naked capitalism

Still in Kansas City, had great fun and got to hang out with fellow bloggers, snow here tomorrow, so may have transit hassles, but hope to be back to a more normal schedule by tomorrow evening.

Key Metric: The F/R Ratio Josh Marshall, TPM Cafe (hat tip reader Scott)

The Model That’s Killing Pension Funds? Pension Pulse

35% fresh grads employed: survey China Perspective (hat tip reader Michael)

CAPEX cuts – Credit Suisse warns steelmakers to shelve all plans Steel Guru

Dire growth data fuel Asian fears Financial Times

Weekend Reading: The Social Dynamics Of The Trading Desk Tyler Durden

Bill Gross, the $747 billion bond man, declares the death of equities Peter Cohen

Antidote du jour:

Funny how a deal that is giving Citi a premium on its common shares that one typically sees in an M&A transaction (ie, the target is sought after) in the course of a salvage operation is being . Similarly, the bank is being asked to have its board members that are insiders resign those seats. Why isn’t Uncle Sam also asking for all board members to resign? While it cannot compel their resignation, under the circumstances it would be appropriate (and anyone who refused would be subject to unfavorable press attention). Board members are recruited by the CEO, hence sympathetic to its interest. And the government could refuse the resignation of any board members it wanted to keep. Frankly, any Citi board member should be ashamed of his abject failure to oversee the company adequately.

From the Wall Street Journal:

The Treasury has agreed to convert some of its current holdings of preferred Citigroup shares into common stock, a move that could better protect shareholders against future losses.

As a condition, the government is demanding that the New York company overhaul its board of directors. Citigroup’s board will soon include a majority of new independent directors, the company said Friday. Chief Executive Vikram Pandit is expected to keep his job under the agreement…..

While the government isn’t injecting additional taxpayer dollars into Citigroup, the agreement will help the company by boosting a key financial metric known as tangible common equity, which essentially measures what shareholders would have left if the company were liquidated. The government and banks have concluded that beefing up tangible common equity was a key to arresting the downward spiral in financial companies’ shares….

Citigroup will still have to endure the so-called “stress test,” which examines banks’ ability to withstand various chilling economic scenarios, and could be required to raise additional capital.

The company will reconstitute its board to include a majority of new independent directors. It said of the 15 current directors, three will not stand for reelection and two will reach retirement age, and it will announce new directors soon.

Citigroup Chairman Richard Parsons has been scrambling to lure new directors. That has proven an uphill battle, with two candidates Citigroup approached rebuffing the overtures, according to people familiar with the matter.

Rare cheetah captured on camera BBC

The “Worst Food Product Ever” May Have Been Found [Awesome] Consumerist

And Yet, Still Rules Their World Digby (hat tip reader Doug)

A few words from a reader on TALF mechanics Ed Harrison

Lonely Geithner Felix Salmon

Moody’s predicts default rate will exceed peaks hit in Great Depression Telegraph. The title strikes me as misleading, since it compares overall defaults in the Depression with projected junk bond defaults. However, the authorities back then did not create an armada of fancy facilities to prop up dud borrowers. Who knows where we’d be in their absence.

Top N.Y. legal officer demands bonus list from BofA CEO Reuters

Antidote du jour (hat tip reader Megan):

Apologies for the terse posts tonight; out of town, will be lighter than usual today and tomorrow.

The Financial Times has been keeping tabs on the results, or perhaps more accurately, the lack thereof, of collateralized debt obligations. A couple of weeks ago, it highlighted research by Morgan Stanley and Wachovia that concluded that nearly half the CDOs made from asset backed securities.

Today, Gillian Tett of the FT discusses research on CDOs by JP Morgan and Wachovia. I’m assuming that JP Morgan released an additional study (as opposed to the first article having mistakenly mentioned Morgan Stanley, as opposed to JP Morgan). Tett mentions not only the impressive level of failures, but also the horrid recovery rate.

From the Financial Times:

Just how much should a debt vehicle backed by subprime mortgage bonds be worth these days? Two years ago, most banks and insurance companies assumed the answer was close to 100 per cent of face value – or more…

But as the zeroes relating to writedowns multiply, a peculiar – and bitter – irony continues to hang over these numbers. Notwithstanding the fact that bankers used to promote CDOs as a tool to create more “complete” capital markets, very few of those instruments ever traded in a real market sense before the crisis – and fewer still have changed hands since then.

Thus, the “prices falls” that have blasted such terrible holes in the balance sheets of the banks have not been based on any real market numbers, but on models extrapolated from other measures such as the ABX, an index of mortgage derivatives…

But now, at long last, one shard of reality has just emerged to piece this gloom. In recent weeks, bankers at places such as JPMorgan Chase and Wachovia have been quietly sifting data ….

From late 2005 to the middle of 2007, around $450bn of CDO of ABS were issued, of which about one third were created from risky mortgage-backed bonds (known as mezzanine CDO of ABS) and much of the rest from safer tranches (high grade CDO of ABS.)

Out of that pile, around $305bn of the CDOs are now in a formal state of default, with the CDOs underwritten by Merrill Lynch accounting for the biggest pile of defaulted assets, followed by UBS and Citi.

The real shocker, though, is what has happened after those defaults. JPMorgan estimates that $102bn of CDOs has already been liquidated. The average recovery rate for super-senior tranches of debt – or the stuff that was supposed to be so ultra safe that it always carried a triple A tag – has been 32 per cent for the high grade CDOs. With mezzanine CDO’s, though, recovery rates on those AAA assets have been a mere 5 per cent.

I dare say this might be an extreme case. The subprime loans extended in 2006 and 2007 have suffered particularly high default rates and the CDOs that have already been liquidated are presumably the very worst of the pack.

Even so, I would hazard a guess that this is easily the worst outcome for any assets that have ever carried a “triple A” stamp. No wonder so many investors are now so utterly cynical about anything that bankers or rating agencies might say these days.

After all, when the ABX started taking a dramatically bearish tone 18 months ago, many banks claimed that it was ridiculous that they were writing their mortgage assets down to prices extrapolated from the ABX, since it was popularly claimed that the ABX overstated likely future loss. Even the Bank of England appeared to share that view.

But with the ABX now suggesting that triple A subprime mortgage assets are worth around 40 cents on the dollar (depending on the precise vintage), the message from that might almost be too optimistic in relation to some CDOs. So where does that leave the banks? In reality we will not know whether that horrific 95 per cent loss is unusual until the rest of the CDO of ABS are liquidated too. But for my part, I suspect that the saga strengthens the case for financiers now biting the bullet – and conducting some open auctions of this stuff, to get a bit of market price discovery….

After all, if an open auction ends up pricing mortgage-linked CDOs near zero, at least the capital hit to the banks and insurance companies will be clear; and if it is higher than zero, it might even cheer investors up.

Our sentiments exactly.

Posts will be thin Thursday and Friday (on the road, then at an econbloggers conference hosted by the Kauffman Foundation), so I am giving you extra goodies to keep you busy in the meantime.

Do chat among yourselves. No food fights, however.

Tiger attacks trigger expert plea BBC

Designer Babies – Like It Or Not, Here They Come Singularity Hub

DNA evidence is in, newly discovered species of fish dubbed H. psychedelica UWN News (hat tip reader Tim)

Three Fourths of the European Public Blames the Central Banks for the Financial Crisis Jesse

New U.Va. Study Sheds Light on Foreclosures in States and Metropolitan Areas UVA Today

Taxpayer to guarantee £600bn of toxic debt Times Online

Obama Showers Wall Street Fees With Muni Stimulus Bloomberg

Nationalize Failing Banks? GOP and Single-Payer 2.0 Thomas Ferguson and Robert Johnson, The Nation

‘There will be blood’ Globe and Mail

Did Sweden really nationalize its banks? Ed Harrison

TALF: A bailout if one reads the the fine print Ed Harrison

Charity warns of ‘lifetime debts‘ BBC

The Two Documents Everyone Should Read to Better Understand the Crisis William Black, Huffington Post

Insight: The flight of the long run Peter Bernstein, Financial Times

Markets are Anti-Inductive Eliezer Yudkowsky

The Inversion Of Corporate and Sovereign Risk, Or The Sovereign Basis Trade Tyler Durden

Antidote du jour:

I wish I had the time to analyze this deal, but my travel schedule is cutting into blogging time, In addition, I don’t have a feel for whether the units mentioned in this article are merely suffering in accord with the crappy financial environment, or may have suffered additional, perhaps lasting damage.

Two observations: First, every time AIG has retraded its deal the US taxpayer has come out worse, so my assumption in the absence of conflicting evidence is that this is more of the same.

