The problem with banks....

What in the world is going on with the financials? The government, the FED...so much as been done to bail out certain institutions and to assist others with transactions, liquidity, and a whole host of other issues. Why, in the face of that, are the stock prices still tanking and now there is a very real fear (though certainly not a government desire) of nationalization. What is going on today? Is there a way to define a particular problem or set of problems? The reason to ask this is that, from 2007, through 2008, and now into 2009, there have been issues. No one can say that they don't understand these issues. And, it started with the financial companies themselves taking write downs and cleaning house. If anyone recalls, the companies that took the biggest writedowns were praised, and others (Lehman, Bear) that didn't take the writedowns are now...well...extinct. The funny thing is that, investors then seemed to think, ok, that will work, everything will be good. And yet, it was really only the beginning. With a scary regularity, banks seem to continue to write down, write off, and mess more and more things up, getting killed subsequently in the markets without an end in sight. So, what on earth is going on?

"If governments have restored confidence in the banks’ ability to survive, why the renewed rush to intervene? And if governments continue to demonstrate support for the banks, why aren’t shareholders also rejoicing? The answer to both questions lies in concerns that not enough credit is flowing. Bankers themselves deny the charge that they are hoarding capital. Jamie Dimon, the boss of JPMorgan Chase, told investors last week that his bank “was making loans all the time”. Analysts at Credit Suisse reckon that British banks have increased their balance-sheets since June.

The problem is that even if individual institutions manage to grow their books, there is still a huge gap in financing capacity to fill. Analysts at Citigroup reckon that domestic banks provided only half of the credit available to British households and companies in early 2008, for example. Foreign lenders are under pressure to focus on their home markets. Last week America’s Treasury asked the banks in which it has injected capital to provide monthly reports on their lending activity: it is safe to assume that officials are more interested in loan growth at home than they are abroad. Corporate-bond markets are much livelier than they were but other non-bank sources of finance, such as the securitisation market, remain stagnant.

Replacing this lost capacity would be tough at the best of times. Right now, it is nigh on impossible. Demand for credit is lower, as companies and consumers retrench. Losses are surging as the economic climate worsens. Regions Financial, an American regional bank, reported a record $6.2 billion quarterly loss on Tuesday on souring property loans. Structured products still have the capacity to wound. Shares in KBC, a Belgian bank, plummeted by more than half between January 15th and 20th on concerns that it would take big write-downs on corporate CDOs (collateralised-debt obligations). Even staid custody banks are finding unpleasant ways to surprise: shares in State Street lost almost 60% of their value on Tuesday as it announced hefty losses on bond investments, among other things.

In these circumstances, the natural (and sensible) inclination of banks is to hold on to capital, not to run it down further by ramping up lending. Hence the renewed efforts by governments to free up banks’ balance-sheets. Hence, too, the violent sell-offs in many bank shares, as shareholders realise that the price of further intervention may be widespread dilution.

Public ownership may be unpalatable to many but it is just as difficult politically for governments to keep injecting money into banks without wiping out their owners. Tactically, too, the approach of injecting capital in the form of preferred shares rather than common equity, has its limits. The British government converted its preferred shares in RBS into ordinary shares on Monday because the former required such hefty dividend payouts. America’s capital injections to date have imposed less onerous terms, but its banks still need a reasonable level of common equity to act as a credible first defence against losses. With share prices so low, any more capital-raising is bound to be hugely dilutive (thereby reinforcing the urge to sell). It may not be imminent or desirable but the spectre of nationalisation haunts the sector."

This is an excerpt of an article from the economist. It hits on a lot of key issues. First of all, there is a sense that there is a global financial system and a global financial crisis, but that individual countries are going to focus inwardly before they focus outwardly, at least, in the absence of an emergency scenario. It simply isn't politically palatable to focus on problems of credit and issues abroad when there are so many issues at home, no matter where the situation concerns itself with. I think of this as a negative, not because I think the US or any other country should do something specific to help the global system ahead of the individual national systems...more so in that it is a limit. We were so quick to embrace globalization when there were no problems and when there were profits to be made. In a crisis scenario, maybe to a degree that the world has never seen at least financially, there could potentially be a broader, more global solution than just cutting interest rates across central banks. Maybe there could be a faster solution. Again, not saying I have the answer, just that the answer might be in other places than the ones we are looking.

