Strange days: Federal Reserve to take stocks in exchange for cash

Amongst the financial news today is something that is truly strange and new.  For the first time in almost a century, the Federal Reserve has announced it will lend out money in exchange for equities (shares of stock).  According the the Reuters’ report:

“One of the biggest changes the Fed made was to accept equities as collateral for cash loans at one of its special credit facilities, the first time that the Fed has done so in its nearly 95-year history. 

One of the most striking new Fed action was its decision to accept equities as collateral for cash loans under its Primary Dealer Credit Facility for investment banks. Until now, collateral was limited to investment-grade debt securities.”

What does this mean?  Essentially, that the quality of the collateral held by the Federal Reserve is continuing to deteriorate.  Long gone are the days of AAA rated collateral requirements.  The Federal Reserve is now potentially the largest player in the stock market.  At the very least, it will be subjected to stock market risk, a scary thought.  Is this the role of a Central Bank? 

The action is summarized by Nouriel Roubini as follows:

[T]he Fed is accepting even more toxic collateral for the TSLF and PDCF, including even equities; so now after having nationalized the mortgage market via the takeover of Fannie and Freddie the government is also starting to manipulate directly the stock market (a step that started with the SEC restrictions on naked short sales of the primary dealers; so the process of turning the US market system in a socialist system controlled by the government is now in full swing. And the Fed takes massive credit and now market risks by its effective purchase of equities.”  http://www.rgemonitor.com/roubini-monitor/253567/if_lehman_collapses_expect_a_run_on_all_of_the_other_broker_dealers_and_the_collapse_of_the_shadow_banking_system

British bank Lloyds TSB’s profits plunge 70%

http://www.thisislondon.co.uk/standard/article-23523323-details/Profit+crash+rocks+banks/article.do

The news hit London on July 30th that one of the most conservative of the British major banking institutions saw its profits plunge by 70%.  “The result was far worse than a pessimistic City was expecting and raised fears for high street rivals. HBOS, which owns Halifax, reports tomorrow and Alliance & Leicester the day after.  Lloyds TSB blamed the global credit crunch and losses in its insurance business. The figures will heighten government fears that more small banks could collapse such as Northern Rock. Lloyds was regarded as the most conservative of the big banks and had won praise for resisting the temptation to make risky loans during the boom years.”

The Shape of Bank Earnings To Come: U, V, or L?

The latest from Satyajit Das analyzes the question of where bank earnings will likely go from here.  It’s a thoughtful and well reasoned piece.  His conclusion:

“Glamorous banks reliant on “voodoo banking” may find it difficult to achieve the high performance of the “go-go” years.  Banks with sound traditional franchises that have avoided the worst excesses of the last 10-15 years will do well in the changed market environment. Such old fashioned banking may ironically do well in the “new” environment. Interest rates that they charge customers have increased. Bank deposits have become far more attractive than other investments. Stronger banks have also benefited from a “flight to quality”.

Will the recovery in bank stocks take the form of “V” or “U”? It may be a “L”. With the Northern Rock and Bear Stearns bailouts, central banks and governments have signaled that major banks are “too big to fail”. This is a necessary but not sufficient condition for recovery of bank earnings and stock prices. The recovery might take the form of a “L” (Kirsten ITC font) – note the small upturn at the far right of the flat bottom.”

Read the entire article:  http://www.eurointelligence.com/article.581+M51e05e0377e.0.html

 

 

Mike Morgan says FL on the edge of a depression

One of the most astute commentators on the economy in Florida and real estate particularly is Mike Morgan. His latest piece is fascinating but makes for a none so cheerful read. He thinks as goes FL goes the rest of the U.S. Is Florida a crystal ball we should all be looking into?

Excerpt: “I was going to call this “Banks March Us Into Depression,” or maybe more fitting is . . . “Complete Collapse of US Banking System.” Folks, that is what we are looking at. I don’t see any way around it. What we’re seeing here in Florida, is your crystal ball. And what happens here, is coming to a town near you . . . soon. This past week I didn’t write anything, because what I am seeing unravel is disturbing to the point I had to question what I was seeing and hearing. So I decided to take as much time as I needed to digest it all, and then put something together for you. So here goes . . .

I could prepare volumes of spread sheets with Bernankesque numbers. I could talk about commodity prices and oil and third world politics and a dozen other metrics that all lead to the same conclusion. But let me give you a ground zero look. That’s what I do best. I will leave the manipulation of the numbers to the folks on Wall Street that do it best. The same folks that have created the precipice they will soon push us off.

