elusive, to put it mildly.

Teitelman: “To cut to the chase: Today, the best of these traditional bankers who viewed credit as a high calling are either dead or retired. The banks are full of the quants who know securitization products but not necessarily the reality of borrowers or the intricacies, even the art, of credit; ironically, many of the credits the banks thought they'd unloaded on someone else are back on their balance sheets (or that of the Feds, which is increasingly the same thing) stinking to high heaven. This isn't about portfolio manipulation, trading or hedging anymore; it's about working out the value of the underlying credits. It's hard, it's dirty, it's real. A lot of it involves old-fashioned banking. But where are all the old-fashioned bankers? How do we restore credit without a credit culture?”

To make matters worse, for a very long time now, traditional business schools have actually trained financial experts in how to skirt the real values and create new marketable securities, including the now clearly toxic derivatives of recent years. With appraisers raised in a different era, bankers used to living in a rising marketplace, it seems that there is a real opportunity for a new set of training requirements and a new set of valuation experts to step and take control. The obvious problem? We have run out of time.

I’m Peter Dekom, and I never cease to be amazed at the litany of issues we face.

Comin’ or Cohan

Peter Cohan, writing in AOL’s February 20th Daily Finance argues against putting taxpayer money into the mega-banks that are failing – effectively nationalizing them (Cohan: “Unfortunately, many of the proponents of nationalization only have a hammer on their tool belt”) – and instead is pressing for the government to create brand new banks with the remaining TARP money.

He’s dealing with the same figure, $1.9 trillion of totally lost credit in the U.S. markets stated in my Sooner or Later Revisited blog. His take: “[I]f , the U.S. used the second $350 billion of TARP to capitalize new banks, at a 9:1 assets/equity ratio, it would create $3.5 trillion in lending capacity to meet demand (more would be available if private investors chipped in).” This number would, in his opinion, more than make up for $1.9 trillion lost.

In the same blog referenced above, I noted that those “securitized bundles” of loans that had been floated in the pre-September 15th meltdown were viewed by the market as toxic assets which no one wants to buy, further freezing the credit markets (because no one values these bundles of bank loans).

Cohan has a solution for that too: “[L]et the FDIC buy the, say, 15% of those mortgages that aren't paying. This would free up the mortgage-backed securities to trade freely since the remaining 3,400 mortgages in that security I mentioned above would consist of paying mortgages that would have a real value. Banks could then sell those securities or keep them on their books at a high value. And they'd be able to lend out their capital instead of hoarding it. Meanwhile, the FDIC could work with mortgage holders to restructure the loans and keep their houses off the market.”

Looks like a set of viable alternatives, and I thought my readers would like to explore all the options. There’s no one clear path or we’d probably be on it by now.

As much as I like the numbers in Mr. Cohan’s analysis, I actually pictured how the U.S. government would physically create these new banks, hire the management, choose where they would be located, etc. My freezing ticking clock turned quickly into the turning pages of a monthly, then yearly, calendar. The theory may or may not work, but the government probably would do better by taking over a couple of existing big banks where shareholders face the ultimate loss and use these shells to implement Gary ’s policies. Back to that “n” word again.

And clearly, draining the worst debt bundles out of the mortgage securitization market does tend to remove a cork in our credit flow. I’d be happy if the FDIC chipped right in on that one. But in the end, it will take direct action from the government, not inducing or trying to incentivize the private sector to take the first steps which the markets are clearly telling you they are not willing to do, to start the thaw. At least the two Peters seem to agree on that one.

I’m Peter Dekom, and I approve this message.

Friday, February 20, 2009

Sooner or Later Revisited

I wrote on February 13th that if you know and I know that sooner or later, the government is simply going to have to be more direct in getting the credit markets unfrozen, why isn’t the government doing that? The February 18th reported that the money “invested” in banks under the TARP bailout has barely created a mild ripple in the consumer and business debt markets. And until those credit markets are unfrozen, the only new jobs we are likely to see are those directly created by the American Recovery and Reinvestment Act… a program that will take years to begin to make a difference in the unemployment rate. Why don’t the government folks get it?!

