Bank of England Fears Financial Meltdown

The BBC is reporting Banks warned over lending fears.

The Bank of England has warned that banks' fears of a financial meltdown may become a self-fulfilling prophecy. Banks previously over-willing to lend are now too reluctant, even with credit-worthy borrowers, it suggests.

My Comment: The psychology of deflation sets in. Banks are unwilling or unable to lend.

This increased fear of risk has itself undermined confidence in financial institutions and made them reluctant to lend to each other, the Bank adds.

My Comment: This is what happens when banks have a bloated balance sheet and deteriorating assets.

Its financial stability report suggests the credit exposure not declared by UK banks may be near to £100bn. The quarterly report says that there is a "significant increase" in the risk that a major bank collapse or reluctance to lend will disrupt the financial system.

In its quarterly Financial Stability Report, the Bank of England warns that there are potentially large exposures that have still not been declared by financial institutions.

My Comment: That suggests that banks may have insufficient capital to lend whether someone is a good credit risk or not.

However, the Bank points out that the freezing up of markets has meant that these estimated losses may be inflated because of the difficulty of pricing the complex securities which are now very difficult to value.

It says that "credit losses from the turmoil are unlikely ever to rise to levels implied by current market prices unless there is a significant deterioration in fundamentals."

And it estimates that total sub-prime losses could be reduced from $400bn to $200bn once market conditions return to normal.

My Comment: Market conditions may not return to "normal" for decades, if "normal" means anything like we have seen for the past 5 years. Otherwise, normal is likely to be years. Whatever "normal" means, talk of reduced loan losses is fantasy.

The Bank of England judges that there is a risk that "the currently elevated risk premia in some markets will persist".

"This could lead to a self-fulfilling adverse cycle in which persistent market illiquidity and falling asset prices further undermine confidence in banks and results in a sharper tightening of credit conditions."

My Comment: The risk is the BOE and the Fed manages to encourage more foolish lending. The more banks lend now, the bigger the defaults will be later. In a world awash in overcapacity, I fail to see the need for massive amounts of lending.

Lending drying up

The Bank's quarterly survey of credit conditions shows that lenders are tightening up credit sharply not just on home loans, but also on household lending and commercial loans to companies.

And the sources of future loans in wholesale money markets have also contracted sharply.

The market for "asset-backed securities" such as sub-prime and other mortgages has collapsed - with the value of such assets issued going from $700bn a quarter in the middle of 2007 to just $100bn in the first quarter of 2008.

My Comment: Tightening credit is the smart thing to do. Banks that tighten the most will lose the least.

The Bank of England argues that to rebuild financial confidence, it will continue to allow UK banks to swap illiquid assets with safe UK government securities.

My Comment: Swaps accomplish nothing. What is swapped today has to be swapped back later. Except in some make believe pretend world, virtually nothing is accomplished by swapping.

Get Ready To Cry For Argentina Again

Bloomberg is reporting Argentine Bonds Plunge on Mounting Default Concerns.

Argentine bonds show growing speculation that the country will default for the second time this decade as inflation and anti-government protests swell.

The nation's $10.8 billion of floating-rate dollar bonds due in 2012 yielded 7.20 percentage points more than Treasuries of similar maturity at 5:43 p.m. in New York. That implies an almost 20 percent chance of Argentina halting payments in the next two years, according to Credit Suisse Group. No other emerging-market government securities have as high a probability of default.

"Argentina has serious problems," said Igor Arsenin, an emerging-markets strategist at Credit Suisse in New York. "There's a lack of investor confidence. They are concerned lenders won't be willing to extend credit if this continues."

Wheels Fly Off Eurozone Economy

The Telegraph is reporting wheels fly off eurozone economy.

Spain's business federation warned that Spanish unemployment will rise by 500,000 by the summer unless the government takes "valiant measures" to offset the housing and construction crash. "For every dwelling not built, two workers will lose their jobs," said the group's president, Gerardo Diaz Ferran.

My Comment: That qualifies for the clown statement of the day. Is Spain supposed to do keep building houses no one needs just to keep people employed? Then again, perhaps there is a place for talent like that on Bush's team of economic advisers.

The country's credit group ASNEF said the volume of personal loans had dropped 30pc in the first quarter, the worst performance since the country's financial crisis in the early 1990s.

David Owen, an economist at Dresdner Kleinwort, said Europe would soon be engulfed by the twin effects of a "collapse in export volumes" and a slow motion credit squeeze. "The wheels are coming off the eurozone economy," he said.

BNP Paribas warned clients yesterday that the "decoupling story" was no longer credible. "We see Europe in the early stage of a credit crunch, and if we are right credit supply will shut down," it said. Key governors of the European Central Bank began to back away from their hawkish stance of recent weeks, clearly disturbed by the market perception that they are mulling a rate rise to choke off price rises.

France is succumbing to the slowdown. Insee business climate index fell harder than expected in April to 106, from 108 in March.

Eric Chaney, Europe strategist at Morgan Stanley, said the April survey by French corporate treasurers was "alarming", pointing to distress in the financial system. "Let's call a spade a spade, some sort of credit crunch is unfolding in the funding of French companies," he said.

Avalanche Of Redundancies In the UK

The Telegraph is reporting UK job cuts feared in economic slowdown.

Britain could be heading for an "avalanche of redundancies" in the coming months as economic reality finally catches up with the jobs market, a leading expert has warned.

John Philpott, of the Chartered Institute of Personnel and Development, said that the labour market was now close to its peak, and that the rise in unemployment could be more sudden and sharp than in previous economic downturns.

At 5.2pc, the unemployment rate is currently the lowest in many years. The warning comes amid growing fears that, having enjoyed some of its best months on record, the jobs market is set for an imminent deterioration.

He said: "I don't believe the labour market can defy gravity. It would be a miracle if there weren't some softening. We probably have peaked and unemployment will go up a little bit. "The conditions are building for an avalanche - the question is whether there will be a trigger point. I suspect the housing market will hold the key. If you get a bigger shock than people are anticipating that will have a knock-on effect, which could cause jobs to tumble."

The global economy is clearly slowing. Increased bank lending makes little economic sense in this environment, and even less when one considers the precarious capital positions at most banks.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Unstoppable Credit Contraction

Steve Saville wrote an interesting article entitled Credit Contraction, Economic Bust, and Deflation. Inquiring minds will want to take a look.

Saville: Members of the deflation camp assert that the large-scale contraction of credit happening within the banking system means that deflation is upon us, even if the money supply is expanding. At the same time, another camp is pointing to the breathtakingly rapid growth in M3 money supply as evidence that hyperinflation is a near-term threat. In our opinion, both camps are wrong*.

The argument of the first camp can, we think, be summarised as follows: Inflation is an expansion in the total supply of money AND credit, whereas deflation is the opposite (a contraction in the total supply of money AND credit). At the present time the money supply may well be expanding, but this monetary expansion is being more than offset by credit contraction.

Mish: So far so good. That is nearly my exact argument. The only thing I want to add is that credit needs to be marked to market, as opposed to some inflated book value.

Saville: The flaw in the above argument can best be explained via a hypothetical example. Consider the case of Johnny, who wants to borrow $1M to buy a house. If Johnny borrows the money from his friend Freddy then the transaction results in a $1M increase in the amount of credit within the economy, but no inflation has occurred. All that has happened is that $1M of purchasing power has been temporarily transferred from Freddy to Johnny. By the same token, when Johnny pays Freddy back there is a contraction of credit, but no deflation. There is also no deflation even if Johnny defaults on his loan obligation to Freddy. In this case Freddy will have made a bad investment, but the money he lent to Johnny will still be somewhere in the economy. The point is that credit expansion is not inherently inflationary and credit contraction is not inherently deflationary.

Mish: The flaw in Saville's analysis is that I agree with him! The reason is that he is ignoring the word "net". When Johnny loaned his friend $1M, money supply (savings) decreased by $1M but credit expanded by $1M. In Saville's example there was no "net" expansion of money (savings) or credit. As I see it, we are in "violent agreement".

Saville: But what if Johnny, instead of borrowing the million dollars from Freddy, takes out a loan at his local bank and the bank makes the loan by creating new money 'out of thin air'? In this case inflation has certainly occurred. Nobody has had to temporarily forego purchasing power in order for Johnny to gain purchasing power, but the total existing supply of money has been devalued to some extent.

Mish: Bingo! That is inflation. No argument in this corner.

Saville: The critical difference is that when Johnny borrows from a bank the transaction leads to an increase in the supply of MONEY. Inflation is the increase in the supply of money that SOMETIMES results from credit expansion; it is not credit expansion per se.

Mish: In my opinion, the critical difference is that Saville misses the word "net", conveniently looking at credit all the time, while ignoring money supply the rest of the time.

Skipping ahead....

Saville: This leads to the question: is the money supply currently expanding? The answer is yes, but not anywhere near as rapidly as many people think. The chart at http://www.nowandfutures.com/key_stats.html reveals that M3 has grown by a mind-boggling 19.5% over the past 12 months, but as was the case during the early 1990s it appears that this broad measure of money supply is currently giving a 'major league' FALSE signal.

Mish: I 100% agree with the notion that M3 is giving a false signal. That is the very premise behind my post MZM, M3 Show Flight to Safety.

Saville: Our preferred measures of money supply are TMS (True Money Supply) and what we call TMS+ (TMS plus Retail MMFs). TMS and TMS+ currently have year-over-year (YOY) growth rates of around 3% and 6%, respectively. In other words, our assessment is that the current US inflation (money-supply growth) rate is 3-6%. Inflation is still occurring, but at a much slower rate than it was during the early years of this decade.

Mish: I do not agree with adding MMFs to TMS as Saville does. I agree with the formulation of TMS and gave my reasons in Money Supply and Recessions.

Furthermore, and it is hard to say who is right or wrong given massive backward revisions in some Fed reporting and delays in other Fed reporting, but the latest M'/TMS numbers that I come up with (more accurately Bart at Now and Futures on my formulation) are as follows.




click on chart for sharper image

The above chart is as of April 18, 2008 as reported in MZM, M3 Show Flight to Safety.

Presumably it is the same as TMS. If it's not, one or more data series discrepancies may be at play, and given numerous backdated changes by the Fed as well as delays in reporting sweeps, I am not going to assume which series is correct. Close analysis will show near perfect correlation over time.

Finally, and this is key: Saville failed to mark credit to market! It is the marking to market process by which I state that deflation is here and now.

Please see Deflation In A Fiat Regime? and Now Presenting: Deflation! No one has rebutted the arguments presented in those links.

Saville: On a side note, the wrongness of M3's current signal is validated by the happenings in the financial world. Inflation-fueled booms generally continue until there is a deliberated or forced slowdown in the inflation rate, that is, the booms continue until the central bank takes steps to rein-in the inflation or until inflation slows under the weight of market forces.

Mish: I agree. Those looking at MZM are barking up the same incorrect tree.

Saville: It is also worth noting that although inflation is a major driving force behind the commodity bull market, commodity prices are generally still very low in REAL terms. Therefore, while we are anticipating a commodity shakeout over the next few months we think the long-term upward trend in the commodity world has a considerable way to go.

Mish: I fail to see how this fits into the debate. Commodity prices may indeed be very low in real (CPI adjusted) terms. Exactly what does that have to do with credit contraction/expansion other than perhaps propose the next bubble may very well be in commodities? If that is indeed the point, then I agree.

Saville: In conclusion, it is clear that inflation is still occurring in the US (and pretty much everywhere else, for that matter), albeit at a reduced rate. Furthermore, if it hasn't already done so it is likely that the inflation rate will bottom-out over the coming few months and then embark on its next major upward trend. It is possible that consumers are 'tapped out' and that the commercial banks are about to reduce the rate at which they lend, but the government will never be 'tapped out' and the central bank will always be able to monetise debt.

Mish: In conclusion, I do not see evidence supporting Saville's conclusion!

I feel he's failed to mark credit to market, to state why credit will not contract greater than central banks' attempt to inflate, to account for global wage arbitrage, walk-aways, boomer retirement and a shift away from consumption, $500 trillion of derivatives that can never be paid back and a secular shift from consumption to saving.

I see no explanation of how consumers and businesses are going to pay back debts in a world of declining real wages, wealth concentration at the extreme high end of the spectrum, global wage arbitrage, declining home prices, rising unemployment, overcapacity at every corner, and insane overbuilding of both commercial and residential real estate.

On the other hand, my thesis is simple: The Fed can address liquidity issues not solvency issues, and we are facing a solvency issue. And because of the enormous amount of debt in relation to the pool of real savings, there is no way that debt can be paid back. Debt that cannot be paid back will be defaulted on.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Proposed Fascist Powers For The Fed

The Financial Times is reporting Treasury eyes stronger powers for Fed.

The Federal Reserve could use proposed new regulatory powers to try to stop credit and asset market excesses from reaching the point where they threaten economic stability, the US Treasury said on Tuesday.

David Nason, assistant secretary for financial institutions, said the Fed could even use its proposed “macro-prudential” authority to order banks, hedge funds and other entities to curtail strategies that put financial stability at risk.

By “leaning against the wind” in this way, the US central bank could “attempt to prevent broad economic dislocations caused by potential excesses”, he said.

The proposed new powers – outlined in a Treasury blueprint published last month – require legislation and may never be authorised. But policymakers see the plan as offering a template for future regulation.

The blueprint envisages giving the Fed roving authority to collect, analyse and publish market data from a wide range of institutions, from banks to hedge funds.

“The market stability regulator must have access to detailed information about all types of financial institutions,” said Mr Nason.

Hedge funds are uneasy about this proposal. However, many European central bankers are eager to acquire the kind of macro-prudential powers the Treasury would like to give to the Fed.

Free Market In Jeopardy

Mr Practical is concerned about a Free Market In Jeopardy.

Do not underestimate the dark power of this legislation and do not listen to the innocuous presentation by government officials.

The proposal essentially would grant vast authority to the Federal Reserve and the government to virtually control markets. It will give them the ability to gather private market information and unilaterally decide if positions taken with that private money for private investment is somehow negative for the financial system. It could then force the unwinding of those positions. Initially the powers will be used to supposedly prevent over leverage in the system (that the Fed created itself). But it doesn't exclude the situation where a hedge fund that is long puts can be forced to unwind those puts at the government's discretion.

The Federal Reserve and the treasury are very clever in blaming free markets for the mess we're in to garner more power. Ironically it's government intervention in markets that has caused the problem in the first place. Through their policies creating negative real interest rates for years, speculative forces in the economy have been able to create vast amounts of debt.

If we continue to bend to government, we will eventually get what we deserve, fascism. Not the Hitler kind of fascism, but simply the government existing and growing for the sake of the government and not the people. This will result in even more massive mis-allocation of capital and stagnation. It will result in slower technological development and a much lower standard of living for our children.

A Disgusted Mr. P

Fed Uncertainty Principle Strikes Again

Fed Uncertainty Principle Corollary Number Two: The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.

The Fed has blown bubble after bubble with their economic policy. Instead of removing the Fed, we are seeing new fascist proposals.

The only market stability regulator that is needed is called gold. It's no wonder credit exploded after Nixon closed the gold window. A gold standard in conjunction with the elimination of the Fed, elimination of fractional reserve lending, and balanced budgets out of Congress is what it takes to cure the problem, not increased fascist powers by those who created the mess.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Nonstop Entertainment Analyzing Citigroup

Surprise! Surprise! Surprise! Citigroup is back raising capital. I went to call this post Ponzi Financing at Citigroup, but alas that title was already taken. I am running out of titles for Citigroup. Seriously, I am going to write this post, then figure out the title. So when you see the title, realize it was formulated at the end.

CNN Money is reporting Citigroup To Sell $3 Billion In Stock To Boost Capital.

Citigroup Inc. (C) is going back to the markets for more funds, less than two weeks after reporting nearly $14 billion in write- downs and a week after selling $6 billion in preferred stock.

Unlike the sale of preferred stock, Citigroup's sale of common stock will further dilute its shareholders. Ratings agencies, however, give more credit to common equity and don't like to see too much preferred in banks' capital structures.