Another key issue regards balance sheets. The way that I understand a bank balance sheet centers around a couple of important points. First of all, you have customer deposits and accounts. This is money that the bank holds, but it can also be demanded by the customers at any time. So it's a liability. Then, the bank makes money, typically, by lending money. This money leaves the bank, but it is expected to be received (hopefully) in the future. It is an asset. And then, we have what the bank does with its cash. Proprietary trading, whatever they do, looks to enhance the returns on cash instead of just having it sit there. Sometimes they structure securities that are supposed to have some type of return based on underlying assets, like houses. Maybe they sell these securities, maybe they hold them, or maybe they buy others from other banks. I think, personally, that we need to throw out any notion that there were any limits. No limits to how complex securities could be. No limits to how many could be sold. So, these were assets, either generating cash flow themselves or through their ability to be sold.

These securities are complex. True. But it's also true that there is always a portfolio of other securities that can be assembled with the same payoffs. What I mean is that if you have a portfolio of securities of which you know the prices generating some types of cash flows and you manipulate those cash flows to match a complex security for which you don't know the price, the law of one price states that you effectively now know the price of of the complex security. An over simplified way of looking at it, but the theory of arbitrage pricing is a classic one, and I have heard that you can assemble a portfolio of zero coupon bonds to basically match the cash flows of anything. Additionally, it is as though we forgot something. No matter how complex any of these things can become, there are people on the other side. These people need to pay their bills. The securities are worthless if not for that fact. It could be a car loan. It could be a mortgage. It could be a student loan. It could be anything. People stop paying, values drop. Simple as that.

So many would then address mark to the market. This article doesn't really go into that. Blaming mark to market 100% is probably a bit asinine. It's one of those things, like short selling. It CAN exacerbate problems and situations, but it doesn't CAUSE anything in and of itself. What seems to be the case would be the "opaque" securities based on the abilities of people to pay loans keep declining in value. They might decline b/c the value of the underlying houses are dropping. they might decline b/c people are losing their jobs, the economy is rough, and it's harder for people to pay back loans. There could be any number of reasons. So, marking to the market, prices on all of these things across the board need to drop. So, banks that thought they could get "some price" for these things now have to turn around and say, yeah, well, actually, we can't get that price, we have to accept a price substantially lower. So, they need to write down the value of their assets, etc, etc. And, it seems like this process doesn't end up exhausting itself. It would appear logical that many different types of people would be having more and more trouble paying their bills for more and more negative reasons about the economy. It make sense that these securities would be declining in value...continually, with no end in sight, down to zero.

So, it is a fact that they are sitting there on bank balance sheets, declining to zero. There is no reason why they shouldn't keep declining. So, banks will continue to need to write them down. The market will continue to punish banks for needing to do that. Talk about a vicious cycle. So, does this lead to nationalization? The only things that should logically lead to nationalization would be runs on the banks (which haven't happened) or a pulling of lines of credit. Low stock prices shouldn't do it. The fact that stock prices continue to drop needs to be looked at in only 1 way. Stock price is indicative of access to the capital markets. If the bank needs to raise capital, how much ownership do they need to surrender to get that capital. Usually, there is a set number of shares, and a set price per share. The problem is, if the government takes equity positions that would mean anything in terms of their amount, they would basically "buy the banks." So, preferred shares? There are limits here, like the article says. If they need to raise capital, how can they enter into huge obligations to continue to pay streams of interest? When would they stop needing inject capital, if we already realize that the complex securities will keep dropping in value further?

There needs to be a solution that addresses the problem, not one that sounds or looks good politically. The best proposal on the table is a single, large, aggregator bank. If this bank buys up all of these complex assets, then the banks themselves wouldn't need to take further writedowns in the future. John B. Taylor, professor of economics at Stanford, was able to do an empirical study showing that confidence, and not liquidity, has been the core of the issues witnessed in the markets. By this he means that adding liquidity isn't going to be the ultimate solution, rather, restoring confidence will play the most major role. To do this, he proposes that we in some manner take care of these "complex assets." Banks cannot continue to have to take these writedowns if there is to be a solution. There needs to be a visible, discernible end to the chaos. This aggregator bank could be a step in that direction.

It won't be the only step, and it will depend on a couple of KEY FACTORS. I can't even claim to know all of the key factors. I just have two thoughts. First of all, it needs to be as simple as possible in structure. Why are we where we are? We have lots of "stuff" that we can't understand. We need this aggregator bank, should we do it, to be a messenger of clarity. We can't have multiple banks. We can't have too many different structures and inter-relationships. We need to know exactly how it works and it needs to be easy to understand to serve its purpose. Then, there is the issue of price. It's a pure game theory type application. We cannot price them in such a way that motivates the banks to not participate. That is similar to what happened in Japan. They would rather have kept the assets on their books and take the write downs than sell to the aggregator bank. True, this crisis might be a bit different than that one, but the fact remains; we can't set up the bank and then have it not work. We need to set it up in a way that will work.

An interesting premise might be as follows. We know that certain banks need money anyway. We know that the government is giving them money. Why not interlock the two? They get money that they would get anyway, only we make them give up those securities as a condition to getting that money. They're already dictating dividend policy anyway and interfering in the "free market" system. I think it's silly that we're paying SOOOOOO much attention to the pricing question. It's an important question, true, but is it so important that we should let the entire thing hinge on it. Some team somewhere, for a fee, should be able to generate a reasonable pricing schematic. It only makes sense, and if saving the system was as important as they claim it should be...it only stands to reason that they would do whatever it took to get some prices on those things.

"You've Got Three Minutes"

"What a weekend." Walt had just arrived at his new office Monday morning. As he sat on his plush, leather swivel chair, the best money could buy, he contemplated the soreness in his back and shoulders. He knew he shouldn't have played that extra 9 holes at the new club, but that Biotech CEO had needed another to round out the foursome...oh well, such was life at Midasonia, the most exclusive club in the state of California. You never knew who you would rub elbows with... Walt perused his calendar for the day. It was booked solid. He had figured that he would need 20 minutes for each of his meetings, the main goal being to assure his clients that his new position was actually a better opportunity for them. New forum...better resources...easier marketing...1.5x trailing 12 gross comission, no wait. That was why HE had moved. He certainly couldn't state that. No, he would come up with some story about bond inventories, that's what was hot right now...credit markets...supposedly some opportunity or something. "Walt, that wholesaler is here, should I send her in?" stated Daisy, his assistant. "Oh, yes, of course." He contemplated this first meeting. It was with Dominique. He'd taken the meeting because her firm was promising some nifty new allocation strategy. Something about different sleeves...hopefully she'd be wearing short sleeves. He always loved the female wholesalers, and hoped that this one would be no less of a pleasure at which to look. As she entered, he looked at his watch. Realizing he still had his breakfast and coffee routine ahead of him, and that his first client was coming in in 30 minutes, he figured he could spare about 3 minutes...ok, 5 if she was hot...
Dominique had received a call from the assistant of a new advisor today. According to her sources, he was one of those corner office big shots recently moved from the other predominant wirehouse. Got 150% of trailing-12 production: typical. She wondered what he was like. Apparently, interested in the core product...what is it that she should bring up first? Dominique knew that the first minutes and approach were critical. Should she ask him questions about his practice? About his book of clients? About how he got started in the business and whether he trained by being handed a phone book and was ordered to "dial for dollars"? What are his theories on investing? on wealth management? Does he even know what wealth management is? Why is he interested in our approach to investing?
She walked into the office face to face with a daunting leather chair and desk of rich mohagany. Walt's eyes bored into her immediately, displaying an attitude of thinly concealed disdain. Did he just give her an up-and-down? "ok," he said, "you've got 3 minutes. Whaddayou have?" This was going to be a piece of work...

Two days ago I had agreed to meet a client down at the St. Regis, the place where we are going to be hosting a dinner event a few weeks from now. She had asked me to tag along because I was her "culinary guru" and could help her pick which appetizer plates were to be passed around. It's funny, because somehow my client thinks that I have this intrinsic talent for food pairing. Although I admit, I did grow up in a home obsessed with the entire culinary experience, I am just a fat kid at heart; I like eating food that tastes good. I just don't get food that tastes bad. Once at the hotel, we were met by the event planner who took us down to the private room we will be renting and then handed us the menus to pick what we would be serving. Half-way down the page, there it was under "Cold Dishes": A water melon goat cheese canape. Let me get this straight....A puff pastry, the strong essence of goat cheese, and a piece of water melon? Ever have that piece of water melon that is so dry it tastes like munching on paper maiche? Is that supposed to taste good? Growing up my mother inculcated us with the mindset of "nouvelle cuisine" being a travesty to the culinary world- I couldn't think of any dish being more nouvelle than this canape.

Althernatively, when I go to an "authentic" Italian restaurant opened up by one of the star chefs of this decade in New York City, I expect each bite to take me back to the canals of Venice, the hillsides of Tuscany, or something like that. If one is to claim authenticity, your reputation should be on the line in every dish served to the public. Sweetbreads.
I prefer grilled over any other preparation. If served any other way, you better make sure all the components are in place. If you put it in tomato sauce, the flavor is really masked so the texture must be perfect, right? That is why I will never step foot in that restaurant again.
Unwashed sweetbreads- good heavens.

IT'S SO EASY...

