Let’s get seized-up banking back on track
By Rob Fraim of Mid-Atlantic Securities
Everybody and their brother (and their sister) has weighed in on the proposed “bailout” or financial institution relief plan. Smarter folks than I have given their opinions and it has be hashed and rehashed ad infinitum/ad nauseum.
That of course will not stop me from adding my 2.3485 cents worth. So, a few observations, opinions, and random musings:
Is The Plan imperfect? Does it have flaws? Of course. No argument. Are there some things that could be added or taken away from it to improve it? You betcha. Is there perhaps a substantially different approach that could be a better way to handle all of the mess? Perhaps so.
The problem is this though: If we wait to act until we have a new version next week … or an improved one the week after that … or a really good one next month … or perhaps a blue ribbon panel will come up with something really great by next year … well, it all becomes academic and theoretical.
Because past a point I believe we will be talking about what “might have been done” or “should have been done” to avoid the Great Calamity of 2008 (and I’m not talking about Monday’s 777 point drop). I’m talking about what lies ahead – a real drying up of the credit and banking system of the country and the unthinkable consequences to the economy and the lives of every person in this country (world.)
I am already hearing anecdotally about otherwise well qualified borrowers being refused credit. My friend the mortgage broker related the case of a customer of his – a 720 credit score, the owner of 5 businesses – who wanted to do a simple refinancing on her house last week. None of the 30 banks with whom he works would loan the money. Why? Because she is self-employed and they only want people with W-2 (employee) income. They are fearful of lending money.
Last year I referred a client to this mortgage broker. My client has approximately $6 million in liquid assets. He got a $650,000 mortgage on a $1,000,000 house. No problem, the broker called it one of the easiest deals he has ever done. He told me last week that if he were trying to place the very same mortgage today he could not do it – because the borrower (an early retiree) has no “earned income”, only investment income.
I read the story yesterday of a small manufacturing company that received some nice customer orders and needed to purchase materials and cover shorter-term costs (since they would not ultimately be paid until the job completed and was billed – which would take probably 120 days in all). So they went to the bank – as they have for many years – to draw $175,000 on their long-standing credit line. The company was told that the credit line had been cancelled and that the bank was no longer lending in that fashion. Nothing to do with the manufacturing company or its operations. They just stopped loaning money. Oh, they did tell him that they would loan the $175,000 if he put $175,000 into a CD at the bank and used it as collateral. Thanks a lot. Small business cannot function without access to credit. Anyone who thinks otherwise has never run a small (or a large) business.
Banks are beginning to run scared. And when scared they hoard liquidity, which means they don’t lend. We would all like to see housing sales improve, car sales pick up, business activity get better. But if Joe can’t get a mortgage and Sally can’t get a car loan and Fred can’t fund his business cash needs … none of that will happen.
The typical spread between Fed Funds and LIBOR (and don’t forget that the “I” in LIBOR stands for “interbank”) is something like 1% – a plus or minus. Yesterday it hit 5%. Banks are afraid to put the money out into the system and are charging accordingly. I spoke to a small community bank today and they had received 6.2% on overnight money yesterday (after the non-passage) That’s great for them in the very short run, but very troubling when looked at as an indicator of bank liquidity and financial system psychology right now.
I contend that if we don’t get a plan passed – and I mean pretty quickly – that the lending and credit situation will get much, much worse. Small businesses and individual consumers and workers will be hurt.
If you want to really scare yourself, and to help you see why I think we can’t afford to fiddle around with this too long, think about the amount of commercial paper coming due in the next 30 to 45 days. Consider the implications of these companies not being able to roll over that commercial paper – and if you think that wouldn’t be an issue if we exacerbate and amplify the already freeze-inclined credit markets, I believe you’re wrong. Remember that $170 billion rolled out of money market funds (the primary purchasers of commercial paper) last week – and caused the Fed to step in and back the funds. In a total lock-up of the system more money would pull out – government backing or not.
The media coverage (and political rhetoric) about this whole relief bill have presented a very inaccurate picture it seems to me. If I hear one more time that this is about “bailing out Wall Street” and that it is going to “cost the taxpayers $700 billion” and that it “works out to $2,300 per person” I think I’m going to pull out what precious little hair I have left.
a) Yes, it will help Wall Street. That’s the way it goes. If the economy is aided and the financial system is kept from imploding, the investment banks (and by the way, the commercial banks too – which were just as guilty) will be helped. You can’t divorce the economy and the financial institutions. Sorry, that’s the way it is. But for the reasons I touched on above I believe that a relief package really, truly does help “Main Street”. If the guy that lives or operates a business on Main Street loses a job, or sees his home value continue to decline, or watches his retirement fund market values collapse, or can’t borrow money to run the business … well, tell me is that worth trying to avoid? A viable, functioning and reasonably healthy banking system is not optional if we want to avoid economic calamity.
