Tuesday, January 27, 2009

Bad Bank/Worse Bank

Hello Everyone!

Ok, its time to post now that I have calmed down after reading about the "good bank/bad bank" proposal that supposedly is about to be unveiled next week. Before I get into this, I wanted to highlight how bad the news was that came out today:

- Consumer confidence falls to a record low.

- Case Shiller reports the biggest drop in housing prices on record(-18%)

- GE faces the risk of losing their Aaa rating from Moody's

- Companies continue to shred workers

I find it amazing that Wall St can continue to gobble up stocks despite the news flow above. You would think that after reading such news, the bankers would be running to the nearest bridge and jumping into the Hudson river "US Airways" style.

As bad as the news was above, it pales in comparison to what was announced after hours. CNBC is reporting that the Treasury is preparing to take the bad assets off of the banks balance sheet and place them into a "bad bank" on the taxpayers I mean errrr...the Fed's balance sheet:

"The Obama administration is close to deciding on a plan to purchase bad—or non-performing and illiquid—assets from banks, according to industry sources. The plan could be announced early next week.

The so-called "bad bank" plan, would address the key problem of how to price the assets by using a model-pricing mechanism.

The model would take account of the government's ability to hold onto assets, even to maturity, and pay for the them with cheap funding. Result: the government might end up paying more than current market prices for the securities.

On the other hand, if the government paid less than the value at which the asset is carried on the bank's books, the bank would issue common equity to the government.

In previous Troubled Asset Relief Program deals, banks issued preferred equity to the federal government. But the conclusion is growing within government circles, sources say, that preferred equity is not sufficient to make the banks healthy.

Clearly, the idea of a "bad bank" is gaining momentum. On Capitol Hill today, Senate Banking Chairman Chris Dodd said he was aware the idea is under discussion and "it makes some sense to me."

In the developing bad bank plan, it's unclear how the government would pay for assets. There has been discussion of a "certificate of net worth" in which the government gives the banks a piece of paper that essentially can be applied to capital levels. But sources could not confirm that funding mechanism for the plan or what role existing TARP money or the Fed would play in funding the so-called bad bank."

My Take:

Lets be clear here folks. We all know how the government plans on paying for these assets. Can you say taxpayer dollars?

This development is infuriating. The bank stocks are soaring after hours because there is absolutely zero mentioning of nationalization in this press release.

Folks, this program cannot work if the current banking management teams are kept in place and the banks aren't nationalized. The banking crisis was resoloved in the early '90's because we played hard ball and took their insolvent asses over.

The reason it won't work without nationalization is the banks will simply refuse to sell the assets at the price the government wants to pay because it will torpedo their balance sheets. This game was played in Japan without nationalization and it went NOWHERE. It turned into a giant stalemate. Bill Seidman explains why in this video.

Bill(FDIC Chairman at the time) was heavily involved with the successful resolution of the last banking crisis so his opinion should be highly regarded.

Some questions and thoughts from an angry taxpayer(Me!):

Why does the taxpayer continue to get pummeled as this crisis deepens? If we need to create a "bad bank" then nationalize the banks and do it the right way. If the current cast of characters on Wall St are allowed to wipe their balance sheets clean without any penalty then what will they have learned? What type of message does this send? If I was a greedy banker I might say to myself "Yahoo! We got away with it! Lets lay low and then do it again!"

I read that the banking lobbyists are heavily involved in the negotiations of this solution...No s**t really? I would be too if I were them. Wouldn't you take a deal from the government that involved them wiping away all of your debts? Talk about a no brainer.

Another thought I have here is if the pigmen are allowed to get away with this massive fraud and stay in power: Who is ever going to trust doing business with them again? How is investor confidence restored when the robbers are allowed run away with all of the money and then leave us with the bill to clean up the mess? I hate to be crude but this is like getting f**ked in the a** twice!

Bottom Line:

I am rapidly losing confidence in the current administration's ability to handle this mess. I see no "Change" in Washington. All I see is more of the same corrupt behaviour that plagued the last administration.

Wake up Obama! You only have one shot to clean this mess up. Choosing a tax cheat from the previous Fed that was directly involved with the failed policy of the 2008 collapse as your Treasury Secretary was bad enough. This resolution is worse! I pray that this "good bank/bad bank" report is not completely accurate. You need to do the right thing here.

Obama is not off to a good start. I was shocked when I read his administration started throwing daggers at China claiming that they manipulated their currency. Uhhh...This isn't too smart considering China is the largest buyer of treasuries! Geez...Are you trying to create a bond market dislocation?

On top of that, Obama's stimulus package was filled with infrastucture building that forces companies to use steel thats made in the USA only. This is the exact type of protectionism that threw us into a depression!

If you plan on bringing real "change" to Wall St and Washington: FIRE THE FRAUDULENT BANKERS THAT CREATED THIS MESS AND TAKE OVER THE BANKS IF NEED BE! Create transparency and mark these assets down to where they belong which is most likely pennies on the dollar.