The old way of getting credit flowing – banks selling off their loans in “securitized” bundles to third parties, freeing up the bank to lend more money – is dead. Those bundles (derivatives) tanked and brought down the balance sheet of the buyers, who now not only have devalued paper on their books but no money to buy any more bundles of bank loans. The February 20th New York Times: “The result has been a drastic contraction of the amount of credit available throughout the economy. By one estimate, as much as $1.9 trillion of lending capacity — the rough equivalent of half of all the money borrowed by businesses and consumers in 2007, before the recession struck — has been sucked out of the system.”

Bottom line, and it isn’t going to be cheap, the government has to pour the money they want to see in the lending markets to save jobs directly into the lenders themselves. The remaining $350 billion of TARP money isn’t going to cut it; we probably need to start with two to three times that amount. And the longer we wait, the more money it is going to take to fix the system.

Right now, the government is trying to figure out how to “stimulate” private investors into feeding the banks who feed the credit markets by guaranteeing such private investors against losses. Investors effectively would have somewhere between 5-16% of the total risk, depending on the loan and the deal with the government, and the government would pick up the rest. Again, we see an indirect effort, but so far, all of these indirect methods have fallen incredibly short. Investors are just plain scared; they’d rather sit on their cash than take any risk. The likelihood is that money put into this indirect program will just be one more government write-off. Sooner or later, it will be the government that is directly funding the loans themselves or we simply slide into a full blown depression.

Estimates presented in my earlier blog suggest that the number that needs to be placed into the banking system – by the government specifically for the purpose of being loaned out into the commercial debt markets is on the order of between $500 billion to as much as $2 trillion. It seems inevitable that at least some of these clearly failing banking behemoths are going to have to be taken over by the government – the new “n” word (“nationalization”) – until they are healthy enough to be spun back into the free marketplace again. As noted in a recent blog, the mere fact that the government is unconcerned about the impact of their salary caps on these larger institutions seems to suggest that some increasing role of government administration and control is the current clear direction.

But if you want an even clearer signal, from the prince of laissez faire, former Federal Reserve Chairman Alan Greenspan, note how he is now contradicting his long-held policies by now advocating the possibility of nationalizing a few banks. From a recent interview in the Financial Times: “It may be necessary to temporarily nationalize some banks in order to facilitate a swift and orderly restructuring… I understand that once in a hundred years this is what you do.” Even Republicans like South Carolina Senator, Lindsey Graham, are willing to accept what is probably inevitable (from the Financial Times as quoted in the February 18th “We should be focusing on what works. We cannot keep pouring good money after bad. If nationalization is what works, then we should do it.”

Japan had a nasty recession, resulting from its own burst real estate bubble in the late 1980s, that literally consumed the entire 1990s with failed infrastructure and other comparable stimulus packages, until the Japanese government finally (and successfully) intervened, in the early part of this decade, and provided the needed capital injections. Sweden saw the wisdom of such intervention in 1992 with positive results. Even the U.S., in the late 1980s, had to step in and save the failed savings and loan business (the “thrifts”) from their real estate excess by putting the nasty loans and sorry foreclosures into the government-controlled Resolution Trust Company before slowly releasing these assets back into the marketplace.

We need credit; banks don’t want to lend but are happy to take bad assets off their books any way they can. They are busy deleveraging, focusing on their survival and not the betterment of our economy in general. Their priorities, further limited by the strict regulation by bank examiners, are not the policies of our highest elected officials or what is best for the nation as a whole. Private investors are looking at falling stocks, falling home prices and rising unemployment; they aren’t going to be easily “stimulated” to unfreeze credit and help fund banks to make loans in a world of declining values and eroding earning power!

I’m getting pretty fed up with the “indirect” approach; if you are going to spend taxpayer money to create a very necessary effect, particularly after a significant period of clear failure with the indirect approach, it’s time to bite the bullet and put the money you want in the credit markets directly into the distributors of money – the banks themselves – for the sole purpose of lending! If the best way to effect that policy is nationalization, the sooner we implement that policy, the less damage we will have to repair! If we do not unfreeze the credit markets, there is no way on heaven or earth to turn this economy around!