IT'S SO EASY...
Some will recongnize that as a Guns and Roses song title. I have to admit, I love the band, but it's not one of my favorites. I mean, come on, when you've got Mr. Brownstone...seriously...as well as the classics Sweet Child O' Mine, Welcome to the Jungle, etc. The funniest thing is that I went to a show once at the Pepsi Arena in Albany. We were on the floor, and it was my freshman year of college, so it was really something...back before the days of 4:50am, paying attn to markets, etc. I would say that we had the full Axel Rose experience. About 2 hours behind schedule, just when many of us felt like the show might be cancelled, the band came onstage. And, from that point forward, it was an incredible show. I heard every song I needed to hear. Axel was out there with a NY Giants Jersey. I don't know what the logic behind that was. He must have been extremely unhappy this past weekend. But, anyhow, the thing that draws me to music is not the lead singer...rather, the guitarist. And this show, it occured maybe in 2002, in the fall, and Guns and Roses wasn't really Guns and Roses at that point. We saw Axel and some "other guys" on the stage. Most notable Omission: SLASH. Obviously, the one guy that I would really really really really want to see. In his place, there was this guy that I had never seen before. And, I guess I couldn't really actually see him, because he had a Halloween mask on and a KFC chicken bucket. Apparently, he is known as Buckethead. Initially, I am standing there like, what the fuck...but then he starts playing. OMG...I mean, many guitar aficionados have their own definition about what constitutes good. Some would say fast, speed, ability to shred. Some like Jazz. Others classical. Others prefer a stevie ray vaughn or BB King, where each note basically cries. Then, finally, there are the Hendrix fans...who knows what was going on in his head and the sounds that he heard, prior to all of the technology and gizmos that we use today. But, the thing is, whether or not speed is your absolute preference, if you play, you can appreciate raw ability and talent, especially when the notes are so closely spaced that your mind wants to freak out and have a seizure. I swear, he has the same six string guitar and 10 fingers that I do...but if we were to play next to each other, it would sound like he had 1000 fingers. Some people just have innate talents and abilities. In my dreams I will always be on a stage, lead guitarist for the greatest act since Led Zeppelin. Then, of course, I will always have to be waking up and going to work.
Now, in this situation, in hindsight, we as fans can EASILY criticize Axel Rose, the other members of the band...or whatever...because they aren't playing together. We are sitting here, outside of the situation, and we can see the sheer sums of money they're leaving on the table. I think now, had they been together on that tour, they could have probably pocketed more money than I will make in the next 10 years of my career, just on that one stint. Hell, maybe they'd make even more. But, in the moment, and I admit I don't know the details, they couldn't get along. And, whether or not they behaved rationally by the definition of a normal human, they made the decision they had to make. Life is spattered with these types of "mistakes." Michael Vick anyone? Adam "Pac Man" Jones? Play 16 games, function w/n the law, make potentially hundreds of millions. Again, so easy for us all in our rational states of mind and our 9 to 5's to point that finger. So easy, but I for one will admit that I won't know...ever...whtat it is like to play in the NFL. So, I truly can't put myself in their shoes.
And so, I come to my main point. I have thought about this for a while. Alan Greenspan. Sandy Weill. Music, NFL...these are ultimately entertainment. Michael Vick is an egregious criminal who tortured defenseless animals. By any stretch Pac Man was piece of work. Axel...probably was an asshole to the other members of his band...and vice versa. Today, we are in a CREDIT CRUNCH that affects millions of people. Celebrities in entertainment can ruin their own lives, and it's terrible, but we can always just turn off our TV's, we can always just change our channels. Greenspan and Weill, today, are frequently being blamed for potentially having a hand in ruining the entire economic system that is the USA. Two guys. People are saying it was obvious...obvious that Citigroup was too big and that they should have known this would happen. It was apparently also obvious that Glass Steagal, had it been kept in place, would have "saved us". And Alan Greenspan...he was in the mortgage business without knowing it, selling all of the ARM's and whatnot. And, Ok, so he recently says that maybe he messed up with regard to derivatives. He was the only one? True, ok, he is the head of the FOMC, so he should be ahead of the rest of all of us. But, he is supposed to instantaneously understand everything that can happen with each new type of investment and security structure, when the top people on the Street, paid millions and millions...couldn't understand them either. They could at the time...but assumptions like normal distributions must have gotten into the models...muddling things up. Oh well....
The biggest thing is think for a second how funny it is. The right move, you claim would have been to raise interest rates sooner, or not put them too low. Ok...I'm sure we'd have all loved Greenspan for that. Or Weill shouldn't have created Citi. Ok...but he did make billions and billions and billions for many shareholders. At the time Citi was awesome. it was the new paradigm. But now we say the smart money would have said not invested. that it would have prohibited the situation. Why didn't it? Or if derivatives were so bad, why did every financial instituation that could write them write as many as possible? Why didn't 1 or 2 players stand back? Why are there no investment banks? Can no one think for themselves? When it's all in vogue, we go all in. Then, when that's not in vogue, we criticize. No one is thinking originally here. You have a few hedge funds who did the right things and bought the write CDS instruments and made out big. But the entire establishment was wrong. It screwed up. I'm sorry, but it just annoys me so much. Greenspan, Weill, they had their faults, they had their problems, but they also had legendary careers. I just think we shouldn't forget that. I know every crisis needs a scapegoat...a singular decision...or a singular reason...that led to everything. And, I feel like I can give it. We're human. All of us. We're not better and we're not worse than those in power making the calls. and if there are billions on the table, we would have taken them too.

Rubbery Tuna

I am a foodie through and through. I have indulged at some of the finest (and some of the not-so finest) restaurants this world has to offer. Regardless of the caliber of restaurant, I enjoy when owners, waiters/waitresses, and someliers exhibit their passion for the dishes in their restaurant. An interesting role in a Japanese restaurant in the role of the sushi chef. They are the embodiment of all that is good in that restaurant. In my head, if a sushi chef doesn't tell me what type of fish I should be trying that evening, educate me on all that's fresh behind the sushi bar, and give me a little taste of something he just created, he isn't worth my time or effort.
There is a restaurant a block away from where I live. Every time I go there, I want it so badly to be good! However, every single time I visit, I leave terribly disappointed. Last Saturday I went on a date with a guy who had done some research on a restaurant to take me to that was in close proximity to where I lived. I was pleased at his effort in researching, so I put a smile on my face and agreed to go (albeit with some reticence). When we sat down, I ordered my typical starter: hamachi, sake, and blue fin sashimi. The combination of these three will typically give you a great look into how fresh the fish is.
Have you ever tasted a piece of rubbery yellowtail? I haven't...and that was the first taste I had that night. It was so off-putting that we couldn't eat any more! Worse still, there were four sushi chef's behind the bar, and a total of 5 customers. The sushi chef assigned to us paid little to no attention to how thinly he cut the fish, gave us no suggestions, and did not take an active interest in our enjoyment (which is what makes the sushi bar experience so worth it). There is nothing like a bad piece of tuna to destroy your appetite. Maybe the moral of the story is to seek out restaurants like this for a great start to your New Year's Resolution to eat small portions?