Lets take a reality check here. No one will ever want to own these assets. Holding them on the taxpayers balance sheet is pointless. Lets call a spade a spade and take the hit and mark them to pennies on the dollar. Lets be honest: Who will ever want a subprime sandwhich that's sliced and diced with packages of both good and bad loans? Selling these assets would be similiar to selling a Fillet Mignon that's stuffed with dog doo. Last I saw there wasn't much of a market for this kinda steak!

Congratulations to the financial innovation wizards of Wall St! They were somehow able to invent assets that cost millions of dollars and turn them into something that's almostcompletely worthless.

Trading:

Let the financials run on the news here folks. It will create a nice shorting opportunity. I think its going to be a quick pop. Sweden's banks popped 20% on the news when they were saved in 1992 before the equity holders were wiped out.

In the long run I still think these banks are toast. They feds may attempt this sticksave but its not going to work. Once the banks and the feds cannot agree on the pricing of the banks toxic assets, expect the government to take them over and finally begin to start cleaning up this financial fiasco. Lets hope we don't go bankrupt in the process.

Our banks are insolvent folks and the last I saw 0+0=0.

20 comments:

ZMonet said...

"The reason it won't work without nationalization is the banks will simply refuse to sell the assets at the price the government wants to pay because it will torpedo their balance sheets."

I hope I'm wrong, but don't you think the answer to this is that the government...ummmm...taxpayer...will overpay for the bank assets? This is obviously the same plan as the original TARP with the same debate of:(1) you can pay market price and then go in and recapitalize the banks; versus (2) you pay over market price and in essence recapitalize the banks at the same time. Of course there is now an option (3) that should be the solution: nationalization.

Man, I keep reading this crap and getting sicker and sicker. My wife turned to me and said, "you're becoming a huge Republican" to which I replied, "this is not a Republican/Democrat issue, but an issue of preserving the sustainability of this country." Man, my stomach hurts.

Do you think the pop in financials happens all at once tomorrow, or do financials move up over the next week. I suppose getting in on either the long or short side for anything more than a real short scalp trade could be disastrous with more news on this bailout liable to leak out at any moment.

Oh, and don't even get me started on this cram down legislation. What a F***ing mess! So let me get this straight, the government buys the bad assets and then the court crams down on the government? Great.

Avl Guy said...
This comment has been removed by the author.
Avl Guy said...

Z, I have a different take on the cramdown but it likely comes down to timing: sure the banks have half-heartedly written-down some MBS, but they're doing that based on 2007-08 performance trends. The recession is changing all that and no way were 2009 cramdowns & beyond already factored in. Yet, the banks have already ID'd the MBS they want to sell to the Feds. So I guess it's just as likely that cramdown 1st, then sell to feds later, in some cases.
By themselves, cramdowns are a bitter tonic that will hasten us towards the 'end game' IMO, and thus I support them. But not if they’re paired off with ‘bad bank’ schemes that let the banks off the hook.

Jeff, Obama has no background at all in banking & finance, look at his record. Unfortunately, he’s 100% dependent on all that Geithner, Summers, Volker, & Krugman are feeding to him and Congress. The Prez’s independent thinking is evident in foreign & social policy matters, and on some tax stuff, but does not extend to finance & banking; so it’s Goldman-esque status quo ‘group think’ all the way on those matters.

ZMonet said...

Avl Guy -- I know we've gone over this before, but I would agree with the cram down idea if the value is somehow reflected in the price of the house. This would, as you put it, hasten us towards the end game. However, I have a feeling -- and I know Jeff disagrees with me on this -- that the crammed down price is not going to be readily available (i.e., listing on a realty web site, a la Redfin, so that it is transparent). Sure, you could go pull it up in town/court records, but not many people do that. I just don't think gov. wants this kind of disclouse because while it will keep people in their homes, it will bring home prices down further, perpetuate the negative feedback loop and require more cram downs. I hope I'm wrong, both as a tax payer and a person looking to buy a house in another 12-18 months.

Avl Guy said...

Z, If I was 'King', I'd explore all kinds of creative limits and rollouts of cramdowns...rolling geographic targets, time limits for applying, and probably a few pilot markets before-hand.
But I'd make it all 100% transparent for many of the reasons u cite...as well as to signaling to The Street which banks are most exposed.

Jeff said...

ZMon

I am sickened by this too.

This is the mother bailout in my view. I don't see how the Fed tops this one.

YOu could see a huge move in financials for several days because this plan won't be unveiled until next week.

A 50% bounce on the XLF isn't out of the question. ES Futures are absolutely soaring. They are currently at +16.25. This will force the shorts to dive out of positions tomorrow.

This move tomorrow could be violent to the upside.

We could see a 500-600 point up day tomorrow if the shorts cover and the sheeple think the bad assets will just go away without any reprocussions.

If you are going to scalp I would attempt the long side via UYG or the XLF. I may try to catch some of this tomorrow but I will be out quick if I do.