"We are issuing common equity at this time as we continue to optimize our capital structure," Gary Crittenden, Citigroup's chief financial officer, said in a release.

Mish Translation: We have filled up our preferred bucket and this is where it gets nasty for us and anyone silly enough to buy our stock at these prices.

Citigroup has already raised more than $36 billion in fresh capital by selling stakes to long-term investors like sovereign wealth funds and by issuing preferred stock. The bank has done so to plug the hole opened by more than $35 billion in write-downs to reflect losses on complicated securities backed by mortgages, high-risk loans like those made to fund LBOs and other damage related to the credit crisis.

Citigroup could sell more than the $3 billion in common stock if markets have the appetite.

"We're pleased with the strong interest we have already received regarding this issuance," Crittenden said in a release.

My Comment: Of course Crittenden is pleased. He is raising capital at cheap prices. As long as there is a pool of greater fools, he ought to try and raise $20 billion. Sad to say, I doubt $20 billion will be anywhere close to enough.

"Given market fundamentals, it's a very opportunistic time to issue," Matt Eagan, vice president and portfolio manager at Loomis, Sayles & Co. in Boston, said Tuesday.

My Comment: Fundamentals? The fundamentals are horrid. What's not horrid is sentiment and most think the bottom is in. I don't. Nonetheless, Eagan has this correct: "It's a very opportunistic time to issue". Indeed it is, because the bottom is in crowd just can't get enough of this garbage right now. Perhaps that is what Eagan meant.

Titles Taken

• Shell Games at First Horizon, HBOS, Citigroup, Merrill
• Citigroup, RBS, Barclays, others, Short of Capital
• Need For Capital At Merrill Lynch, Citigroup, RBS
• Digging Into Citigroup's Numbers
• Ponzi Financing At Citigroup
• Less Than Meets The Eye at Citigroup, Goldman
• Dear Citigroup Customer ....
• Is Citigroup's Dividend Safe?
• Citigroup Freezes HELOCs
• Citigroup VIEs Raise Question Of Solvency
• Abu Dhabi Deal Raises Questions About Citigroup's Health
• Cost of Capital "Ratchets Up" at Citigroup and Merrill
• Analyst Meredith Whitney Asks Banks "Where's Waldo?"
• Citigroup's Strange New Definition Of "High Risk"
• Citigroup's Cannibalization Policy
• More Writedowns Force Citigroup To Sell Assets
• Question of Solvency at Citigroup
• Chuck Prince Resigns : Replaced by a Parrot
• Enron Accounting at Citigroup
• Super SIVs - A Fraudulent Attempt at Concealment

And kicking it off back on July 10,2007 was Quotes of the Day / Top Call

Chuck Prince - Citigroup Ceo

No End Soon to Buyout Boom: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing".

Mish reply.

If ever there was market arrogance, the statements by Chuck Prince says it all. ...
It's tough calling a top but I am going to try. I suggest the current trend is exhausted.

Citigroup Weekly Chart



click on chart for sharper image

To be fair my "top call" was for the S&P not Citigroup. The S&P made a marginal new high by 20-30 SPX points (about 2%+- for which I received many taunts) in October. There may be one more blast higher, but this rally looks about over.

A Word Of Thanks To Citigroup

I do want to thank Citigroup and Chuck Prince's arrogance for calling the exact top in Citigroup and damn near doing it for the entire index as well. In addition, I want to thank Citigroup for providing plenty of entertainment since June of 2007, continuing even after Prince danced out the door. And with that idea in place, I formulated the title of this post. Typically I start with some sort of title in mind.

Citigroup (C), Ambac (ABK), and Countrywide Financial (CFC) have been standouts in providing entertainment. However, Ambac will soon be worthless, and Countrywide will be taken over by Bank of America (BAC). So Citigroup will have to carry the entertainment torch single handedly. All indications are that Citigroup will be up to the task.

One thing is nearly certain. The bottom in Citigroup is unlikely to occur as long as it foolishly clings to a dividend it cannot afford.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Case-Shiller Shows Steep Declines In Home Prices

The February S&P/Case-Shiller Home Price Indices are now out. The index shows declines in the prices of existing single family homes across the United States worsened in the second month of the new year, with 17 of the 20 now reporting MSAs posting record low annual declines, 10 of which are in double-digits.

The following chart was produced by "TC" who has been monitoring C.A.R. data, DQNews data, and Case-Shiller Data. Although individual cities topped at varying times, the top-10 and top-20 cities peaked in a June-July 2006 timeframe.

Let's take a look.



click on chart for sharper image

"TC" writes: I've included data available from the CME Futures market so your viewers can see when people are betting the downturn will end and how much lower it will go. The CME Futures market only trades the top 10 cities.

One interesting "transition" since I last checked the Futures quotes (I do so monthly upon the release of the Case-Shiller data) is that West Coast markets are now predicted to decline further than previously forecast, yet bottom sooner. That seems rather odd to me and it may be because the Real Estate Futures Market is so thinly traded that its forecasting ability is limited.

Inquiring minds will also want to take a look at commentary from Calculated Risk on Case-Shiller: Year-over-year Price Changes.



click on chart for larger view

Calculated Risk discussed the discrepency between Case-Shiller and the OFHEO (Office of Federal Housing Enterprise Oversight) in House Prices: Comparing OFHEO vs. Case-Shiller and House Price Indices.

Following is a sip from the first link above.

This suggests that one of main differences between OFHEO and Case-Shiller was that Case-Shiller included many non-agency homes financed with subprime loans. These homes saw more appreciation during the boom, and are now seeing larger price declines.

Whatever the reasons, the Case-Shiller index seems to more accurately reflect the current price declines in the housing market, as opposed to the OFHEO index. And this has significant implications for the economy.

The Fed uses the OFHEO index to calculate the changes in household real estate assets. If the OFHEO index understated appreciation during the boom that means households have MORE real estate assets, and more equity, than the current Flow of Funds report suggests.

That sounds like good news, but ... that also means that during the housing boom, the wealth effect was larger, and the impact on GDP greater, than current estimates. This also means - if OFHEO understated appreciation - that the negative wealth effect, and the drag on GDP, will be probably be greater than expected during the housing bust.

Leave it to the government and the Fed to cause the housing bubble, to totally screw up measurement of the housing bubble, and to screw up the measurement of the housing bust as well. It's a perfect track record of incompetence.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Shell Games at First Horizon, HBOS, Citigroup, Merrill

MarketWatch is reporting First Horizon to sell $600 million in stock, change dividend.

Tennessee bank First Horizon National Corp.(FHN) announced plans to sell up to $600 million in common stock and change its dividend payments to stock, showing even smaller financial firms are going to the capital-raising well and taking other moves to preserve capital.

The company gave no reason in a statement for the stock sale, which will give underwriting the option to sell an additional 15%. First Horizon on Friday filed with the Securities and Exchange Commission to sell an undisclosed amount of mixed securities from time to time; the stock fell 7.9% to $10.75. There was no premarket trading Monday.

In addition, First Horizon will stop distributing cash dividends after the dividend payable July 1. Instead, payments will be made with 20 cents a share in First Horizon stock, matching the cash rate.

First Horizon was among the banks eager to expand in recent years. In the mid-1990s, it began buying mortgage companies around the country. A few years ago, First Horizon decided its mortgage customers may also be interested in other services. In markets including Atlanta, Baltimore and Dallas, it started turning its mortgage offices into retail-banking branches, according to analysts and a company statements.

By last summer, as more homeowners around the country began having trouble repaying their mortgages, the bank retrenched. It set plans to sell the nearly three dozen new branches and focused again on its 200 or so locations in Tennessee. First Horizon is also scaling back its mortgage business, shuttering offices and laying off workers. Earlier this year, the bank announced it would discontinue its national home-building and commercial real-estate lending programs, and would focus on Tennessee and the Southeast.

Struggling To Survive

First Horizon is struggling to survive. It is also playing shell games that is going to cost it money. Stock dividends are tantamount to no dividends. The effect is the same as a stock split, and splits are clearly not dividends. It's even worse than meets the eyes.