So, I saw a crazy statistic this weekend at the gym, on CNN. I mean, I was only half paying attention. Hell, I get up at 4:45am, Eastern, every day, to take in first sportscenter...then CNBC. I'm not endorsing CNBC as the best thing out there...not in the slightest. It's more I am in a routine, and I genuinely enjoy some of the regular guests. But, I'm at the gym, and to give myself a break, I have my ipod on, with which I am using my new wireless headphones and watching, of all movies, cruel intentions. It was a 5 dollar special on Itunes...I had a gift card...and like many other americans responsible for knee jerk type reactions and purchases (just on credit, not gift cards...you'd like to think in some cases that some thought they had gift cards...they must have...10x salary for a house in an urban area...seriously?) And, in the movie satisfaction is supposedly derived from some finite amount of happiness. If you think about it, no one is creating happiness. From the first scene, the therapist gets off by over-charging the patient, who then gets off by pulling the wool over her eyes and fucking her daughter. Zero sum game anyone? For one to win, the other must lose. And, it's interesting b/c as this debauchery was playing on my 32 gig ipod (which I know, is like the ultimate in electronic debauchery, who needs 32 gigs of multimedia at their beck and call...right?) I saw out of the corner of my eye warren buffett being quoted on CNN...or interviewed...or whatever...about the national debt. And, I have paid attention to warren buffett...as anyone who even thinks about investing in any way should, and he was expounding on one of his common themes. America's financing of its lifestyle. One word...Debt. In a word, we as a nation are like the weak side of the "emotional trade" and game going on in Cruel Intentions. Please buy our pieces of paper...please....please...please. And please, do be kind enough to keep rolling them over and never "calling it in." We'll do anything...ANYTHING...to make sure that this relationship persists. But, like in the movie, in the end, the weak player becomes the strong, in that the strong tries to grasp power from the weak at the climactic point (the protagonist dies) and, as evil is about to plant itself for the long term, her foundation collapses and she realizes she has never created happiness...nor has she created anything. She has merely traded disfavor. How is it any different? I see Buffett, I see a statistic that the national debt will balloon to something like 54 trillion or 184,000 for every american. Not saying that's a good thing. Not saying that it will do anything to help interest rates or borrowing costs. But, would we not have to see a new world power supplant the USA to really have a threat the foreign powers would call the notes? They haven't created anything of their own if, when our credit markets melt down, global aggregate demand stops on a dime. Where is their domestic demand? China has 1.2 or 1.3 BILLION people. If they call our notes, who would buy their exports? Japan was also supposed to destroy us in the 1980s...right before they more or less lost a decade. So, in the movie it was happiness, and when the protagonist figured out how to create happiness, by looking outside of himself, his death awakened the little "society" of the private school to the larger possibilities of living well. Until countries or regions can find their own economies and their own footing, independent of what happens externally, why should we bask in the empty rhetoric of worrying about our ballooning national debt? I could certainly see benefits in not embarking on such a massive jaunt of fiscal stimulus. The market always knows best. But, there is ideology, and then there is what is politically palatable. How it was specifically done aside, our government had to do what it had to do in terms of injecting money...it's a different point about how it was done...it had to lower interest rates, it had to do something like the tarp, it had to do something like buy the troubled assets, and it had to embark on the quantitative easing. No system would ever be PERFECT, but the fact that it is a system and we have committed to it is a start. Secondly, if not treasuries, what the hell else are other central banks going to buy? Really? In an environment of crisis, where do you want to be? What currency combines the liquidity, the property rights, and the reputation as a safe haven like the dollar? If we're to assume that the USA is to be supplanted anytime soon, just realize one thing. We're making a ton of assumptions on other governments of the world and other societies...many of which have given us no long term reason to do so.