Play small in either direction. We just drove our financial truck off a cliff.

Wells reports tomorrow as well so that should be kept in mind.

Jeff said...

ZMon

One thing to add. From what I am hearing: There were people in Washington that were proposing that the the Fed's pay the full 100% value of the toxic assets!!

So we cramdown and then buy them back at full price. Anyone see a cop anywhere?

Its interesting that the NIKKEI is down on this news.

Jeff said...

AVL

Man you are spot on. This legislation wreaks of goldman doesn't it?

Poor Obama is getting played by Wall St. Can you imagine the lobbying effort thats going on down there?

I'll vote you king avl if you promise that I have full transparency!

Zmon

You might want to push your target out for buying a house. Say 5 years from now??

The fallout from what we are attempting to do is going to take years to play out.

Anonymous said...

Yes, yes, Obama is the nice guy. I can't hear it any more. Who put Summers and Geithner into the seats in the first place? Obama is a WallSt guy. How did he raise so much money for his campaign? Open your eyes, people. He's worse than Bush. Get used to it.

ZMonet said...

Thanks for the advice on playing financial Jeff. I'm growing and more and more affinity for scalp trades because then I don't have to worry as much about gov. action changing the rules of the game.

If financials do bring us higher over the next week, I wonder if this eventually sets up the retest of the bottom. People will get overconfident as the market rallies, then, when they realize that there is nobody spending money but the gov., come flying down.

Anonymous said...

Hey Jeff,

So are CDS contracts an issue outside of the good bank / bad bank scenario? Seems to me we could take all the bad debt out of these banks and they could still collapse if a tidal wave of CDS redemptions washed through the financials. A big foreign bank defaulting could start that wave.

Jeff said...

ZMon

No problem

Oh don't get me wrong. This will not end well. I totally agree. This is the final bull orgy before stocks collapse.

THis rally could have legs so I wouldn't front run it. THe Bear Stearns rally lasted 2 months.

I don't think this one lasts nearly that long but it could last several weeks.

YOu really need to be flexible here. There are many shoes that could drop and take this market lower. However, the sentiment is bullish so you gotta just trade the tape.

This is a tough trading market.

Jeff said...

Anon

The CDS are definately an issue and its a big unknown. Know one knows the true losses here because its so complex.

In the worst case sceanrio if the banks get nationalized then the Fed's balance sheet is your counterparty risk because they own the bank.

So the Fed could attempt to create legislation that untangles and eliminates these CDO's and absorb whatever losses that there are.

WHen Lehmans CDS's were untangled there were losses but they were not nearly as bad as some thought. Most of those swaps were hedged with other positions.

One thing is for sure: This is one giant multiple trillion dollar web that needs to be untangled and it is a huge threat to the banking system.

Avl Guy said...

Hey jeff, "13' readerncomments...isn't that a record for your blog?
Congrats.

Jeff said...

avl

Thanks

The blogs been growing slowly but steady.

I always appreciate your comments along with all the others that contribute to the board.

I think this is turning into a nice little spot on the web to share some solid trading ideas and thoughts on the economy.

I was hoping this place would attract an intelligent audience and become a nice alternative to the craziness and stupidity of the Yahoo Finance message boards.

Everything has turned out great so far. I have learned a lot from the comments section.

Thanks to all for sharing your thoughts!

Anonymous said...

Anyone think SRS around $51 is a good buy? Since the financial rally might last longer, I wonder if I should wait for sub $50 entry.

Jeff said...

Anon

Tough one.

If you are in for the long haul I think its a nice entry.

You might take some short term pain as the Fed continues to throw money out of helicopters.

SRS might be violent over the next week until we here from Geithner next week.

ZMonet said...

Should have taken your advice and not fought the tape. I fought it all day. Initially I took FAS up, but then decided that the market might sell of in the afternoon and moved to FAZ. Big mistake. I fought the tape, should have closed out my position a dozen times, and finally won at the end of the day when the market dropped (thankfully I was smart enough to get out with some small profits -- instead of huge losses -- at that point). Man, be careful playing these levered ETFs. When volume goes up these things move FAST.

Anyway, learned an important lesson about not fighting the tape. I'm generally a contrarian investor and that doesn't work so well on scalp trades.

Loving your blog Jeff. I like and read a number of blogs, but I really do look forward to yours the most. You add a personal touch to it that I can't get at Mish, CR or elsewhere. Thanks for taking the time.

Jeff said...

ZMon

Thanks a lot for the compliment. Glad you were able to escape FAZ. 3x leverage will move quick on you!

I am a contrarion as well Z so I understand where your coming from. Its very tough to fight the Fed and their balance sheet right now on the short side.

I'll tell you what though, SRS is getting real interesting here in the 40's.

I will have a post up in an hour or so.

Anonymous said...

I took a jump on SRS at $48.50 hoping for a dead cat bounce tomorrow.