Aroma Of Stock Dividends

Minyan Peter, ex-treasurer for a large US bank offered his opinions on non-cash dividends and hybrid preferreds this morning. Let's tune in.

A Few Morning Thoughts

First Horizon (FHN) and HBOS, as part of their capital raising announcements, have both indicated that they, for the foreseeable future, are switching from cash dividends to stock dividends. Unless these banks intend to repurchase an equivalent amount of stock from the open market and send it back out to shareholders as a dividend (which I highly, highly doubt), experience suggests these stock dividends represent nothing more than a fractional stock split. (Do the math.)

Further, these seemingly innocent dividends require a massive amount of work for the companies' accounting teams who must now go back and restate all prior year data to reflect the new share count. Net-stock dividends are nothing more than aroma.

Having been asked to comment on all of the "Hybrid" equity coming out of the banks and investments of late, I'll just offer that like corn based Ethanol, I believe that these securities will be of limited long run benefit. Substantially all banks need to stop paying cash dividends and issue more common stock.

These 8%+ preferreds, while currently celebrated, will be unsupportable by future earnings.

Hybrid Preferred Shell Game

I spoke about Hybrid Bonds in Need For Capital At Merrill Lynch, Citigroup, RBS.

Citigroup is another bank playing expensive games to keep its dividend intact. It makes no economic sense to borrow money at 8.4% to pay a dividend yielding 5%. The aroma of that deal stinks as well.

Things are so screwed up at Merrill Lynch, that it cannot even count as tier 1 capital the amount of money it is raising via hybrid preferreds because credit-rating companies typically don't allow more than 25 percent of a bank's capital base to be made up of preferred stock, and Merrill is well over that limit. I talked about Merrill Lynch's actions in Are Low Interest Rates Fueling Price Inflation?

HBOS Capital Raising Efforts

MarketWatch is writing HBOS may raise some $8 billion from shareholders.

HBOS, the U.K.'s biggest mortgage lender, may ask shareholders for as much as 4 billion pounds ($7.9 billion) at its annual meeting Tuesday to balance write-downs and strengthen its balance sheet as the economy slows, according to media reports.

If it goes ahead with the plans, HBOS would become the second major U.K. bank to require a so-called rights issue this month, on the heels of Royal Bank of Scotland (RBS) saying it would seek another 12 billion pounds last Tuesday.

HBOS is also likely to take further write-downs of about 3 billion pounds on its exposure to U.S. mortgages, the newspapers reported.

Analysts at Lehman Brothers said in a note to clients Monday that HBOS would need to raise some 3.2 billion pounds before any write-downs in order to increase its Tier 1 capital -- a key measure of financial strength -- to the 6% level that RBS is targeting.

The bank's capital ratio could also come under further pressure later in the year if U.K. house prices continue to fall. The latest data from Halifax's own closely watched index of house prices showed a 2.5% fall in prices during March, and the bank is forecasting low-single digit declines for the year.

Numis Securities analyst James Hamilton, however, contends a rights issue isn't the best course of action for HBOS, saying it would destroy shareholder value.

It's time for these shell games to end. Citigroup is going to have to eliminate its dividend because it cannot afford to pay it. Non-cash dividends at First Horizon are a farce, and Merrill Lynch acts as if it is raising capita when it can't even count it because it is already loaded to the gills with preferred issuance.

Ironically, some think the bottom is in. The bottom cannot be in when corporations are playing these kind of shell games and the deals are getting done. The bottom will be when these kind of deals can't get done.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Property Taxes Bite Vancouver Store Owners

CBCNews is reporting Vancouver residential property tax up 3 per cent in 2008.

Vancouver city council approved a one per cent property tax increase for 2008 on Tuesday evening, but homeowners will pay a three percent increase following a tax redistribution from businesses to homeowners.

Opposition councillors were quick to point out the tax increase for 2009 could be much higher.

Vision Vancouver Coun. Raymond Louie said last year's municipal strike saved the city millions of dollars, and the full cost of expanding Vancouver's police force won't be felt until next year.

"We're talking about potentially an 11 per cent tax increase right out of the gates [in 2009]," said Louie.

This year's modest one per cent overall tax increase is part of the governing Non-Partisan Association's campaign to get re-elected in November, while keeping the bigger increase for 2009, said Louie.

Some of the comments are pretty funny. Here is one from Sandy who writes:

Let's not forget the additional windfall they get from the inflated property values in Vancouver, where a dump of a house which should be worth $300,000 has an assessed value of $1,500,000 (but where the homeowner's income hasn't gone up by a factor of five to match). Throw in the savings from the strike last year, and it's another City of Vancouver rip-off.

If this "moderate" tax increase is supposed to encourage us to vote for the NPA, I don't think it will work. However, people in Vancouver will believe anything and vote for anyone - like the gullible idiots who obediently "backed the bid" when our corporate masters bought that fake Olympic referendum a few years back. Truly, anything is possible in the Most Liveable City on Earth.

Olympic Casualty

Matt pinged me with this email about a casualty of the 2010 Olympics.

Hi Mish,

Thought I'd pass on this new little juicy tidbit of info from Vancouver, BC.

I was just in Rona, which the big competition for Home Depot here in Canada. This is a brand new store in a brand new commercial development that opened in late 2005, and is now closing at the end of June. Why? Because property taxes have skyrocketed over four hundred percent. Yes that's right over 400%! Why so much of an increase? To pay for the brand new Olympic Speed Skating Oval less than a mile down the road!

After talking to a few of the employees, who were concerned about where they were going to be working, some told me that there are more stores closing in the area due to the increase in tax as well.

Oh well, I guess the City of Richmond can just increase taxes on the remaining businesses again to make up for the shortfall.

Anyways here's a link to their Grand Opening Flyer:

Oh yeah, and perhaps the most ironic thing is, they are a "Proud Sponsor of the 2010 Olympic Games!" See page 4 in the above link. I wonder if they are still proud 2 1/2 years later?

Matt
Vancouver, BC

Forced Out By Property Taxes

With that tip from Matt it did not take long to find this article: Rona store owner Forced out by the Olympics.

Two years ago Mack Foster faced a huge decision. His 20-year lease on the building of his Rona store at 7111 Elmbridge Way was about to expire.

He could shut down his longtime business, move to a new Rona store in Bridgeport or renew his lease. He encouraged his two sons to take greater control of the business and to give it stability, he signed a new 10-year lease for what he believed to be a superior location.

“Let me tell you, if I had forward sight, if I had realized this, I would have never re-signed my lease,” said Foster, 64. Like dozens of other businesses in a light industrial zone near the oval, Foster is facing massive property tax hikes resulting from skyrocketing real estate values.

As a leaseholder and not a landowner, Foster is on the hook for rising property taxes each year and will never see a benefit in the rising price of real estate. And with a lease that’s locked until 2015, he’s stuck between “a rock and a hard place.”

Last year, his tax increase was $29,951, but this year, the increase is $207,029. Foster is trying to stay positive and cut expenses wherever he can to stay in business.

“It’s almost so bad there has to be a solution. No business can sustain this kind of situation,” he said. “Some of the businesses will disappear this year, some will disappear next year. But all of them will disappear in three years.”

Michael Bailey, owner of Lang’s Glass at 5871 Minoru Blvd., said he’s expecting his tax bill to inflate from approximately $8,000 to $24,000 this year.

Roy Van Hest owns the Art Knapp Plantland on Minoru Boulevard at Alderbridge Way with his family. When his store opened in 2005, his tax bill was $59,625. He estimates his 2008 bill will be $269,070.

“There’s no way that we can stomach it. Basically my taxes will be 400 per cent greater than they were three years ago.”

Robert McCullough, senior property manager for properties in the area owned by Richmond Holdings Ltd., said it’s not unusual to see 100 to 200 per cent increases in taxes this year. McCullough predicts the neighbourhood will become “an empty industrial ghetto” before 2010 on the doorstep to the Olympic oval, made worse by criminals arriving by Canada Line.

Fallout from the Olympic crash is going to be enormous and it's starting already. What an incredible waste of money for a onetime event. Legitimate businesses and taxpayers are getting the shaft, while concessionaires selling corn dogs, trinkets and other Olympic junk will likely make out like bandits.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Buffett: Recession Longer, Deeper Than Most Think

Warren Buffet expects Recession Longer, Deeper Than Most Think.

