US Considering Nationalizing Banks

From the NY Times:

Treasury officials say the just-passed $700 billion bailout bill gives them the authority to inject cash directly into banks that request it. Such a move would quickly strengthen banks’ balance sheets and, officials hope, persuade them to resume lending. In return, the law gives the Treasury the right to take ownership positions in banks, including healthy ones.

The Treasury plan was still preliminary and it was unclear how the process would work, but it appeared that it would be voluntary for banks.

The proposal resembles one announced on Wednesday in Britain. Under that plan, the British government would offer banks like the Royal Bank of Scotland, Barclays and HSBC Holdings up to $87 billion to shore up their capital in exchange for preference shares. It also would provide a guarantee of about $430 billion to help banks refinance debt.

The American recapitalization plan, officials say, has emerged as one of the most favored new options being discussed in Washington and on Wall Street. The appeal is that it would directly address the worries that banks have about lending to one another and to other customers.

Let's look at this plan. The US government essentially injects capital (money) directly into banking institutions. The US government gets some kind of ownership interest in the bank (usually preferred shares). The idea behind this is in giving the banks money the banks will turn around and make loans.

The primary benefit of this program is taxpayers will get an ownership interest in the banks. Therefore, when the banks become more profitable the taxpayers various interests will increase in value and therefore provide a return on the investment.

There are serious drawbacks to this plan:

1.) The US government becomes an owner of banks. How many owners are hands off? Not many. Is this a good idea?

2.) There is no reason to think this will be cheap. We've already seen over $500 billion in writedowns. With 1 in 6 US homeowners now underwater there is no reason to think the trend in writedowns will diminish anytime soon. In other words, if someone says this will be cheaper they're not seeing reality clearly. Any option is going to cost serious money.

3.) Why will banks magically start to lend? We're seeing increased problems according to the latest Quarterly Banking Profile from the FDIC:

The continued downturn in the credit cycle, combined with lingering weakness in financial markets and falling asset values, had a pronounced negative effect on banking industry performance in the second quarter. Insured commercial banks and savings institutions reported net income of $5.0 billion for the second quarter of 2008. This is the second-lowest quarterly total since 1991 and is $31.8 billion (86.5 percent) less than the industry earned in the second quarter of 2007. Higher loan-loss provisions were the most significant factor in the earnings decline. Loss provisions totaled $50.2 billion, more than four times the $11.4 billion quarterly total of a year ago. Second-quarter provisions absorbed almost one-third (31.9 percent) of the industry's net operating revenue (net interest income plus total noninterest income), the highest proportion since the third quarter of 1989. A year ago, provisions absorbed only 7.3 percent of industry revenue. The average return on assets (ROA) in the second quarter was 0.15 percent, compared to 1.21 percent a year earlier. Large institutions as a group had more substantial earnings erosion than smaller institutions, but downward earnings pressure was widely evident across the industry. At institutions with assets greater than $1 billion, the average ROA in the second quarter was 0.10 percent, down from 1.23 percent a year ago. At institutions with less than $1 billion in assets, the average second-quarter ROA was 0.57 percent, compared to 1.10 percent in the second quarter of 2007. More than half of all insured institutions (56.4 percent) reported year-over-year declines in quarterly net income, and almost two out of every three institutions (62.1 percent) reported lower ROAs. Almost 18 percent of all insured institutions were unprofitable in the second quarter, compared to only 9.8 percent in the second quarter of 2007.

In other words, this is not an environment where banks will start to make loans -- it's the natural time when banks start to slow down anyway. My guess is banks will use the cash to shore up their balance sheets.

Here's the real bottom line. There are no good answers to this problem. There are no magic bullets. The financial system is in serious trouble. The Feds are one step ahead of the latest domino falling. But the dominoes will continue to fall for awhile.

Media Appearance

I'll be on the BBC's World Have Your Say at noon CST.

What Will Be the Chain Of Recessionary Events

There's a great article in today's WSJ which uses California as an example of what will happen to the rest of the US. This gives us a good template for how events will unfold. Let's take a look:

But even before the most recent blows to the national economy, Californians were feeling the downward drag of a consumer-led recession -- in which shrinking home values caused people to rein in their spending, fueling unemployment and, in turn, sparking further spending cuts and joblessness.

This explains why the housing downturn is so incredibly destructive. It's not just home prices that take a hit. Homes are the single biggest asset most people own. When its value is dropping it hits homeowner's psychology incredibly hard. And dropping home prices are.