I spend a great deal of time dealing with Asset Managers hired by banks stuck with REOs. So as not to re-hash the events leading to the housing crisis, I will not discuss the free-money policies of the past, and I will not discuss the absolute lack of accountability in making the bad loans of the past. Let’s just deal with how the banks are attempting to recover.

Unfortunately, banks are not making a realistic effort to address the crisis. That may be because they cannot. As the banks and builders have announced write down after write down, my mantra has been . . . and continues to be . . . NOT ENOUGH – NOT ENOUGH – NOT ENOUGH. I still believe that. The builders and the banks have underestimated the magnitude of the problem, and they continue to do so. Analysts continue to look at the rear-view mirror and attempt to manipulate numbers based misguided historical assumptions.” Full article floridacrystalball

Banking crisis – money IVs

No, we’re not out of the woods.  B&B in  the UK and now Lehman on Wall Street are showing that when the tide goes out, we see who’s swimming naked.  Simply put, it’s not a good sign when investment banks and banks have to use credit to survive.  As observed so well today, what goes up must come down harder:

“Lehman is in serious trouble on Wall Street. But that’s nothing compared to Bradford & Bingley in the UK, which may be wiped out in a matter of days. As you can see below, they were very close a few days ago. A bank run has been avoided so far because of an alleged government guarantee for every first £35.000 in deposits. What that is truly worth remains to be seen if bank failures come fast and furious in the UK.

That scenario is not that far out in left field; most large UK banks are caught up in rights issues. That over-supply means that to get any new capital, they’ll have to sell themselves dirt cheap. Which in turn will provoke enormous anger among shareholders. It could happen very soon. But yes, it’s still possible that Gordon Brown sells the future of his people to save the banking system.

Not that Lehman is looking good, mind you, they’re going “money intravenous” for the third time in a few months, and they lost over 50% of their values at the same time. If that trend doesn’t stop, there is no way out of failure or a fire-sale. And following tight on the Lehman heels, Wachovia is lined up for the emergency room, and perhaps the last rites. Or, you guessed it, a fire-sale.

People are often asking for “the” moment, and “the” writing on the wall. How about this: “Sales of [US] commercial properties were down 71 per cent in the first quarter compared with a year earlier.[..] Commercial property prices in the US in February saw their sharpest decline since records began nearly 15 years ago.”

http://theautomaticearth.blogspot.com/2008/06/debt-rattle-june-3-2008-what-goes-up.html

Banks in high “gear” – high risk asset levels remain

Despite some variation, average ratio of high risk assets to equity was 188% across these major banks:


Many thanks to Russ Winter for chart and graphic!

This is not business as usual

For curiosity’s sake, take a look at the historical dollar amount of borrowing by depository institutions (banks) from the Federal Reserve.  It is hard not to notice that what we have here is unprecedented over the last 100 years.  When you hear someone say the credit crisis is almost over, check this chart and think again.

Total Borrowings of Depository Institutions from Fed. Reserve 1910 – present (Billions $US)

Scary chart: British banks undercapitalized

Germany’s BaFin Internal report says financial institutions to lose $430 – $600 billion

Germany’s Federal Financial Services Authority is known as BaFin. According to information obtained by SPIEGEL, an internal BaFin report says that shortfalls at finance institutions worldwide could end up totalling $600 billion (€380 billion). The shortfall comes as a result of ill-advised speculation on the US subprime market and resulting jitters in markets worldwide. BaFin says that its prognosis is merely a worst-case scenario. “Given what we know about the current situation on the markets, we presume that a total of $430 billion is more probable,” the 16-page report says.

Fed chart shows current borrowing schemes

Click through to see New York Federal Reserve Bank’s March 2008 chart explaining TAF, TSLF, among many others including acceptable collateral for each type of lending:

forms_of_fed_lending.pdf

The Fed running low on ammunition?