Second, many observers refer to AIG as “nationalized” due to the government’s 79.9% ownership. But has the Federal Reserve, for instance, asked board members to submit letters of resignation? Power is not simply a function of standing, but also of will, and the powers that be seem to have exercised just about no influence, save the ouster of CEO Robert Willumstad and raising a stink about fancy parties. Note the desire expressed to keep AIG afloat. In context, it could just as well mean preserving their standing as a private concern, rather than merely operating as a business. If AIG were truly nationalized, rating agency downgrades would not be an issue; the firm would be treated as state owned, hence state backed and deserving of an agency-type rating.

Informed reader comment encouraged. From the Financial Times:

AIG and the US authorities are in advanced discussions over a radical restructuring that would split the stricken insurer into at least three government-controlled divisions in an attempt to keep it afloat, according to people close to the situation.

The restructuring, described by one insider as a “controlled break-up”, could lead to the end of AIG’s 90-year history as a stand-alone global insurance conglomerate. It also could provide a template for carving up other troubled financial groups – such as Citigroup – should they be brought under government control…

Under the plan, the government would swap its current 80 per cent holding in the insurer for large stakes in three units – AIG’s Asian operations, its international life insurance business and the US personal lines business. A fourth unit, comprised of AIG’s other businesses and troubled assets, could also be formed.

In return, the authorities would relax the terms, or even cancel a large portion, of a $60bn five-year loan to AIG and convert $40bn-worth of preferred stock into shares, in an effort to ease the company’s burden.

If the plan goes ahead, AIG would remain as a holding company for now. But people involved in the talks say that company could disappear if the government decides to recoup taxpayers’ investments in the insurer by selling or listing the three divisions separately…..

However, people close to the situation said AIG was on track to announce the overhaul on Monday, when it is expected to report a $60bn loss with its fourth-quarter results….

One of AIG’s most prized assets, American International Assurance, its Asian business that was once valued at $20bn, attracted lukewarm interest. Potential bidders have been deterred by turbulent conditions in insurance and credit markets.

The sale of AIG’s US personal lines business, which had been close to being acquired by Zurich Financial, has also run into trouble as funding markets remain under pressure, according to people familiar with the process.

The two divisions are likely to split off. The third unit to be carved out, American Life Insurance Company, is a global life insurance company with operations in more than 50 countries and a large presence in Japan.

It remains unclear whether the US life insurance business and Foreign General, AIG’s international property and casualty insurer, will be included in one of the three divisions or sold separately. International Lease Finance Corporation, AIG’s large aircraft leasing business, is likely to be given a government credit line and put up for sale.

Note the wording Goldman used in describing the implications of the decline in income tax revenues in China, via Bloomberg (hat tip reader MIchael):

“Tax data show much sharper deceleration in income and consumption in the past few months than suggested by official retail sales or income growth figures,” Goldman Sachs analysts Joshua Lu, Caroline Li and Fiona Lau wrote in a note today.

Value-added tax has “de-linked sharply” from retail sales figures, the analysts wrote. VAT rose 1 percent in the fourth quarter from a year earlier, while retail sales gained 21 percent, according to the note….

Growth in China’s individual income-tax receipts “slowed down significantly” in the second half and shrank in December and January, the Goldman Sachs analysts wrote. This compares with nominal wage growth of 21 percent in the third quarter, the report said.

One obviously has to tread carefully when pointing out official data looks to be cooked.

Reader M&M called my attention to a Bloomberg story I was really hoping to avoid, “U.S. Sets a Six-Month Deadline for New Bank Capital“. The opening:

The government set a six-month deadline for the biggest 19 U.S. banks to raise any new capital deemed necessary after a mandatory review of their balance sheets.

The regulators will oversee the so-called stress tests by the end of April, which will identify how much extra cushion each bank will need, the Treasury said today in Washington. Lenders will have six months to raise private capital or accept government funds and the conditions that come with it.

“While the vast majority of U.S. banking organizations have capital in excess of the amounts required to be considered well capitalized, the uncertain economic environment has eroded confidence in the amount and quality of capital held by some,” the Treasury said, announcing guidelines for new bank reviews.

Let’s work through this starting with the last paragraph. The new Administration has been in office only a bit more than a month, and the double-speak has already started to wear thin. If anyone really believed these banks’ capital was adequate, would we have this never-ending parade of special facilities, rate cuts to near zero levels, and programs to rescue stressed borrowers? All the interventions say loud and clear that most if not all of the big banks are in parlous shape, but the Administration keeps repeating the canard that the banks have more capital than needed “to be considered well capitalized.” Well, either the standards for capital adequacy are rubbish or all the weekend specials and Congressional high stakes poker have been a complete waste of taxpayer money. You can’t have it both ways, and you reduce your credibility by peddling this sort of thing. And this isn’t just my reaction; readers who have seen this sort of formulation (it has shown up before) find it either comic or pathetic.

