Good People Becoming Desperate
From Hugh Hendry’s Latest Letter, and with comment from Barricade Contributors:
Good people are becoming desperate. I know a man who is planning to capitulate and buy stocks. He cannot comprehend what is happening today. He is, to employ Churchill, a fanatic; he won’t change his mind and he can’t change the subject. But, fearing the loss of his franchise, he will change his portfolio.
He laments that it is as though last year’s events never happened. Rhetorically, he asks whether we have all been sent through time to invest in equities at the end of the 1970s when stocks were cheap and society had thoroughly deleveraged (the opposite of today). “Why do other investors not contemplate the prospect of further household deleveraging when building their profit forecasts?” he fumes. “Can they not see that the private sector’s deleveraging is more than offsetting the public sector’s expansion?” Despite such ranting my Minskian friend remains a most entertaining and charming individual.
Now I know I have not covered myself in glory these last few months. Stock markets have gained 50% from their lows and the Fund has little to show for it except a modest reversal and no wild swings in our monthly NAV. Nevertheless, I would contend that this game of playing “chicken” with the market is not for us. Our ambition has been modest. To survive the onslaught of a positive change in social mood without being forced to capitulate in the face of a frenzy of optimism; so far so good, I think?
In this regard we have been helped immensely by a quote from Robert Prechter in early April. Having correctly called for a counter-trend rally in stock prices in late February, he then described the most likely nature of the advance, “…regardless of its extent, it should generate substantial feelings of optimism. At its peak, the President’s popularity will be higher, the government will be taking credit for successfully bailing out the economy, the Fed will appear to have saved the banking system, and investors will be convinced that the bear market is behind us.”
So far his prophecy reads well. It is reminiscent of Warburg’s line that the business cycle is “a subject for psychologists” rather than economists. Bernanke is already being compared favourably with Volcker. Continental Europe has apparently “escaped” from recession. Positive economic growth across the world for the remainder of the year seems certain. And yet Prechter went on, “Be prepared for this environment: it will be hard for most investors to resist. But beware… [the next move] will be the most intense collapse in stock prices”
This seems hard to reconcile with the determination of governments to resist the bear market; the more plausible Cassandra scenario remains something more akin to the long drawn out agony of the Japanese stock market. Nevertheless, let us assume that he is right, what could possibly generate such a black turn of events as to send stock prices back to challenge their March lows?
Not withstanding, of course, a tapped out private sector, lingering high levels of unemployment, capacity utilisation levels which never rally sufficiently to raise industry profitability, a speculative orgy in China which is likely to burst at some indeterminate moment and the complete uselessness of fundamentals in determining turning points.
Apologies, I am susceptible to my friend’s ranting after all.
Rain, rain, go away…
In attempting to answer the question of what could reignite a sell off in risk assets I have found myself returning time and again to my February 2006 investment report in which I drew the obvious parallels between the economic circumstances of the 1920s and today. The paper had the title, “Trees don’t grow to the sky”, and focused on the economic consequences of those periods when one country or region dominates world trade.
In the 1920s it was America in the ascendancy but something similar arose in the 1950-60s with the recovery in continental Europe, in the 1980s with the rise of the Japanese economy to preeminent creditor nation status and, of course, today with the rise in China. The one constancy is that unbalanced world trade has a tendency to pit domestic monetary policy considerations against international and, as a result of this tension, credit is created which fuels asset price bubbles and their resulting busts.
I want to spend some time reviewing such periods because I believe they suggest an outcome which challenges today’s near universal fears concerning the US dollar. I believe they reveal something distinctly non-consensual: that weakness in global economic demand can force the most painful adjustments not on the “sinful” low savings trade deficit countries but rather on the “virtuous” high savings trade surplus economies.
Consider for a moment the economic disequilibrium left behind by WWI. Europe was saddled with debt and America had become both a creditor nation and a net exporter. If economic orthodoxy had prevailed, the US should have imported more and the Europeans, especially the Germans, should have exported more. Under this scenario, gold, the international reserve currency, would have flowed from the US to Europe, and financed the latter’s reconstruction.
Ground Control:
The Federal Deposit Insurance Corp.’s fund that protects more than $4.5 trillion in U.S. bank deposits fell to just $10.4 billion at the end of June, as the banking industry continues to struggle with souring loans and regulators brace for pain in trying to clean up the mess.
The level of the FDIC’s fund, the lowest since the savings and loan crisis, almost guarantees that the government will have to hit the banking industry with another special fee to recapitalize its reserves. The agency said it had 416 banks on its “problem” list at the end of the second quarter, up from 305 at the end of March.http://online.wsj.com/article/SB125137695691263385.html?mod=djemalertNEWS
Pigpen: this is from a friend of mine who works for an private equity group in the US. he has been trying to buy small community and regional banks for the last year. here is his latest missive regarding our FDIC accounting and valuations.
OK, it’s a competitive world for bad banks:
Just got off the phone with another ibanker pitching a massively broken bank here in Chicagoland. 10% nonperforming/past due, mostly in land/dev loans. Which we all know are going to be worth something like…well, not much, at best.
100% certain that this is another FDIC failure….someday, over the rainbow.
Here’s the kicker as to “Why you should think about this OPPORTUNITY”: The bank has an $8MM note from a regional bank on it’s books….”If you put in equity capital, of course that note can be renegotiated.”
Really? Hasn’t it already marked it down by both firms? To a FMV close to, I don’t know…zero?
“Oh, no, they’re both holding it at par.”
This is the kind of insanity that is not in the news. Banks holding loans to ‘walking dead’ banks…at par.
Green shoots!
Thought you’d love this:
I’m continuing to wade through the ‘zombie pools’ of small banks for sale, and came across a deal in Florida that is my current poster child for the mess we’re in.
Bank is a mortgage lender that has ~$10MM in equity.
They have $30MM–yes, $30MM!!–in past due and nonaccrual loans.
Their ibanker calls me up, tells me there is going to be the ‘opportunity’ to invest. “Via the FDIC?” I ask.
Nope, as a minority stake investor at a premium to tangible book! Management and the board will, of course, stay on, as they are ‘victims of the economy’.
Wow, such a deal….while I look for my checkbook, can you tell me why haven’t the regulators put these folks in leg irons yet?
Oh, not to worry, they’re switching regulators over to the FDIC!
This is what’s going on…..from the trenches.
Obviously, if the FDIC actually made the banks do anything that resembled real accounting, the banking system would be strewn with hundreds of critically undercapitalized banks.My take is that the Feds know how bad the books are, but choose to look the other way in hopes that time (forebearance) will help some of the banks raise capital or earn their way out of the mess.
Of course, the number of salvageable banks is really small–most I’ve seen have no chance in hell of raising cash.
Here’s a rule of thumb: if a bank only needs $5MM, they might be able to raise it locally via HNW investors. If they need more than $5MM, they have little statistical odds b/c they need PE type money, and the PE guys can’t do most of the smaller deals b/c of ownership limitations and want to deploy sizable amounts of capital.
What you get is a system where the VAST majority of banks have no realistic chance of raising capital, and are either going to be closed, or will remain at the mercy of the FDIC and it’s Soviet-style accounting policies.
Community banks are toast–regulatory compliance costs and capital standard charges make $100MM firms worthless. Minimum scale now thought to be $500MM ish….which makes a big percentage of the banks in this country targeted for extinction.
Also running:
