Friday, March 13, 2009

The Globama Fund

I was half listening to the news on Wednesday and the reporter was casually going through the day's headlines. She moved from one topic to the next with no emotion and ended the segment with a nice smile moving on to the next topic. The news ran something like this:

-DOW Jones up huge today posting new highs for the session
-Treasuries hold modest gains for afternoon session
-Freddie Mac reports $23.6 Billion loss and will need $30 billion this week to survive

Wait, stop right there. Did you just casually say that Freddie will need $30 billion to survive? With no emotion? No care? What has happened here?

It made me think back only twelve months ago when we had the Bear Stearns collapse over a weekend in March. News streamed across that Bear was going to be bought for $21 billion by J.P. Morgan and that the Fed was going to cover the difference of $7 billion to get the deal done.

The world went crazy. The media went crazy. Shouts were heard everywhere: "$7 billion? That's insane! They can't just give that company that much money!" What about the tax payers?"

Now, only twelve months later, its a small headline at the bottom of the screen that Freddie Mac will need a $30 billion bailout. No big deal.

About an hour later Obama announced his plan to raise the IMF's reserves to $500 billion from its current total of $50 billion. (The IMF is a global version of the Federal Reserve, a lender of last resort for foreign banks and countries)

His plan was for the US to donate $100 billion, and for the rest of the world collectively to add $400 billion.

$100 billion!!! And the news reporter didn't blink an eye! What is happening right now?

What are these leaders seeing in our future that they feel the need to take the IMF reserves from $50 billion to $500 billion? That's a pretty big difference.

Meanwhile the markets are in euphoria right now. I keep hearing that the banks are now making money, have strong balance sheets, and their stocks are now strong buys for the future.

Really? Has their balance sheet really changed that much in a week? In fact it has, it has become much worse.

The real news of the day today, the one you probably will not ever hear about, is that China's Premier Wen Jiabao is very concerned about the future value of China's assets in the United States.

As Obama talks about putting $100 billion in an IMF fund and sending $30 billion this week to Freddie Mac, Wen Jiabao is sitting over in China wondering........where are they getting the money to do that?

Let's hope he doesn't put the puzzle together, otherwise our real crisis can begin and the true value of American stocks, bonds, currency, and real estate will be revealed to the world.

Tuesday, March 10, 2009

Goodbye Mark, Hello Zombie

We finished the day today with one of the biggest one day bear market rallies in stock market history. Up 5.8% for the day. The biggest gainers for the afternoon were financial stocks.

What caused this violent upward move? Well, there was news released from Citigroup's CEO Vikram Pandit that the company has been profitable the first two months of this year. Anyone with any sort of sense knows that comment is ridiculous in every way. The market cheered the news and bought their stock today.

There was also some positive words from our Treasury Secretary who announced today that our economy would recover in the second half of this year, one upping Pandit's comment with another of equal stupidity. The market surged on the news.

But the big, big news of the day came from our senator Barney Frank. He announced that progress was being made on the return of the uptick rule. What that means is that a stock is not allowed to be shorted until it ticks upward. This keeps shorts from attacking stocks and beating them down. They will do this to try and protect the stocks of our nationalized financial companies that short sellers have a fondness of feeding on, like blood thirsty sharks.

This comment, while cheered wildly from the trading floor, was only a warm up for his second announcement: They are working diligently on a plan to remove mark to market accounting for their nationalized financial institutions.

Mark to market means that you have to put a value of the assets on your balance sheet based on what they would sell for in the free market. It is the equivalent of an appraiser coming to your house and giving you a value for your home based on what it would sell for in the free market.

For example, let's say Citigroup loaded up on $1 trillion worth of mortgage securities in 2006. Then in 2009, the underlying homes that the loans were made on have fallen by 50% in value. The mortgage securities are now worth $500 billion because that is what they would sell for if the companies put them on the market today. (In real life most of the debt is worth far less because there are currently no buyers for mortgage CDO's, other than our Federal Reserve)

The banks have to keep a certain capital ratio in order to keep their door open. So based on our example above, if they had $100 billion in capital (cash) and they had to write off $500 billion then they are under water and have to declare bankruptcy. (Unless they can raise $400 billion in cash) This is why the government has been stepping in and giving the banks trillions in cash. It is to allow them to keep their doors open after they are forced to write down this debt.

Barney Frank's plan to remove mark to market means that the banks would not have to declare what their assets are worth so they would not have to mark them down and be forced to take the losses. Seems like a brilliant idea right?

Japan tried this in the 1990's. Their actions are what coined the now popular term "zombie" banks. Their banks carried on for years and years with the worthless assets on their books, and investors never knew what the value of the banks were. This gave investors no confidence to invest in the banks or the country for a full ten year period known now as the "lost decade."

To remove mark to market would be an unmitigated disaster. In fact, the one bright spot I've seen during this whole nightmare has been the government's will not to remove it. They have done something you could say is equally horrific by forcing the tax payers to pay for the losses, but at least that concept has an ending. At some point the losses will be cleaned. With zombie banks, the losses are never cleaned, and we become zombie America forever. (Just like the Japanese who are still recovering today from this mistake, 20 years later)

How long will the rally last? Who knows? Maybe months. Its fun to see people get excited about a market rising that has only changed fundamentally for the worse. A market rally means that expensive stocks just become more overpriced. For some reason this makes people want to buy. I guess that's why a market can stay irrational for a very long time.