Right now banks are scared, and they are scared because they have seen how quickly that liquidity issues can lead to bank failures. In normal times they could simply sell the mortgages on their books, receive cash for them, and thus improve their regulatory capital positions. (It’s all about the amount of liquid assets banks are required to maintain. Tier 1 capital, risk based capital, etc.) But these are not normal times. No one is buying the mortgages and other loans from the banks – even the good ones – and thus there is not way to reposition balance sheets via the normal market function. So rather than move money from a low-returning but liquid asset into a good (but for-the-moment less liquid) asset – a new loan, the banks are simply hunkering down and keeping the cash. That is called a credit freeze, and the longer it goes on the uglier it gets. It feeds upon itself.
b) Is it going to “cost the taxpayer” $700 billion? No. Because, and I believe that this has been so, so poorly communicated, the US government (the taxpayer) is not giving the money away to the banks. Rather it is buying assets. If I buy your car or your house I’m not giving you the money – we are swapping my money for your asset. Now, depending on the price paid by the US government for those assets – mortgages and mortgage securities – the government will recoup either part of, all of, or more than what was paid for them. And I very much agree that there has to be a pricing mechanism and management program to see that both parties are treated fairly – and especially the taxpayer. But given that mortgage pricing in the market right now (and even more so the pricing for mortgage securities) is depressed and things are selling cheaply, there is at least a very good chance that at worst the government ultimately spends/loses a little bit or at best actually makes some gains as those depressed assets are either sold later on or paid off.
By and large I am a free-market kind of guy. Survival of the fittest and keep the government out of things and all of that. Really I am. But there are extraordinary times when I believe that government involvement is necessary. Unfortunately and sadly I believe that this is one of them.
As to ultimate cost, my unscientific and yanking-it-out-of-thin-air anticipation is that there will ultimately be something in the order of $50 to $100 billion in profits to the Treasury in the long run. Call me a cockeyed optimist, but if the assets are bought right they can and should provide modest returns down the road. (By the way, I am heartily in favor of spending the necessary money to have someone other than the government itself – be it Bill Gross or Paul McCulley or Warren Buffett or hey … Rob Fraim … manage the assets. The odds of getting the money back rise significantly in that instance. (Well, maybe not so much with me, but I could use the fee income. And I couldn’t be much worse than the government at it.)
By the way, I believe that the government will break even on the AIG $85 billion (plus get paid the big coupon for the 2 years), will end up injecting somewhat less than the $200 billion slated for Freddie and Fannie via the “super preferred stock” – as the re-liquification of those institutions will allow lending to resume and real estate – and the mortgages on their books to rise in value sooner than many envision. I think on Fannie we will break even (plus the coupon) and on Freddie it will cost a modest loss. On Wachovia/Citi – something tells me the government will end up spending a bit to pay Citi back on the indemnification above the agreed upon Citi loss. Perhaps more than they expected – to the tune of $10 billion or so.
Put it all together – $50 to $100 billion gain on the “bailout”, breakevens on AIG and Fannie, manageable losses on Wachovia/Citi – I’ll bet you a dollar to a doughnut that it ends up a wash to maybe a little gain (especially when you look at the “coupon” earned on the capital injections and the fact that the Treasury will borrow the money via treasury bond issuance at under 4% – a very nice spread/carry actually).
Oh, and the FDIC managed to pull off the takeovers of Washington Mutual and Wachovia without any money at present out of the FDIC fund. That’s actually pretty commendable and rather well done. And we’re that much to the good already in the “not spending taxpayers dollars” department.
I haven’t read everything, but I have looked at a lot of the analysis and opinion out there. And I know … trust me I know … that there are weak points in this package and there are things that should have been included that aren’t and there are things that should have been kicked out that stayed in there. I get it. And I know there are completely different plans and approaches that have been suggested by others that have potential merit and that are quite interesting. Understood. And if we had the leisure and luxury of spending a few months looking at it all, maybe there would be a better approach crafted. But I really don’t believe that we have that luxury. I’m that nervous about inaction at this point.
And you know what they say: “If you laid all the economists in the world end to end, you still wouldn’t reach a conclusion.” Add in “analysts” and “strategists” and “pundits” and “politicians” and it gets even more inconclusive. If (and that’s a big “if”) we had the luxury of a few months, do we really believe that we would know definitively what to do then? That there would be unanimity of opinion? That the heavens would have opened up and a message from above have clarified it all for us? There has never been and will never be perfect harmony of opinion. That’s why we have markets – someone’s a buyer and someone’s a seller and its all about opinion.
So we are where we are – and it’s a shame.
But we’re still there.
And there is plenty of room for differing opinions. But there is precious little time to continue analyzing and comparing these opinions.
There is something called “paralysis by analysis.” When I started in this business I worked with a guy who would come in the morning, sit at his desk, pick up a prospectus for a fund or a partnership and dutifully read it word for word all day long. Then at the end of the day he would say “Well, I don’t like that one either,” put on his coat and go home. He washed out of the business because he could never make a decision, never make an investment.
“Fish or cut bait.”
“Do something. Lead, follow, or get out of the way.”
That’s where we are folks. Action is needed, and in this case what is arguably imperfect action is preferable to inaction in search of perfection.
A former prime minister of Great Britain is reported to have said that while democracy is the best system of government – since it allows for free and full discussion of issues – “it is only effective if you can get people to finally stop talking”.
Enough talk. Enough politicking. Let’s get it done, let’s get it working, let’s get it back on track.
Source: Rob Fraim, Mid-Adlantic Securities, October 1, 2008.
More on this topic (What's this?)
How Bankers Intervened and Stopped a US Stock Markets Crash on July 8 (the Underground Investor, 7/23/15)
Something Wicked This Way Comes (the Underground Investor, 8/11/15)
Market Update (NYSE:C): Citigroup combines retail banking and mortgage operations (Jutia Group, 6/25/15)
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