Let us return to the first part, which is even more remarkable. The government is giving banks six months to raise more equity if they are deemed to need it, and if not, they will have to take government funding on whatever terms are on offer.

Anyone with a passing familiarity with the banks suspected of being in most urgent need of new funding, Citigroup and Bank of America, knows that their stock prices have fallen to levels that suggest serious doubts about their survival. Meredith Whitney, the bank stock analyst whose forecasts have been most accurate, said her best idea was to short Ciitgroup, last week, even at super depressed levels.

So my assumption in reading this post was that this was the Team Obama approach to nationalization, or whatever term they use to try to rebrand the process. Show you’ve bent over backwards by given banks every chance to dig their way out of their mess (six month is long enough that they could try a restructuring or breakup, as well as conventional fundraising) and then do what needs to be done.

But my assumptions may be uncharacteristically optimistic. Tom Ferguson (via e-mail) has another take:

The stress test “worst” scenario is pretty silly and optimistic; 3.3 % decline this year, small rise next year. So not too much stress. That sets the parameters of necessary capital. If you believe Bernanke, most pass. They just won’t lend.

While I agree that the stress test scenarios are not dire enough (and others, see here and here share that view). Even the anodyne New York Times casts doubts:

But analysts say the administration’s worst projections, which it describes as unlikely, are not much more dire than what many private forecasters already expect.

According to the new Treasury Department guidelines, the banks would have to assume that the economy contracts by 3.3 percent this year and remains almost flat in 2010. They would also have to assume that housing prices fall another 22 percent this year and that unemployment would shoot to 8.9 percent this year and hit 10.3 percent in 2010.

“I don’t think they are harsh enough,” said David Hendler, an analyst at CreditSights, who said the dire projection was itself too optimistic about the growth that would be generated from President Obama’s stimulus program. “That would be a pleasant outcome, but you have to plan for the worst.”

However, there has also been language in some of the pronouncements on the stress tests that it would call for capital above normal levels. That may simply be to finesse the difference with regulatory requirements, but the wording was sufficiently imprecise as to give the impression the new buffer might be temporary (forgive me for failing to find it, but I have to be on an early flight tomorrow, and was unable to locate it in the five minutes I could spare). Thus even with the less than dreadful worse case, banks could still be required to stump up more equity.

But the scary view comes from Ed Harrison:

Obviously, Geithner, Bernanke, et al. believe ‘irrational despondence’ is the source of what ails us and that propping up asset prices will be the cure.

Witness remarks made by Ben Bernanke just recently before Congress:

Federal Reserve Chairman Ben Bernanke said Wednesday recent sharp declines in stock prices mostly reflected investor attitudes about risk and had become detached from real U.S. economic fundamentals.

The risk appetite of investors changes over time and right now the standard measures of the risk premium that investors are charging to hold stocks are at very high levels relative to anything we have seen in recent decades,” Mr. Bernanke said in semi-annual testimony to Congress.

The stock values reflect not so much the fundamentals, the long-term profitability of the economy, but they also reflect investor attitudes about risk and uncertainty which right now are at very high levels,” he told lawmakers during questions.

U.S. stocks have fallen to 12-year lows this month, with the benchmark S&P 500 down about 15% and the Dow Jones industrial average off about 16% since the start of 2009.

This goes to the mindset here. What Ben Bernanke does not say but clearly suggests is that asset prices are being depressed artificially by ‘irrational despondence.’ Stepping in to offer a bid to these assets will lift them — at which point the despondence will go away and all will be fine with the world.

This view is misguided because many asset prices are still above their long-term trend. This is certainly the case with house prices, where renting is still significantly cheaper than purchasing in many locales.

Yves again. Looking at “recent” norms with stock prices is also misleading. Martin Wolf, who had no axe to grind, pointed out that equities were overvalued in March 2007. Indeed, a significant deviation from long-term trends started in late 1996 (remember Greenspan’s “irrational exuberance” remark?) and the excess of that decade was enough to shift long term averages. When I was a young person on Wall Street, market PEs of 16 were peak multiples. They came to be seen as normal.