About 75.5 million U.S. households own the homes they live in. After a housing slump that has pushed values down 30% in some areas, roughly 12 million households, or 16%, owe more than their homes are worth, according to Moody's Economy.com.

The comparable figures were roughly 4% under water in 2006 and 6% last year, says the firm's chief economist, Mark Zandi, who adds that "it is very possible that there will ultimately be more homeowners under water in this period than any time in our history."

Also consider the drop in the case shiller home price index (chart from Calculated Risk):



As those prices have dropped people have cut back on their spending.

John Luc has seen how housing problems bleed into the broader economy. Mr. Luc is the 36-year-old manager of Homestore Furniture in Ontario, a middle-class community 40 miles east of Los Angeles and one of the centers of the housing bust. Since last year, retail sales have fallen, while unemployment and office vacancies have soared. Eighteen months ago, he watched a nearby Levitz furniture store close down in a bankruptcy sale. Since then, he said, the few buyers who've visited his store ask for discounts. "Everybody negotiates," he says.

The other day, Mr. Luc was presiding over the store's going-out-of-business sale. Although the father of two young children expects to get a job at another Homestore outlet, he and his wife have checked their spending. He says he saves $50 or more each week by packing a lunch each day, and he makes coffee at home instead of stopping at Starbucks during his long commute. "I haven't gone into a steakhouse like a Black Angus for dinner in six to eight months," he says.

When 2/3 of economic growth comes from the spending described in the above graphs, you've got serious problems.

Thursday Oil Market Round-Up

On the weekly chart, note the following:

-- Prices are below all the SMAs

-- The 10 and 20 week SMA are both headed lower

-- The 10 week SMA has crossed below the 50 week SMA

-- The 50 week SMA is turning sideways (and will start moving lower within the next few weeks).

Bottom line: this is a bearish chart



On the daily chart, notice the following:

-- Prices are below all the SMAs

-- All the SMAs are headed lower

-- The shorter SMAs are below the longer SMAs

-- Prices have been dropping for about three months

-- Prices are using the 20 day SMA as technical resistance

Bottom line: This is also a bearish chart.

Today's Markets

A look at the chart reveals a very bearish chart.

-- Prices are below all the SMAs

-- The shorter SMAs are below the longer SMAs

-- All the SMAs are moving lower

BUT, also note

-- Today was a high volume day, with a

-- The candle is an upside down hammer

However, by all technical indicators the market is extremely oversold right now.



The MACD is the lowest its been in three months, as is



The relative strength index.



Stochastics are also scraping the bottom.

In other words, don't be surprised to see a relief rally over the next few days.

Consumers are Reigning Spending In

From the WSJ:

As the U.S. economy entered into crisis mode in September, so did the retail sector, ramping up discounts and special offers to entice reluctant shoppers.

But the retailers who reported September sales results Wednesday -- with the exception of Wal-Mart Stores Inc. and other discounters -- are indicating the promotions hardly helped. Many retailers reported worse-than-expected declines, with some -- such as Target Corp. and J.C. Penney Co. --- issuing downbeat estimates for the quarter.

.....

For the most part, the discount sector has been the only one to perform well amid recent economic troubles. Shoppers increasingly have been turning to warehouse and big-box discounters as they try to get the most for their money. Most other sectors have been suffering as shoppers continue to pull back on discretionary items, despite retailers' efforts to lure the bargain-hungry shoppers with greater discounts.

A rise in discount sales at the expense of all other stores is a bad development. It's worse when you consider that 70% of US growth comes from consumer spending.

Consider the following charts.



The simple line chart tells us that real retail sales (inflation-adjusted) have been stalling for some time).



The year over year percentage change shows that retail sales have been dropping hard for some time.



Personal consumption expenditures -- which also include durable goods -- shows the same decline.

The bottom line is the consumer is definitely pulling in his spending.

Round 2 Of the Credit Crisis

I say round 2 because this is the first step of a coordinated effort by all the central banks in the world (or at least the really big ones) to make a coordinated effort to stave off the credit crisis. Why the coordinated effort? Because the problems are now worldwide. Consider the following news from last week:

Fortis nationalized:

The governments of Belgium, the Netherlands and Luxembourg took partial control late Sunday of struggling bank Fortis NV, while Britain seized control of mortgage lender Bradford & Bingley early Monday.

Germany injects 50 billion euros into Hypo Real Estate:

The German government and the country's banks and insurers agreed on a 50 billion euro ($68 billion) rescue package for commercial property lender Hypo Real Estate Holding AG after an earlier bailout faltered.