Warren Buffett, the world's richest person, said Monday that the U.S. economy is in a recession that will be more severe than most people expect. "This is not a field of specialty for me, but my general feeling is that the recession will be longer and deeper than most people think," Buffett said. "This will not be short and shallow.

"I think consumers are feeling gas and food prices," he added, "and not feeling they've got a lot of money for other things."

I agree with Buffett and made the Case for an "L" Shaped Recession on April 8th.

What Morgan Stanley thinks depends on who you talk to. Morgan Stanley analysts see things much differently than John Mack, Morgan Stanley's CEO. Please consider Morgan Stanley analysts see big bank woes just beginning.

Morgan Stanley (MS) analysts on Monday told clients to "sell the rally" in financial stocks, slashing forecasts for big bank earnings and warning that the current credit crunch is only just beginning.

In aggregate, Morgan Stanley reduced its estimates for 2008 large bank earnings by $17 billion, or 26 percent, and reduced 2009 forecasts by $13 billion, or 15 percent. The analysts expect higher loan losses and expenses, offset by higher net interest income, though profits could fall further still if the Federal Reserve stops lowering interest rates.

"More capital hikes and dividend cuts (are) coming as our credit deteriorates and forward earnings decline," analysts led by Betsy Graseck wrote in a report. "We think we are only in the third inning of the credit cycle and expect this credit cycle will be worse than (the slump in) 1990-91."

Flashback April 8, 2008

Morgan Stanley's Mack Expects Credit Crisis to Last A Couple of Quarters Longer.

The collapse of the subprime market in the U.S. has reached its eighth inning or "maybe top of the ninth," Mack said today before the company's annual meeting, referring to the final period of a baseball game. Europe is in the sixth inning and the market for securities backed by commercial mortgages is "probably in the fifth," he said.

My Comment: I doubt the subprime mess is in the 9th inning but it is well established. However, the Alt-A crisis, the commercial real estate crisis, the prime loan crisis, and the credit card crisis are only just beginning. Happy days are not just around the corner.

Former Federal Reserve Chairman Alan Greenspan, speaking in Tokyo today, said the drop in U.S. home prices will probably end "well before" early next year as the number of houses on the market diminishes, aiding an economic rebound.

"It will not be until early 2009 that we will get close to having eliminated most of this home inventory", Greenspan said at a conference sponsored by Deutsche Bank AG and co-hosted by Bloomberg LP. "But it is very likely that home prices will stabilize well before that."

My Comment: Anyone who thinks home inventory will be worked off by early 2009 is either delusional or reporting from another planet.

Economic Outlook

• Buffett is calling for a severe recession.
• Morgan Stanley analysts call for more capital raising and dividend cuts.
  
• Morgan Stanley CEO John Mack thinks the subprime crisis is in the 8th or 9th inning and commercial mortgages are in the 5th inning.
• Greenspan says the inventory of homes will be worked off by early 2009 and home prices will rebound in advance.

The top two opinions coincide with mine.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Stimulus Checks Already Spent

The Financial Times is reporting Waiting game begins on US tax rebates.

The first of more than $110bn in tax rebates for US households start arriving on Monday, amid a vigorous debate as to how big an impact this emergency stimulus – and accompanying investment incentives – will have on the US economy.

Some analysts, including Macroeconomic Advisers and Goldman Sachs, believe it could deliver as much as a 2 percentage-point boost to annualised growth in the quarter in which it kicks in.

Others believe that the effect will be much smaller. Bank of America sees a growth boost of a bit under 1 percentage point, Merrill Lynch as little as 0.5 of a percentage point.

Hank Paulson, Treasury secretary, now says that $50bn will be distributed by the end of May, with the first payments sent by electronic transfer this week.

This means the effect may first be seen in May and June retail sales. Some analysts believe the impact will be primarily on second- and third-quarter growth, others on third- and fourth-quarter growth.

The Congressional Budget Office admits that there is “some uncertainty about the rebate’s effect”.

Studies of the 1975 rebate suggest that only about 12-24 per cent of the package was spent in the quarter in which it was received. However, analysis of the 2001 tax rebate suggests that 20-40 per cent was spent in the first quarter it was received, and about two-thirds over two quarters.

In one crucial respect the 2001 and 2008 rebates are fundamentally different. The 2001 rebate was a downpayment on a permanent tax cut; the 2008 rebate is not. This suggests it may have a considerably smaller impact on spending.

Whatever the size of the boost to spending, the effect will be temporary – six months at most – and there will be a negative effect on reported growth when it fades.

Maths mistakes

Many top Wall Street groups are underestimating the short-term impact of the tax rebates on growth by a factor of four, owing to a maths mistake.

To understand why, consider the effect of a $20bn boost to spending on the annualised growth rate of the quarter in which it takes place.

Most analysts did their sums like this: $20bn annualised is about $80bn. That is 0.8 per cent of annual consumption. Since consumption constitutes about 70 per cent of gross domestic product, that equates to slightly less than a 0.6 per cent boost to annualised GDP growth in the quarter.

But the Bureau of Economic Analysis - which compiles the GDP series - says the maths here are wrong.

The correct way to do the sum is as follows: the level of consumption goes up by $20bn or 0.8 per cent in the quarter. But you then have to annualise this increase to get an annualised growth rate, which works out at 3.2 per cent.

Since consumption constitutes about 70 per cent of GDP that equates to about 2.2 per cent extra growth - a four times bigger boost to annualised growth in that quarter than the incorrect approach suggested.

Of course, the actual extra amount spent in the quarter remains the same - $20bn - only the reported growth rates are different.

Rebate Check Is In The Mail

Professor Kevin Depew was talking about the above article in point number one and two of Today's Five Things. Inquiring minds may wish to take a look. I will add to his thoughts with a suggestion that the money is already spent.

Money Already Spent

Those looking for a big pickup in spending in the third quarter due to stimulus checks need to think again. A Poll shows most Americans will use stimulus check to pay bills.

Nearly 70 percent of taxpayers receiving a rebate plan to use it to pay bills or buy necessities, according to Jason Bloch, a Boston-based district manager in training for H&R Block, the tax-preparation service.

Breaking down the numbers, 45 percent of the respondents indicated they would use the rebate to pay bills; 21 percent plan to spend it on a necessity, such as groceries or car repairs; 18 percent said they would invest the money; and only 16 percent planned to splurge on luxury items, jewelry, electronics or a vacation.

“The survey feedback clearly indicates that American taxpayers are counting on their rebates and refunds to help make ends meet this year,” said Bloch. “It’s important for Americans to remember that the only way to receive a rebate is to file a tax return this year.”

Interestingly enough, more than 40 percent of the respondents indicated they would prefer the government use the money from the $168 billion economic stimulus program elsewhere, such as reducing the national debt (37 percent), improving health care services (32 percent), shoring up Social Security (17 percent), or improving education (15 percent).

Assuming the numbers are reasonably close, 45% are going to pay down existing debt. Clearly that is money already spent. Another 21% are going to spend it on stuff they were going to buy anyway.

For the sake of argument, let's assume the remaining 34% are going to spend it all even though 18% said they would "save it". The question now is how big a blip one would expect to see from that in the third and fourth quarter. The answer is not much.

Some of those willing to spend have already gone out and purchased a new flat panel TV or whatever in anticipation. It's easy to find 0% interest offers for big ticket items, so the gotta-have-it-now crowd is happily chirping "Why Wait?" That leaves the 18% who claim they will save it. However, let's assume they will spend it anyway, sometime in the third or fourth quarter.

Before we go too far with this idea, remember that $50 billion will be sent out in May and much of that increase in spending will occur in the second quarter rather than the third or fourth. This means whatever stimulus effect there is will be spread out over three quarters not one.

And none of these economists seem to have factored in the fact that stores are reducing prices by 10% or more trying to win a chunk of those checks. I talked about this idea in No Stimulus From Stimulus Checks.