What is amazing is the degree to which Bernanke has been unable to process what has happened over the last year and a half. It isn’t simply that he is trying to restore status quo ante; he seems to see the only possible operative paradigm as the status quo ante. Worse, he has a romanticized view of it too.

We had a massive stock market bubble, followed by an even bigger asset orgy, with housing at the epicenter, but plenty of other types got dragged along with it. Having asset appreciation fueled by debt is NOT how a healthy economy operates. It is going to take some time for the excesses to work themselves through. Carmine Reinhart and Kenneth Rogoff’s study of major postwar financial crises have found stock prices take 3 1/2 years to bottom.

But Ben believes the trend from here has to be up, and seems unable to consider that rather than the risk appetite being irrationally low now, it may have been irrationally complacent earlier.

Nassim Nicholas Taleb, of Black Swan fame, joins the chorus in attacking asymmetrical bonuses, the “head’s I win” if things go well, “tails you lose” syndrome.

An oversight in this piece is that this approach nevertheless worked reasonably well in the old Wall Street. Why? The big reason was that you had owner/managers whose capital was at risk making the bonus decisions. And in the old days, partners had smaller spans of control. Any unit or desk that was a reasonable size profit center had a partner in charge, which meant they were working side by side with the troops, familiar with the risk of deals and positions and able to observe individual actions at close range.

The old Wall Street also featured far less cash comp. The line at Goldman was that partners lived poor and died rich. When they became partner, they took a considerable cut in current income from what they would have been making as vice presidents (their partnership earnings were reduced by the interest on the loans to acquire the stake). Thus new partners had to keep working hard to increase their ownership stake in the firm to realize a better lifestyle. And the VPs and juniors were no where near as well paid (relative to average salaries) as in recent years. They certainly lived well by any standards, don’t get me wrong, but their is a big difference between being well paid and lavishly paid.

Taleb suggests that rewards need to be more symmetrical, with performers taking hits or having clawback provisions, but does not say how they might be put into effect. He also reminds us that money is not the only reward system; in other professional cultures in the US, pay differences are minor; status and reputation count for more.

From the Financial Times;

One of the arguments one hears in the compensation debate is that the bonus system used by Wall Street ….is there to “reward talent”. While I find this notion of “talent” debatable, I fully agree that incentives are the heart of capitalism and free markets – but certainly not that incentive scheme.

In fact, the incentive scheme commonly in place does the exact opposite of what an “incentive” system should be about: it encourages a certain class of risk-hiding and deferred blow-up. It is the reason banks have never made money in the history of banking, losing the equivalent of all their past profits periodically – while bankers strike it rich….

Take two bankers. The first is conservative. He produces one annual dollar of sound returns, with no risk of blow-up. The second looks no less conservative, but makes $2 by making complicated transactions that make a steady income, but are bound to blow up on occasion, losing everything made and more. So while the first banker might end up out of business, under competitive strains, the second is going to do a lot better for himself. Why? Because banking is not about true risks but perceived volatility of returns: you earn a stream of steady bonuses for seven or eight years, then when the losses take place, you are not asked to disburse anything. You might even start again, after blaming a “systemic crisis” or a “black swan” for your losses. As you do not disgorge previous compensation, the incentive is to engage in trades that explode rarely, after a period of steady gains.

Here you can see that this mismatch between the bonus payment frequency (typically, one year) and the time to blow up (about five to 20 years) is the cause of the accumulation of positions that hide risk by betting massively against small odds….

If capitalism is about incentives, it should be about true incentives, those resistant to blow-ups. And there should be disincentives to remove the asymmetry of the free option. Entrepreneurs are rewarded for their gains; they are also penalised for their losses. Now, by comparison, consider that Robert Rubin, the former US Treasury secretary, earned close to $115m (€90m, £80m) from Citigroup for taking risks that we are paying for. So far no attempt has been made to claw it back from him – only UBS, the Swiss bank, has managed to reclaim some past bonuses from its former executives….

[W[hen it comes to banks and other “too big to fail” entities, the problem is severe: we taxpayers in our respective countries are funding these global monsters and are coughing up money for mistakes made by bankers who retain their bonuses and are hijacking us because, as we are discovering (a little late), banking is a utility and we need them to clean up their mess....

The Obama administration has been trying to set compensation limits for banks under the troubled asset relief programme. But this is insufficient. We need to remove the free option. Beware the following situations.

