Saturday, February 14, 2009

Insolvency vs. Liquidity

The current consensus among the big name economists around the world is that we will see total losses from the global banking sector between $3 and $4 trillion. (Remember just one year ago, the worst case scenario from these economists was $500 billion. We have already passed $1 trillion in losses to date)

The total capital of the banking system including all assets is estimated to be around $1.5 trillion as of today. This means the entire banking system is currently insolvent. It is important to understand the difference between a liquidity problem (what you hear is the problem on the news) and a solvency problem.

With $1.5 trillion in current assets, it will take an additional $2 trillion to bring their value to zero. The problem that we keep hearing is that people cannot spend because banks are not lending. Their insolvency is why they are not lending. Even when the government prints and borrows that $2 trillion to make these zombie banks whole, the credit market will still only be a fraction of its former self.

The reason is because the buyers around the world that bought all this debt are currently getting burned today, and they are not going to just line back up to buy more once this all blows over. How long do you think it will take before a Wall Street executive can con a foreign government into purchasing mortgage backed securities? A long, long, time.

Towns, cities, states, and even countries around the world are heading toward bankruptcy because they made the mistake of lending Americans money.

Obama's new stimulus plan will be signed into effect Monday morning. The problem with the plan is that it is a spending plan, not a stimulus plan. It was not put together to maximize job growth. It was put together to maximize health care, education, and tax cuts.

Over the next few months as the administration realizes that this plan is doing nothing to help this economy, they will begin immediately putting together a plan for "stimulus two." My guess is that this plan will be released around summer time and may dwarf the size of this 800 billion dollar waste.

Everything they are doing to stimulate the economy is making it worse. As the economy gets worse they continue to make the stimulus packages bigger which in turn makes it even worse. This larger problem then calls for a larger economic stimulus package. We will follow this vicious cycle until the entire pile of debt collapses on itself.

Most people talk about the actions taken today as being a problem for our grandchildren in the future. Based on the speed and the size of the mistakes being made today, I think the bill will come sooner than most people realize.

Friday, February 13, 2009

Do you know who wrote this?

“Owners of capital will stimulate the working class to buy more and more expensive goods, houses and technology, pushing them to take on more and more expensive debt, until their debt becomes unbearable. The unpaid debt will lead to the bankruptcy of all banks, which will have to be nationalized, and the State will have to take the road which will eventually lead to communism.”

Can you guess which author and publication that quote came from?

It came from Karl Marx, who wrote it over 100 years ago to describe the Soviet Union.

Does it have a familiar ring?

The public and the markets have had a few days now to digest Geithner's new stimulus plan. The major response has been one of disappointment and confusion.

The truth is that they they really don't have a plan. They have entered all the major banks this week to "stress test" their balance sheets to see which banks have the capability to survive with additional capital. When their analysis is complete they'll probably work with all banks in unison to come up with a solution. (See quote above)

The Obama administration was extremely frustrated with the stock market's continued poor performance and during the lows of yesterday's trading session they panicked and announced a homeowner refinance program that will be announced next week.

I have discussed in depth in the past that I thought they would eventually come to this program. They will do a combination of re modifying the loan balances and interest rates. They will use government money as a subsidy to bridge the gap between what is owed and the new mortgage. They've even gone as far as to say they will be doing this for loans even before they start to get in trouble. This will just go out to everyone.

Obviously, I don't have to sit here and tell you about the other problems happening in our economy. The meltdown has become front page news and is no longer a question of if, but how long will it last.

CNBC ran a very well put together special last night called, "House of Cards." If you are still confused about how we got here with the housing market it helps explain it from the very beginning. I'm sure they will run it again, and I highly recommend watching it.

Tuesday, February 10, 2009

Financial Stability Plan

I've been patiently waiting the last few days for today's announcements that carry enormous implications for our economy.

The day started with Geithner's press conference announcing the new "Financial Stability Plan." Only a few days ago it appeared certain that there would be a "Bad Bank" that would take the toxic assets off the investment banks balance sheets. It appears that plan has been scrapped, and we're now back to where we started which is to give around $500 Billion in additional capital to troubled banks. That money, just as before, is as good as flushing it down the toilet.

The second part of the plan involves the Fed expanding its original $200 billion asset purchase program to $1 Trillion. This program involves the purchase of student loans, car loans, commercial real estate loans, and residential mortgages.

Both these programs will be a fraction of the total costs needed to make these markets whole, and as the economy continues to deteriorate you can expect for them to announce larger and larger stimulus projects.

As the market plunged today on these new programs of mass destruction, we got a call from Obama down in Ft. Myers letting us know that we will have a foreclosure program in place to look forward to in the next few weeks.

As his call came through, we also received word that the Senate has approved his $838 billion stimulus plan. This is Obama's new program to create jobs using government money. The only problem with the plan is that the government does not have any money. In order for it to create jobs it must take it away from other business opportunities, and this usually equals an even greater total job loss.

I was talking to my friend the other day about how I watched the financial crisis build for years and years before the entire system collapsed in one month in October last year. All the bad loans and decisions were created, packaged, and leveraged onto the banks balance sheets back in 2004-2007. But it took until October of 2008 before the entire system collapsed on itself.

I think it will be a similar event with our currency. Many people understand what is happening right now and what the final outcome will be, but you just have to wait and wait for something to trigger the collapse. It will happen quickly and when it does we can begin the true crisis. What we have seen thus far is just the opening act.