February 2, 2009
Good morning. Another week, another sell-off in the S&P. The good news is that the week was only down a little, about .3%, the bad news is that there was a 3.4% up day erased. The up day was caused by the announcement that the Obama administration was going to announce a so-called bad bank to take bad assets from struggling commercial banks, the subsequent sell-off was caused by glitches in that plan as well as increasing issues with the new stimulus package. For the month of January, the SPY was down over 8%, not exactly the way to start the year, or a new administration. The VIX, or implied volatility index, was down 5% on the week, from 47.27 to 44.84, but that is still rather high.
One continual driver of the bad news is the scary level of layoffs in virtually every industry, with the announced layoffs early last week close to 100,000. I think most of us realize that those numbers (along with the unemployment numbers due this week) do not count contract workers, some types of temporary workers, etc. that would make the numbers much worse. As an example, in the housing industry, virtually all self-employed general contractors, plumbers, carpenters, painters, etc. and real estate people on commission (virtually all) are nowhere to be found in the “official” numbers. The same would be true of contract IT people. It is true they are not counted whether working or not, but when the Labor Department says 2 million jobs were lost last year, the number of real people thrown out of “work” last year is probably way higher. Remember too that this is not 1973, 1958, or 1947, when the personal debt load was much lower. A lot of these people currently being down sized (Riffed, laid off, canned, pick the term of the particular recession) are being tossed into the abyss of huge indebtedness; student loans, mortgage problems maybe, possibly credit card debt, car loans, etc. maybe all held by the same institutions. I was not around in 1947, but I do know that in 1973 colleges charged a sane amount, meaning not anywhere near the student loan issues, there were no credit cards other than maybe a gasoline card, most people had put 20% down on their house, etc.
How about those banks? I was just reading an article last night about how divisive some of the panel discussions were in Davos, Switzerland, regarding worldwide opinion regarding our bankers. None other than Vladimir Putin (former KGB agent that former President Bush seemed to think had morphed into a boy scout of sorts) was leading the charge against western capitalism and its warts. It appears the only real U.S. Bank exec that showed was Jamie Dimon, of J.P Morgan/Chase, and he was put on the defensive the whole time. It does seem to me that the rest of the banks around the world were just as greedy and mis-managed as ours, but that would just be my opinion. Not to mention, again the postman seems to have lost my invitation to that conference, maybe next year.
Anyway, what is with the banks, and why does every day seem to bring about ten new solutions from every talking head that can grab a spot on TV? Again, it is all in the numbers. Read, if you can, an article by John Markman on MSN Money. In it John spells out the problems with the Bank balance sheets in very simple terms. At the beginning of 2007 the entire worldwide banking network had around $2 trillion in shareholder equity. It is probably fair to say that through mismanagement, greed, and being “competitive” (as Mr. Paulson would put it) these banks were probably right up against (or cheating) a roughly 10% capital requirement (meaning the combined assets were $20 trillion or more). They have collectively taken approximately $1.5T on write-offs so far, plus they are being forced to put on balance sheet all the “stuff” they somehow felt they could keep off, some real estate loans, leveraged investment vehicles, etc. The $5-10 trillion of the new stuff now on the balance sheet is causing another $.5-1 trillion in requirements, meaning that the roughly half a trillion the government has ponied up plus the half trillion from sovereign wealth funds still leaves them almost a trillion short. I don’t know when I have written something before where every number is in the trillions.
When you look at the numbers from that magnitude, and that simply, it is easy to see how it is a problem currently defying a solution. The numbers are huge, taxpayers are incensed at what they have been asked to do already, and think (accurately) that the regulatory sector is in over its head. The assets held by Royal Bank of Scotland exceed the total GNP of Great Britain, the assets held six months ago by Citigroup (C) exceeded $2T, and the total tax intake of the U.S. is barely above that, at $2.4T. Who were the morons that let these places get so big, and who bought the insane arguments “Why is big bad?” “Should we be penalized for growing?” “Think of the efficiency.”
Do I have a solution? Maybe. For one thing I would stop trying to hurry a solution. These banks have been technically insolvent for a while now, but Japanese banks were probably that way for over a decade, and Chinese banks have surely been that way for a while. It is not ideal, but as long as they are operating it is not a crisis either. Lower the capital requirements for a while, say for the problem banks the capital “goals” are 2% by the end of 2009, 4% in 2010, etc. Force the closing out of the crazy stuff, like credit default swaps, etc. Let the banks know they can operate normally with the reduced capital with some sort of government backstop, start the banking process (meaning normal lending) working. You can’t get it going by giving them hundreds of millions of taxpayer money, then saying it has to be kept in reserve. Things will still work at a lower capital requirement, for a while.
I think the solution is time, time and the effort to actually go through all the real estate loans in question and either adjust, write-off, affirm they are ok, whatever. I think the holders of this paper still do not know exactly where they stand, and they need to find out the exact numbers they are dealing with. In the Resolution Trust it was necessary to move the assets from the Savings and Loans because the insanely high interest rates (thank you Mr. Volcker) put the S&L’s out of business. The paper needed a new home, now it does not. Also, despite the idiots (I won’t say it), I mean the learned gentlemen on TV talking about the Resolution Trust in glowing terms; it was a cesspool of corruption and politics. The last thing we need is to transfer millions of properties to some governmental agency for distribution in some secret manner to the well connected at huge discounts. Doing that once in my lifetime is more than enough. Having said that, the banks in question have huge capacities for earning money; they will repair themselves over time. We need to watch them to make sure they are healing, and we need to encourage the growth of many new banks. The European model of a few large banks is broken; let’s go back to our old model of strong banks of all sizes.
If we can put the bank issue on hold for a while maybe we can concentrate on the rest of the economy. That is a whole different subject, maybe a subject for next week. What about investing? Looking at the current levels of corporate profits, I think we need to concentrate on those companies that seem to be handling the current situation in the black with eyes still forward. That is hard to do, as some companies are being affected in a dramatic manner. One of the managers of a Best Buy near me tells me sales were off almost 25% from last year in his particular store. I don’t think that was a company wide number, but it is a huge number to deal with and stay in the black.
At PTI we believe there is no question we need to stay protected in our investing, we need to take advantage of the high premium levels, and probably need to have some cash available. Obviously, if the market continues to fade we want to maintain our equity (or better) and be ready when any turnaround should happen. I do not think we are going to go down 8% per month all year. We’ll be ready when things turn positive.