First, those who are taking risks even outside Tarp or society’s protection can still be gaming the system – since their risk-taking can result in a collapse, with the taxpayer having to step in. For instance, Goldman Sachs, the US bank, might want to avoid the limits on executive compensation for its managers. That should be fine so long as society does not have to bail out Goldman Sachs (or, worse, its creditors) in the future.

Second, Vikram Pandit, Citigroup’s chief executive, while claiming to want to earn one single dollar a year in compensation unless the bank returns to profitability, is still getting a free option given to him by society. He does not partake of further losses; we do.

Third, leveraged buy-out companies used the free option by borrowing heavily from the banks and taking monstrous risks: they get the upside, banks (hence we taxpayers) get the downside. These partnerships made fortunes in the past on deals that society will have to bail out. They too should have their past profits clawed back.

Indeed, the incentive system put in place by financial companies has produced the worst possible economic system mankind can imagine: capitalism for the profits and socialism for the losses.

Finally, I was involved in trading for 21 years and I can testify that traders consciously play the free option game. On the other hand, I worked (in my other job as risk adviser) with various military organisations and people watching over our safety. We trust military and homeland security people with our lives, yet they do not get a bonus. They get promotions, the honour of a job well done and the disincentive of shame if they fail. Roman soldiers signed a sacramentum accepting punishment in the event of failure. This is prompting me to call for the nationalisation of the utility part of banking as the only solution in which society does not grant individuals free options to look after its risks.

No incentive without disincentive. And never trust with your money anyone making a potential bonus.

To be honest, I’m not quite sure how to read this Wall Street Journal piece, since this is a spat between two parties, with a “he said, she said” quality to it. However, the title, “Citigroup Chafes Under U.S. Overseers:” suggests a bias in favor of Citigroup.”Overseers” is a weak word, suggesting Uncle Sam really doesn’t have legitimate authority to take the actions it is demanding.

But that assumes both viewpoints are equally legitimate, when the case can be made that they aren’t. Poor abused Citigroup is unhappy that the government is trying to leash and collar the behemoth company. They somehow seem unable to process the fact that if they had done the same lousy job with a smaller institution, it would already have been seized by the FDIC and put in to receivership.

This viewpoint is not an exaggeration of the facts on the ground. As former bank regulator William Black points out in “Why Is Geithner Continuing Paulson’s Policy of Violating the Law?“:

Whatever happened to the law (Title 12, Sec. 1831o) mandating that banking regulators take “prompt corrective action” to resolve any troubled bank? The law mandates that the administration place troubled banks, well before they become insolvent, in receivership, appoint competent managers, and restrain senior executive compensation (i.e., no bonuses and no raises may be paid to them). The law does not provide that the taxpayers are to bail out troubled banks.

The other bit of bias is in how the piece characterizes the relationship. It mentions the 7.8% equity state the government holds, but fails to acknowledge the additional guarantees of what amounts to $250 billion of loans (once you parse out first losses and loss sharing arrangements). The story also depicts a possible effort to break up the bank as politically motivated, as opposed to something that would make managerial sense. The span of control in the bank is simply too large, and the synergies between many of the businesses are weak to non-existent. Plus every study ever done of banks in the US had found that banks, once they exceed a certain asset size, show a slightly INCREASING cost curve, as in their costs/revenues rise. Big banks are not more efficient; the evidence is that they become a tad less efficient the bigger they get.

So why were banks so keen to consolidate? Might have to do with the fact that CEO pay is (was) correlated with asset size of bank.

From the Wall Street Journal:

Citigroup executives are attempting to strike a seemingly impossible balance: Run the business in a way that will please their new federal masters, but also help the bank rebound from $28 billion in losses over the past five quarters.

Yves here. That is another company-serving bit of spin. Does anyone think, with pretty much all advanced economies contracting and deleveraging likely to continue, that there are great profit opportunities out there?

The “help the bank rebound” bit makes it sounds as if the Citi crowd is really trying hard to do the right thing, when looking high returns in a market like this is what economist Tom Ferguson calls a “Hail Mary pass”: taking risk with taxpayer money.

Remember the original terms of the TARP funds: preferred stock with a 5% coupon for five years, then the dividend rate increases. One could argue that for a not-so-large loan, that might be a good incentive (I don’t subscribe to that view), but the fact is it gives the bank reason to gamble. And the more they’ve borrowed, the higher the desperation level (until the debt reaches a level where it is clear, like AIG, that there is no way out). Back to the piece:

Former federal officials have dubbed Citigroup the “Death Star,” comparing the bank’s threat to the financial system with the planet-destroying super weapon in the “Star Wars” movies. Privately, in the words of one official, they regard the banking giant as “unmanageable.”