I’m Peter Dekom, and I approve this message.

Wednesday, February 18, 2009

Wiggling Interest

Governmental debt is consuming massive amounts of global borrowing capacity, and tightened governmental regulation is effectively keeping the consumer and business credit markets in an icy if not frozen condition. The February 18th noted: “The 20 largest recipients of capital from the Treasury's Troubled Asset Relief Program reported modestly declining total loan balances during the last three months of 2008. The median percent change in residential mortgage balances was down 1%… In the first of a new monthly bank lending survey, the Treasury Department said total residential mortgage balances remained ‘essentially flat.’ Corporate loan balances decreased slightly while new commitments for commercial real estate lending decreased 19%. Renewals for existing commercial real estate accounts increased as did credit card borrowing. Overall credit availability for cardholders decreased, Treasury said.”

As the senior financial ministers and secretaries met recently in Rome to decide the level of joint cooperation and policy-making aimed at fighting this managed depression, signs of the next economic crisis, particularly the United States, are settling into the markets. Even after a very-distant recovery shows the slightest indication of beginning, and I think we are a couple of years away from even that slight nudge (even though we will bottom out much sooner), with so much pent up and growing demand for credit in the system, there are existing undercurrents that portend the next fear.

The culprit? Rising interest rates. At some time in the future, relative currency values are going to be much more reflective of a combined examination of aggregate individual, corporate and governmental debt reduced by measurable increases in average per capita productivity – for those nations with scarce or valuable resources, natural or otherwise, that factor will be considered too. In short, in relative terms, how much we owe versus our ability to service the debt and pay down the loan.

If we don’t play this game right, by using our massive borrowings to fix this economy significantly to increase our productivity (education and training with newer, more productive tools and equipment, reducing waste and obvious costs like expensive power consumption – building new industries with new technologies along the way), the fact that we may have created more debt than our neighbors will only result in the devaluation of our currency relative to those nations that borrowed less and/or increased productivity more.

And if our currency depreciates, even after a recovery has begun, global commodities will take more dollars to buy them – basically stuff will cost more. We call that “inflation.”The Federal Reserve reacts to inflation by raising interest rates, making borrowing increasingly expensive, which is supposed to slow spending and shore up the currency. In the late 1970s and early 1980, even mortgage interest rates were in the high teen percentages. We could get there again.

The nascent signs of increasing interest rates reflect that we have to fund our increasing national debt, rising by trillions of dollars to fund one or more stimulus packages, by floating treasury bonds into the global market. Short-term treasuries are/were yielding, effectively, a zero rate of return, but now the government has to find buyers for our governmental debt instruments in an environment where many other governments are following the same path. At the moment, that means we have to pay a higher rate of interest to attract those buyers, normally with T-bills with longer maturity dates, even as the Federal Reserve discount rate (best rate paid to the best banks) hovers around zero.

Foreign buyers still think the U.S. is a safer bet than many of the alternatives. Mexico was forced to withdraw its offering of 21-year-maturity bonds when it was clear there was no real interest in that Mexican paper (and remember, if Mexico destabilizes, they are our most immediate neighbor in the south – it will impact us). But the U.S. only placed its 30-year bond into the marketplace with a 3.54% (actually down from 3.7% earlier); ten year notes were auctioned at 2.82% and three year notes generated 1.42%.

As the U.S. continues to float increasing levels of government debt, the auction market could pressure us to pay increasing levels of interest. Countries like China, usually one of our best debt customers, itself faces the implementation of a $600 billion stimulus package. We simply have to make U.S. treasuries more attractive than those of our competitors, a task that becomes increasingly difficult if the relative value of the dollar begins to fall for the reasons discussed above.

Every economic action produces a set of economic reactions, and that “forever” changing set of variable requires a government to bob and weave in an effort to produce stability within a vector of at least some level of sustainable growth. Those monetary and fiscal policies, combined with how we regulate finance and commerce, will determine how the next generations live… and how much we may have to ask them to reduce their standard of living.

I’m Peter Dekom, and I approve this message.