Germany's financial industry agreed to double a credit line for Hypo Real Estate to 30 billion euros, Torsten Albig, a spokesman for Finance Minister Peer Steinbrueck, said late yesterday in an e-mailed statement. The federal government's guarantee for the credit line remains unchanged, Albig said.

The government and the Bundesbank have said that Hypo Real Estate, Germany's second-biggest property lender, is too big to fail. They met with banks and insurers in Berlin all day yesterday to discuss a revamped rescue package after private banks on Saturday withdrew their support for a 35 billion-euro rescue package brokered a week ago.

The Fed and ECB doubled their credit lines:

Additionally, the European Central Bank joined with the U.S. Federal Reserve in doubling the credit swap line that makes dollars available to cash-hungry banks from US$120 billion to $240 billion. The Bank of England doubled dollar availability to US$80 billion, while other central banks offered smaller amounts.

Yesterday, the Fed announced it would now start lending to private companies:

The Federal Reserve Board on Tuesday announced the creation of the Commercial Paper Funding Facility (CPFF), a facility that will complement the Federal Reserve's existing credit facilities to help provide liquidity to term funding markets. The CPFF will provide a liquidity backstop to U.S. issuers of commercial paper through a special purpose vehicle (SPV) that will purchase three-month unsecured and asset-backed commercial paper directly from eligible issuers. The Federal Reserve will provide financing to the SPV under the CPFF and will be secured by all of the assets of the SPV and, in the case of commercial paper that is not asset-backed commercial paper, by the retention of up-front fees paid by the issuers or by other forms of security acceptable to the Federal Reserve in consultation with market participants. The Treasury believes this facility is necessary to prevent substantial disruptions to the financial markets and the economy and will make a special deposit at the Federal Reserve Bank of New York in support of this facility.

And today Britain announced a very bold plan:

Britain's banks will get an unprecedented 50 billion-pound ($87 billion) government lifeline and emergency loans from the central bank after the freeze in credit markets threatened to bring down the financial system.

The government will offer to buy preference shares from Royal Bank of Scotland Group Plc, Barclays Plc and at least six other banks, and provide about 250 billion pounds of loan guarantees to refinance debt, the Treasury said in a statement today. The Bank of England will make at least 200 billion pounds available. The plan doesn't specify how much each bank will get.

The emergency action came after the FTSE 350 Banks Index fell almost 20 percent in the past month. Prime Minister Gordon Brown is following U.S. President George W. Bush, who approved a plan last week to spend $700 billion to prop up financial institutions with untested measures as equities plunged around the world.

``The global market has ceased to function,'' Brown said today at a press conference in London. ``The banking system must be sounder, and that is why we are putting the capital in.''

None of these plans/efforts is doing what it is supposed to do: calm the markets and bring a sense of confidence back to the market. The bottom line is clear: despite all of these efforts, the short-term lending markets have completely frozen because no one trusts anyone's officially stated balance sheet numbers regarding what they are worth. This is called "counter-party risk." It simply means that lenders are so concerned about a borrowers solvency even in the short-term that no one is making even the shortest loan.

We've seen a lot of one-sided action. But now the central banks are doing things together:

Joint Statement by Central Banks

Throughout the current financial crisis, central banks have engaged in continuous close consultation and have cooperated in unprecedented joint actions such as the provision of liquidity to reduce strains in financial markets.

Inflationary pressures have started to moderate in a number of countries, partly reflecting a marked decline in energy and other commodity prices. Inflation expectations are diminishing and remain anchored to price stability. The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability.

Some easing of global monetary conditions is therefore warranted. Accordingly, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, Sveriges Riksbank, and the Swiss National Bank are today announcing reductions in policy interest rates. The Bank of Japan expresses its strong support of these policy actions.

The Federal Open Market Committee has decided to lower its target for the federal funds rate 50 basis points to 1-1/2 percent. The Committee took this action in light of evidence pointing to a weakening of economic activity and a reduction in inflationary pressures.

From the US perspective this is largely symbolic. US Interest rates are already 0% ofter adjusting for inflation. However, this is important for the European Central Bank, as Trichet has been very hawkish on inflation until very recently.

I say round 2 because there are now a number of coordinated policy measures various central banks could take together. For example, The ECB could create its own bail-out fund to match the US' and then coordinate the two funds actions to really start helping the battered institutions.

Either way I do think this is good news because the big policy makers realized one very important thing: we're in this thing together now.