Complicating the issue is the government’s back-and-forth between bouts of micromanaging the banking giant and periods of ignoring it. In trying to be neither an active nor a passive investor, the U.S. is directing the business without a firm strategy or particular expertise.

Yves here. That sounds completely plausible. But if you have ambiguity in the relationship, Citi could have used that to help define it, by being very pro active on certain axes (of course, ones that suited them) and hope that the display of seeming good faith (and keeping supervisory personnel busy) would buy them slack on other fronts. Back to the piece:

Central to the confusion: There’s no one individual or entity in charge of the federal oversight of Citigroup.

That’s because banks like Citigroup are regulated by a patchwork of agencies including the Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. The Treasury Department also has oversight because it’s the one that is injecting government capital into the banks. And members of Congress, who initially approved all that money, have their own stake in how things play out. All these interested parties have been handing Citigroup a jumble of sometimes conflicting orders, advice and critiques.

Officials with the Fed, for instance, informed Citigroup executives they have “observer rights” that entitle them to participate in the bank’s board meetings. Though the government hasn’t joined in so far, the fact that it might has led some Citigroup executives to complain privately that the U.S. now has “unlimited power” over the bank. One person close to the company compared the government’s role to the sword of Damocles, an ever-present evil hanging over their heads.

At a minimum, the powers that be should be getting minutes of board meetings. But the sword of Damocles is par for the Citibankers not getting it. They are wards of the state, yet want the rights of a private concern. Back to the article:

But even as the government has ensured Citigroup’s survival for now, bank executives say they have been left to read tea leaves about how to implement federal directives.

U.S. officials say Citigroup’s problems are wide-ranging, presenting issues for various governmental agencies — all of which are also engaged in handling problems involving other banks and the economy. Some officials say they have given Citigroup executives broad outlines of what they’d like the company to do. They say thus far it’s not been the government’s position to give Citigroup a specific playbook about how to put directives in place. The current talks for federal assistance, however, could result in more direct orders on how Citigroup should proceed.

Without having more detail, it is hard to know what to make of this. The Citi staffers are unhappy that the government is giving orders, and then unhappy that the orders are vague? The various government officials may indeed be being vague to try to avoid being overdirective.

But if Citibank isn’t sure what will fly, why not write a plan or program back as a forcing device? The fact that this wasn’t done makes me think the complaints are mere kvetching. There is more that Citi could do to make this messy arrangement less ambiguous, and they don’t appear to be taking those steps. This bit argues otherwise:

In recent weeks, Citigroup executives have reached out to various government officials for guidance — with little to show for their effort. Last week, Mr. Pandit met with Lawrence Summers, the government’s chief economic adviser, in the White House’s West Wing. Mr. Summers made clear that he wouldn’t discuss Citigroup specifically, and Mr. Pandit emerged from the meeting with no better idea of where the Obama administration stands in managing ties with the big bank.

Yves here. I would not have recommended a meeting of that sort without doing groundwork. And how involved is Summers with Citi on a day-to-day basis anyhow? It is impossible to tell, but it give the impression that Pandit walked in trying to get an answer from Summers, who is probably unfamiliar with the details anyhow even if he had been inclined to answer? An approach more along the lines of “we’d like to have a productive relationship, here is our impression of where things are working well, here are areas where we have a lot of uncertainty. Should I look to you to help work this out? If not, how do you suggest I proceed?” Now that may have been what happened, but the article does not give that impression.

And then we get this:

Amid the anxiety, Edward Kelly, a senior investment banker and one of Mr. Pandit’s closest confidants, used his personal misfortune to ease tension within Citigroup. After a trying visit to Washington to brief regulators, Mr. Kelly returned to his Baltimore home tired — and soon woke up to a screeching smoke alarm. Finding flames in his home office and working to halt the fire from spreading, Mr. Kelly burned his right hand and arm so badly that doctors kept him home for several days to prevent infection.

In a flurry of phone calls while he was home recuperating, Mr. Kelly joked to colleagues that he was putting out fires at both his home and his company.