The Federal Reserve has certain assets — about $800 Billion in Treasuries.  Once it lends away the additional $200 Billion announced today, and counting the TAFs (Term Auction Facilities), about one-half of the Fed’s reserve of Treasuries will be gone.  This chart shows the Fed’s reserves before this additional $200 billion is given out, so you’ll have to continue that line downwards to imagine what it’ll look like by the end of March:

Germany’s state owned banks on the verge of collapse

Der Spiegel reports that Germany is facing its worst banking crisis since 1931, with the government fearing the domino effects of allowing the insolvent banks to fail.  For now, capital infusions keep coming and instantly vanishing into thin air.  Included in the report is a very interesting story on WestLB, a bank that was insolvent and which was initially turned away at the door when it went begging for capital to stay afloat.  This shows how ugly can get:  “ In a crisis meeting two weeks ago, the two savings and loan associations in North Rhine-Westphalia that own half of WestLB had to admit that they were unable to come up with €1 billion in fresh capital for the ailing bank. They insisted that it was up to the state to cover another €3 billion in risks.

A far cry from U.S. banks: Arab bank assets hit $2 Trillion

RECORD HIGH: Arab bank assets to hit $2 trillion this year. (Getty Images)

Arab bank assets for the first time top $2 trillion at the end of December 2007 as Middle East and North African economies expand, and the banks lender more, the Union of Arab Banks said.

Combined, lenders from Morocco to Oman are likely to post a 25% increase in profit this year to $32 billion, Adnan Yousif, chairman of the union, told reporters in Dubai on Wednesday.

“The banks are doing very well because of liquidity, and the growth and expansion of economies,” said Yousif. “You have to have cash for this.”  The union, whose members include 400 financial institutions, coordinates activities between Arab financial services firms and acts as a consultant to the industry. (Reuters)

Loopholes swallow bank $ reserve requirements

Turmoil in the financial markets has resulted in more attention being given to the banking system.  Many are familiar with the FRB data recently showing bank’s non-borrowed reserves dropping. 

So, what about the reserve requirements for banks?  A layperson would think that a bank has to keep a percentage of its total deposits as actual cash, actually available on demand.  But these days it seems that’s an old-fashioned passe attitude.  In actuality, banks are able to avoid the reserve requirements to an amazing extent.  That way they can devote much more of your deposit accounts to suprime lending! 

Curious exactly how its done? The FDIC (which is funded by the banks) published a study explaining it.  Among other techniques, banks are using ”sweeping” rules to decrease the amount of cash reserves they must actually hold.  One bank “successfully” used sweeps to “reduce its required reserves from $788,000 in August 2000 to $48,000 in August 2001, a period when deposits at the institution rose by $36 million.”

“An additional impetus to establishing sweep accounts is the dollar amount required to meet a bank’s reserve requirements.  All depository institutions must reserve an amount equal to between 3 percent and 10 percent of the funds they have in interest-bearing and noninterest-bearing checking accounts.  The total required to be held in reserve is determined relative to the total deposits held in the qualifying accounts at each bank.  Once the amount of the reserve is determined, banks may choose to hold their reserves in the form of cash (vault cash) or in an account at a Federal Reserve Bank (FRB) (sterile reserves), but in either case the funds are nonincome producing.  As a result, a key strategy of bank liability management has been to discover ways of building a bank’s deposit base while keeping required reserves to a minimum.”

In the context of an ordinary checking or savings account (“retail demand deposit account”), the study explains the reserve requirement on these monies can actually be zero, and explains exactly how it works:

“. . . when newly designed computer software enabled a bank to analyze its depositors’ use of their transaction accounts, sweeps became one of the main tools used to minimize a bank’s required reserves: any funds deemed by the bank to be excess were automatically transferred into MMDAs.  (As a result of these transfers, a bank’s required reserve ratio could go from 10 percent to zero).  And in 1994, when the Federal Reserve Board authorized banks to use this software to reclassify any transaction-account, retail sweep programs developed as banks notified their customers when they opened an account that “your deposit may be reclassified for purposes of compliance with Federal Reserve Regulation D. . . .”  Banks began initiating sweeps without the customers’ explicit approval, and the volume of transfers occurring between transaction accounts and MMDAs increased dramatically.

The MMDA used in a retail sweep program operates as a “shadow” account that is visible only to the depository institution.  The bank reduces its required reserves while leaving unchanged the transaction deposits that are available to the depositor.  A bank’s level of transaction accounts decreases sharply, whereas the depositor’s view of the account appears unaffected.  Just as this transfer occurs without the depositor’s explicit approval or knowledge, so, too, any profits that the bank earns are not generally shared; in addition, banks also can choose how the funds will be invested.”

 Bottom line:  the bank may be operating a shadow account under your checking account, sweeping the money out, using it, and keeping the profits – and you’ll never know.  Read the study here → fdicbankliability.pdf