"Certainly it does seem like retailers are planning for a battle on where to spend that check," said Chris Donnelly, a partner in the retail practice at consulting group Accenture. "We're going to see a lot of competition from a promotional standpoint among retailers really trying to lay claim to that."

Sears, Kroger, Pizza Hut, Wal-Mart, and even Home Depot are offering deals to win the hearts and minds of consumers. And it won't just be stimulus check shoppers that pick up those savings.

Let's piece this story together assuming 34% of this stimulus plan will actually result in future sales. 34% of $110 billion is $37.4 billion. Let's assume that is spread out equally at say $12.5 billion per quarter. Now that needs to be reduced by lower sales prices offered by all the stores competing for those checks.

And if the 18% who said they would save it really do save it, the increase in spending will only be $5.9 billion per quarter not $12.5 billion, and again that is before factoring in the effect of competition for those sales.

Factor In Jobs

Over the last three months payroll employment has declined by 232,000 (see Unemployment Soars, Jobs Collapse). I am looking for another grim set of numbers for April. In fact, I am looking for a grim set of job numbers for the rest of the year although there could be a surprise somewhere along the line.

Those 232,000 people will all be spending less whether they want to or not. And pretty soon 232,000 is going to be 500,000. And the reduction in spending stemming from that will be month in and month out vs. a one time stimulus from these rebate checks.

Rising unemployment and consumer attitude changes towards debt are going to make mincemeat out of theories that GDP is going to soar in the third quarter.

Addendum

Aaron Krowne at the Bank Implode-O-Meter just pinged me with ...

Extending your point that retailers are lowering prices to attract "stimulus check spending" it's important to remember that price drops don't just reduce the $6-12 billion additional likely to be spent each quarter, they reduce total sales and hence consumer spending because all prices are affected.

For example a 1% drop in prices, all other things equal, would cause sales to plummet by about $25B for each quarter. That is more than enough to wipe out even generous estimates of the quarterly impact of the stimulus.

-Aaron


Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Minyan Mailbag: The Fed, Inflation and Aesop's Fables

I recently received an interesting email from Michelle who is frustrated by a Fed that is punishing ants in favor of grasshoppers. If you are not aware of this fable please consider The Ant and the Grasshopper by Aesop.

Let's now listen to what Minyan Michelle has to say.

Dear Professor:

I had the good fortune to be raised by a father who graduated from high school during the Depression and passed his wisdom on to me.

My father always told me that there were two ways to make money--work and save. Already you can already tell I'm out of touch with most Americans. That said, I keep reading articles and listening to programs on economics in hope of better educating myself on where to put my money.

Frankly, I'm worried, and here's why:

When I spoke to three women older than myself on 'The Ant and the Grasshopper' while waiting in line at the grocery store, they'd never heard of that fable. I then attempted to use the Biblical reference of the story of Joseph storing up goods in years of plenty to be prepared for famine with the same results.

Now we have a government rushing in to bail out banks who showed poor judgment deciding every citizen 'deserved' a $500,000 house when they had an income of $30,000 and never saved a dime. I was instructed by my father to look at a house as a place to live, not as an investment or a place that would always rise in value.

I'm still not sure Wall Street or our government gets our current situation. We are paying for years of "I want it" rather than "I need it." We are paying for a lack of education on credit. Consider my dad's adage of: "If you have to charge a stove which will far outlast your payment in the long run then you do so paying off more than your payment as fast as you are able. You never charge clothes, meals, holiday gifts, etc. as that would mean you were running a tab on non-essentials."

I wish I felt hopeful about the current status of our nation's money supply. Heaven knows I've tried to save as much as possible, but I wish I'd done even more. My husband received 2 days notice before losing his job and found out his company had not paid our hospitalization for over 90 days. This left us unable to buy insurance covering preexisting conditions as you only have 60 days to do so by law.

Luckily, we found a decent human being who 'allowed' us to pay ALL our back insurance (over five thousand dollars) so we could then pay close to a thousand dollars a month to have hospitalization for the nine months he was out of work. Had I not listened to my father and saved, we would have been up the proverbial creek.

Losing a job at age 60 leaves you with few open doors.

While I have some money in the market and am suffering along with the rest of the country, I'm not as exposed as some as my father always believed that if you bought treasury notes you could use the interest to help supplement your income without touching the principle. Course, that was before the dollar slid and I began receiving such great interest as one and three quarter per cent. With no pension, however, I can't afford to gamble in Vegas or Wall Street.

I have to admit that right now I'm one grumpy ant. I missed the party. I never charged up my credit cards to play. My husband and I pay our bills, pay the IRS, and owe no one. He's now reduced to working at a retail home improvement store and limping home at night happy that he even found a job.

The government is burning me to save all the grasshoppers. They continue to print money to satisfy the air-blowing braggarts in Washington who pass inflated programs to satisfy this cry-baby generation who 'want it all.' This group will walk away from their McMansions and cry into their coach handbags blaming everyone but themselves and I will have to pay for them.

What we need in this country is accountability and responsibility for Wall Street and Main Street. I doubt we'll get it because we'd have to grow up and accept that we made this mess and it 'd going to be painful getting out of it.

Good luck trying to keep posting about these ideas within your articles. I, for one, enjoy reading them. I fear, however, that the grasshoppers you are attempting to reach won't or don't want to hear from you.

Regards,

Michele an old crone in South Jersey...home of high taxes and a state that has practiced the "I want it now" mentality for years.

Dear "Ant" Michelle

I know of what you speak. And the problem is the Fed. I truly wish Bernanke could read your email. Maybe it would matter, but most likely not. You see Bernanke has a stated desire for "inflation targeting". In other words, Bernanke has a stated positive rate of "price" inflation.

I have to state "price" inflation for two reasons.

1) Inflation is not about prices. Inflation is about expansion of money supply and credit. The fed does not want anyone to know what inflation really is, as that allows the Fed to talk about capacity utilization, jobs, productivity, the CPI and a whole bunch of other nonsense instead of the one thing that matters: expansion of money supply and credit. For more on this please read Inflation: What the heck is it?

2) Inflation benefits those with first access to money (credit). In other words, inflation benefits the banks and the wealthy. Is it any wonder that bonuses at Merrill Lynch, Goldman Sachs, Lehman, Citigroup, and even Countrywide Financial soared as the credit bubble inflated in its last stages to suck in those who had no business buying a house but ended up buying them anyway? That bonus money was extracted even though the profits were a mirage. Mozillo, CEO of Countrywide Financial actually managed to execute $1 billion (yes that is billion) in stock options over the years. Were it not for a bailout by Bank of America, shares of Countrywide would be worthless. What a racket!

Positive Inflation Is Positively Theft

Bernanke has a stated goal of theft. He disguises theft under a policy of favoring a 2% rate of inflation. Two percent sounds innocuous until you chart it out.

Inflation Targeting at 2% a Year



click on chart for sharper image.

The above chart was discussed in Fallacy of Inflation Targeting.

Making matters far worse is the Fed's reaction to prices. The Fed ignored huge asset bubble in the dot com era, then again in the housing bubble. You see, asset prices do not factor into the CPI at all, and therefore into anything the Fed openly talks about.

Houses soaring from $200,000 to $600,000 was not any part of their CPI calculation. Nor was the Nasdaq soaring to over 5000, a number that is still miles above.

I feel the Fed conveniently ignores what it wants to ignore while discussing total nonsense like productive capacity. And if that was not bad enough, the Fed has stripped out the only things that can be measured with any degree of accuracy (food and energy prices), while concentrating on "core inflation" which in my opinion is so manipulated by hedonics that it defies all reality.

So now, as a result of past (yes, past) inflationary policies, the asymmetrical policies of the Fed are in the spotlight. Those policies are to ignore bubbles but deal with the aftermath.

The aftermath is not a pretty picture. The housing bubble was the bubble of last resort. There are no more bubbles to inflate except perhaps food, energy, and gold, and those are the last bubbles the Fed wants to ignite.

The Ants Win

Michelle, do not regret your decision to be an ant. Instead, be thankful that you were not one of the last minute grasshoppers now about to be foreclosed on. Because the Fed cannot reignite that housing bubble, millions will lose their home. You have your house, your husband (for better or for worse), and most importantly your sanity.

Good luck to you Minyan "Ant". You deserve it.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Are Low Interest Rates Fueling Price Inflation?

Citigroup, Merrill Lynch, and Bank of America kicked off a Record Week of Bond Offerings.

Citigroup Inc. and Merrill Lynch & Co. led $45.3 billion of U.S. corporate bond offerings, the busiest week on record, as financial companies sold debt at the highest yields since April 2001.

Citigroup, the biggest U.S. bank by assets, sold $6 billion of hybrid bonds in the company's largest public debt offering, while New York-based securities firm Merrill Lynch raised $9.55 billion by issuing debt and preferred securities.

"Investors are feeling better about banks being proactive about raising capital,"said Mike Difley, who helps oversee $21 billion in fixed-income assets as a portfolio manager at American Century Investment Management in Kansas City. "They're trying to get their house in order."

My Comment: Banks and brokers may be trying to get their houses in order, but the emphasis should be on trying. They are not succeeding. A wave of commercial real estate defaults is coming (see Shopping Center Economic Model Is History). And on top of that wave will be a wave of credit card defaults. Target wrote off a stunning 8.1% of credit card debt in March (see Card Losses Soar at Target, Bank of America). Furthermore the walk-away crisis is just picking up steam. This is more like the eye of the hurricane than anything else.

Citigroup sold perpetual preferred shares after posting almost $16 billion in writedowns, increasing the New York-based bank's total capital raising since November to $37.2 billion, Bloomberg data show. The sale helps compensate for more than $40 billion of credit losses and writedowns since last year.

The perpetual hybrid bonds pay interest of 8.4 percent for 10 years. After that, if not called, the interest rate will begin to float at 4.03 percentage points more than the London interbank offered rate, or Libor, which is currently set at 2.91 percent.

Merrill Lynch, after writing down the value of $6.5 billion of assets, sold $7 billion of senior unsecured notes in its biggest debt offering, attracting investors with spreads as much as triple what it paid a year ago. Merrill Lynch, the third- biggest U.S. securities firm, also issued $2.55 billion of perpetual preferred shares that yield 8.625 percent, its largest sale of the securities.

Bank of America Corp., the second-biggest U.S. bank by assets, sold $4 billion of perpetual hybrid bonds that pay 8.125 percent until 2018, and French investment bank Natixis SA raised $750 million in an offering of perpetual subordinated securities yielding 10 percent.

My Comment: The idea that the credit crunch is over is pure fallacy. The Fed Funds Rate is 2.25%, LIBOR is 2.91% and Citigroup is raising money at 8.4%, Merrill Lynch is raising money at 8.625%, and Bank of America is raising money at 8.125%.

Merrill Lynch may now lose its A1 ranking at Moody's Investors Service because the credit rating service won't count the proceeds of the preferred sale as equity, Sanford C. Bernstein & Co. analyst Brad Hintz said today in a note to clients. Credit-rating companies typically don't allow more than 25 percent of a bank's capital base to be made up of preferred stock, a limit Merrill is "well over," he said.

My Comment: Judging reality by what credit rating agencies do or say is certainly fraught with error (see Nothing Left To Lose At Ambac), but it does look like Merrill Lynch has run out of free lunches by issuing preferred sales that count as equity.

The financial companies are "coming out with some pretty yieldy paper," Moini said. "That's why all these massive deals are getting done. And people still have a lot of cash."

My Comment: That cash is being burnt up like mad as is the destruction of capital that is fueling the issuance of preferreds. Those thinking "the bottom is in" and buying now are going to regret it later.

Four high-yield, high-risk companies sold $2.85 million of debt this week, the most since the week ended Nov. 30, according to Bloomberg data. FireKeepers Casino, owned by the Nottawaseppi Huron Band of Potawatomi, sold $340 million of seven-year senior secured notes at a yield of 13.875 percent, and Russian mobile phone company OAO VimpelCom raised $2 billion in the country's biggest sale of dollar-denominated debt.

My Comment: 13.875% sounds like a lot. But it's only a good deal if it doesn't default. And if I was trading fixed income I would not touch it.

Interest Rates Only Appear Low

Minyan Peter, an ex-treasurer for a major U.S. Bank, wrote last week:

"It would appear that interest rates are low, the reality is that for most borrowers the rates they are paying aren't - particularly in the financial services sector.

At least so far, it looks like less than 15% of the rate reductions are passing through the end user - whether that is in mortgages, credit cards or other consumer lending areas. And if you look at the spreads brokerages and banks are paying for money, their costs have clearly risen."

To that I will add that Jumbo Mortgages are going 2-3 points higher than conforming mortgages with puts jumbos at 7-8%, and even higher still in Fannie Mae and Freddie Mac distressed areas. And those mortgages now require substantial down payments that were not required before.

If one looks at what banks and brokerages have to pay for debt, what spreads junk bonds are yielding, and what jumbo mortgages are costing, the widely held idea that "Interest rates are low" is easily debunked.

Except for the paltry yields one receives on treasuries, savings accounts, and CDs, real interest rates are actually high as those who need to raise cash, finance an LBO, buy commercial real estate, or refinance a jumbo mortgage are finding out. And another thing stands out as well: It makes no economic sense for Citigroup to keep going back to the well raising money at 8.4% while paying dividends at a forward annual rate of 5%.

Fed Uncertainty Principle

This post is not an attempt to justify the current Fed Fund's Rate. To make that clear, I will repeat what I said in Fed Uncertainty Principle:

The Fed, in conjunction with all the players watching the Fed, distorts the economic picture. In a free market it would be highly unlikely to get a yield curve that is as steep as the one in 2003 or as steep as it was just weeks ago when short term treasuries traded down to .21%.

I don't know, you don't know, and the Fed does not know what to do. This is part of the "Fed Uncertainty Principle" and a key reason why the Fed should be abolished. After all, how can you give such power to a group of fools that have clearly proven they have no idea what they are doing?

Key Rate Is Not The Fed Fund Rate

The easily seen and often quoted interest rate is the Fed Fund Rate. However, the Fed Funds Rate is not a valid perspective from which to state "low interest rates are fueling price inflation".

On the other hand, if one wants to state that past interest rate actions by the Fed and past monetary printing by the Fed are still causing current economic distortions, I can embrace that. The Fed, by its very nature, causes economic distortions including price inflation.

But the key rates now are the rates it takes to get a deal done. And those rates have been climbing since last Summer. Clearly it's harder and harder to get a deal done. Credit has dramatically tightened. There are no more liar loans, covenant lite agreements, huge commercial real estate deals, etc.

Nonetheless, the market has been cheering lately simply because deals are getting done, even thought the cost (excluding the last week or so) has been rising. But don't be fooled, there is no bottom in sight. As professor Bennet Sedacca suggests, the bottom will come when the deals can't get done. That could be quite a long ways off. Economic Winter is setting in.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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C.A.R. Median Home Prices Down 29% In March

The California Association of Realtors® has released its report for March.

Home sales decreased 24.5 percent compared with the same period a year ago, while the median price of an existing home fell 29 percent.

“Sales continue to be impacted by problems in the real estate finance sector, which by some measures have eroded since the start of the year,” said C.A.R. President William E. Brown. “Sales in 2007 reached their peak last February; going forward, the year-to-year declines in sales should shrink.”

The median price of an existing, single-family detached home in California during March 2008 was $413,980, a 29 percent decrease from the revised $582,930 median for March 2007, C.A.R. reported. The March 2008 median price fell 1.3 percent compared with February’s revised $419,640 median price.

“Both tighter underwriting standards and the ongoing effects of the credit/liquidity crunch continue to constrain sales,” said C.A.R. Vice President and Chief Economist Leslie Appleton-Young. “Historically, mortgage rates on jumbo loans are 0.2 percent to 0.4 percent higher than those on conforming loans, but the spreads in recent weeks have been as large as 2 percentage points, reflecting an increase in the perceived risk associated with these loans.

“The lack of available funds for loans, even for qualified buyers, continues to keep the demand side of the market thin, and enables buyers with financing (or all cash) to exert leverage over sellers,” she said.

Highlights of C.A.R.’s resale housing figures for March 2008:

C.A.R.’s Unsold Inventory Index for existing, single-family detached homes in March 2008 was 11.6 months, compared with 7.6 months for the same period a year ago. The index indicates the number of months needed to deplete the supply of homes on the market at the current sales rate.

Thirty-year fixed-mortgage interest rates averaged 5.97 percent during March 2008, compared with 6.16 percent in March 2007, according to Freddie Mac. Adjustable-mortgage interest rates averaged 5.12 percent in March 2008, compared with 5.44 percent in March 2007.

The median number of days it took to sell a single-family home was 56.7 days in March 2008, compared with 52.9 for the same period a year ago.

Declines From Peak



click on chart for sharper image

The above chart is from "TC" who has been monitoring C.A.R. data. DQNews data contains resale single family residences and new homes. C.A.R. data contains resale single family residences and new homes.

Median price analysis has its flaws, and by tracking each county in terms of declines from peak, further bias was introduced. Nonetheless the table gives one measure of what is happening.

Case-Shiller data comes out next week, and it is based on repeat sales, arguably a much better way of looking at things vs median prices. We will take another look when the data comes out.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Earthquake Insurance Threat

Earthquake insurance is an expensive proposition, at least it seems that way to the vast majority that decide to do without it. Let's see if we can quantify the risks, starting with Forecast: Big quake likely in California.

California faces an almost certain risk of being rocked by a strong earthquake by 2037, scientists said Monday in the first statewide temblor forecast.

New calculations reveal there is a 99.7 percent chance a magnitude 6.7 quake or larger will strike in the next 30 years. The odds of such an event are higher in Southern California than Northern California, 97 percent versus 93 percent.

"It basically guarantees it's going to happen," said Ned Field, a geophysicist with the U.S. Geological Survey in Pasadena and lead author of the report.

"A big earthquake can happen tomorrow or it can happen 10 years from now," said Tom Jordan, director of the earthquake center, which is headquartered at the University of Southern California.

Researchers also calculated the statewide probabilities for larger temblors over the same time period. Among their findings: There is a 94 percent chance of a magnitude 7 shock or larger; a 46 percent chance of a magnitude 7.5 and a 4.5 percent chance of a magnitude 8.

The northern San Andreas produced the 1906 San Francisco earthquake, but the southernmost segment has not popped in more than three centuries.

Scientists are also concerned about the Hayward and San Jacinto faults, which have a 31 percent chance of producing a Northridge-size temblor in the next 30 years. The Hayward fault runs through densely populated cities in the San Francisco Bay Area. The San Jacinto fault bisects the fast-growing city of San Bernardino east of Los Angeles.

Earthquake Insurance Expensive, Risky Business

The San Francisco Chronicle is writing Earthquake insurance in the Bay Area is expensive, risky business.

Statewide, only 12 percent of California homeowners have earthquake coverage, according to the California Earthquake Authority, a publicly managed entity that sells policies through private companies. The number of Bay Area homeowners with coverage is even lower than that.

Someone who paid $700,000 for a home might insure the home for $450,000 - the cost of rebuilding the home from the ground up, he said. Annual premiums for such a policy would typically cost $1,500 to $2,400 a year in the Bay Area, Wehde said.

That's as much as the average homeowner's policy, he said.

Homeowners trying to decide whether to buy earthquake coverage might consider how much equity they have in their homes, said Comerio, the Berkeley professor.

"If you own more of your home than the bank, you stand to lose more in a catastrophic loss," she said. "It makes sense to link insurance with your equity status."

And should the Big One rock the Bay Area, a 15 percent deductible might not seem so bad, said Allstate's Halberg. "I'd urge you to compare a 15 percent deductible to 100 percent. For many of us, our, home is the single biggest and most significant investment we have. In terms of protecting that from a catastrophe that everybody says is not an if, but a when, it seems pretty reasonable."

Institutional Threat

"TC", a claims manager in the insurance industry writes:

The San Francisco Chronicle's numbers are from last October. When I discussed the issue last week with our Insurance Commissioner I was informed only 11% of Californians carry earthquake (EQ) insurance and consequently only about 15% of outstanding loan balances are insured for a CA EQ.

So if lenders are having trouble today with Californians walking away and leaving them with a property worth 80 cents on the dollar, how can the lenders survive when tens of thousands of homes are decimated by EQ damage and they become worth just a few cents on the dollar? Obviously, CA homeowners would walk away in masses and leave financial institutions holding the bag.

Of equal importance why don't lenders mandate EQ insurance in high risk areas? They certainly wouldn't underwrite a mortgage without Fire Insurance and they definitely won't underwrite a mortgage in a "flood zone" without Federal Flood Insurance. So why not mandate EQ insurance? My best guess is because it has been 15 years since the last "big one" occurred.

Some of this risk has been recognized by our CA Insurance Commissioner Steve Poisner and consequently he has very recently set up a committee to look into mandating EQ insurance in high risk areas (EQ insurance in CA is sold through the semi-public California Earthquake Authority). However, with a depressed housing market he doesn't sound too eager to mandate that Californians purchase a $1000+/per year policy.

I should also mention this isn't simply a residential housing problem. Most commercial loans also don't carry EQ insurance, with a huge potential for dire financial scenarios.

Willingness to forgo insurance is yet another unseen effect of 0% down payments in California. Many are deciding to skip coverage because the likelihood in any one year is small and it is the lending institution at risk not the homeowner. Institutional risk to "the big one" is extremely high.
" it's going to happen," said Ned Field, a geophysicist with the U.S. Geological Survey in Pasadena and lead author of the report.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Congress Threatens Oil Producers

Before we discuss Congressional threats on oil producers, let's first consider the Florida legislature's move to ban fake testicles on vehicles.

Senate lawmakers in Florida have voted to ban the fake bull testicles that dangle from the trailer hitches of many trucks and cars throughout the state.

Republican Sen. Cary Baker, a gun shop owner from Eustis, Florida, called the adornments offensive and proposed the ban. Motorists would be fined $60 for displaying the novelty items, which are known by brand names like "Truck Nutz" and resemble the south end of a bull moving north.

Some might think that legislators have better things to do than debate "Truck Nutz". Not me. I would like to see state and national legislators spend more time debating "Truck Nutz", flag burning, baseball steroids, the nation anthem, and motherhood and apple pie on the general principle the more time they spend debating frivolous topics of no economic importance, the less likelihood they will do real damage somewhere else.

For example, please consider U.S. arms sales to OPEC at risk over oil.

Democrats in the U.S. Senate stepped up their attacks on OPEC oil producers on Thursday, threatening to block billions of dollars in arms sales to suppliers such as Saudi Arabia if they fail to take action to tame record oil prices.

Democratic senators Charles Schumer of New York, Byron Dorgan of North Dakota and others called on the White House to "jawbone" OPEC members to boost output or risk Congress blocking arms deals with Saudi Arabia, the United Arab Emirates and other OPEC members.

"The Saudis have to understand this is a two-way street," Schumer told reporters. "We provide them weapons, our troops provide them protection, and then they rake us over the coals when it comes to oil."

Last year, Democrats in the U.S. Congress pushed through a bill that would allow the federal government to sue OPEC for price manipulation. The White House has said it would veto the so-called NOPEC bill, and opponents have warned that OPEC members could retaliate by turning off the taps.

Leave it to Congress to threaten a major oil producer when prices are at record levels, brag about out troops on their soil when most of Saudi Arabia does not want them there, and threaten to stop sales of weapons when our balance of trade is in shambles.

A more rational viewpoint came from Frank Verrastro, an energy expert at the Center for Strategic and International Studies who said, "Tying oil prices to arms sales could motivate Middle East producers to seek cozier arms-for-oil agreements with countries such as Russia and China."

This is so basic a child could figure it out, but apparently it is far too complex for the minds of Senators Charles Schumer of New York and Byron Dorgan of North Dakota. And so... what this country desperately needs is another baseball steroids scandal or other similar episode of no economic importance, or anything else to distract these "Numb Nutz" from saber rattling in the Mid-East.

Congress typically does the most damage when it tries to get something done. This case is no exception.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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