What does this have to do with the thrust of the article? And we have this:

Communications from government officials, meanwhile, have been spotty. Friday afternoon, after the bank’s shares had closed the week at an 18-year low of $1.95, top executives reached out to the Office of the Comptroller of the Currency and the New York Fed. They wanted to discuss Citigroup’s proposal to substantially enlarge the government’s ownership stake. The conversations were constructive, but they couldn’t progress much until they heard from Treasury, the government arm that had invested in Citigroup’s preferred stock and therefore would need to bless converting that stake into common shares.

Through the weekend, Citigroup didn’t hear from Treasury officials. Then on Sunday evening, Mr. Pandit’s phone rang. It was Treasury Secretary Timothy Geithner, calling with a message: “I think we just need to do something.” Mr. Geithner was short on specifics, but said he was ready to entertain Citigroup’s idea of converting a big chunk of the government’s preferred stock into common shares.

Yves again. Citi wanted a weekend special. Team Obama has a lot on its plate (auto bailout, G20, need to flesh out details of housing plan). As we indicated at the time. we did NOT see Citi getting a deal over the weekend. Why? With all the government backstopping, a tanking share price isn’t the big deal it once was. In the absence of a depositor or counterparty run, this indeed COULD wait a few days, But Citigroup characterizes it as poor communications. Heck, they were the ones who called in a panic.

And we have this:

Citigroup’s guessing game also extended to congressional hearings held earlier this month. Legislators pounded Mr. Pandit and other bank executives for putting their institutions in jeopardy. As Mr. Pandit prepared for the hearings, some Citigroup executives urged him to make two concessions: apologizing for the corporate-jet fiasco and agreeing not to get paid until Citigroup returns to profitability. Others argued that such conciliatory gestures would validate unfair criticisms of the company. Mr. Pandit ultimately made both concessions at the hearing.

Yves again. Huh? A guessing game? Lee Iaccoa knew exactly what to do when he asked for a bailout for Chrysler (merely a Federal guarantee of its bonds). He took a $1 salary until the debt was repaid. The “guessing game” monicker makes it sounds like its the government’s fault that Pandit was getting conflicting advice from his team. No, he was merely getting bad advice from some that he needed to reject, as he did. Anyone who didn’t live in the Wall Street entitlement bubble would have known better.

There is a good deal more in the piece, but you get the point. That does NOT mean the Administration is handling Citigroup well either. It’s a new team dealing with an unprecedented situation. But my reading of this article says it should be taken with a fistful of salt.

Japan has been hit by a double-whammy: the global fall in trade, made worse by its (formerly) rising yen.

While deteriorating conditions in China generally get more media attention, the falloff in Japan is stunning and serious. Japan has spent more than a decade stagnant, but the overall growth figures mask the fact that the domestic economy contracted, while the export sector exhibited good growth.

The export plunge (December’s results horrid too, a 35% fall in exports), means that Japan’s only engine of growth has gone into stall. China, by contrast, is not as dependent of trade for its overall performance as is popularly believed (commercial real estate and infrastructure spending have also been important sources, although CRE has taken a dive too).

The fact that Japan is now running trade deficits also means they will not be accumulating foreign exchange reserves, specifically buying Treasuries (Japan could still buy Treasuries to lower the value of its currency, but the terrible economic news has already put the yen on a downward path).

From Bloomberg:

Japan’s exports plunged 45.7 percent in January, resulting in a record trade deficit, as recessions in the U.S. and Europe smothered demand for the country’s cars and electronics…

Gross domestic product shrank at an annual 12.7 percent pace last quarter, the most since the 1974 oil shock, and economists predict the slump will drag into this quarter. Toyota Motor Corp., Sony Corp. and Hitachi Ltd. — all of which forecast losses — are firing thousands of workers, heightening the risk the recession will deepen.

“The drop in exports is unbelievably bad,” said Yasuhide Yajima, a senior economist at NLI Research Institute in Tokyo. “The pressure on companies to cut jobs and investment is rising and that will make the recession deep and protracted.”…

Japan’s economy, the world’s second largest, may shrink a record 4 percent in the year starting April 1, faster than this year’s projected decline of 2.9 percent, according to the median estimate of 15 economists surveyed by Bloomberg News. The worst contraction to date was fiscal 1998’s 1.5 percent drop.

Lifeline for endangered albatross BBC

First evidence of a supernova in an ice core physics arXiv

Thousands queue at New York job fair Financial Times

The Media Continue to Ignore Welfare for Citi Shareholders Beat the Press

AIG’s Liddy May Shift Strategy as Asset Sales Stall Bloomberg and As A.I.G.’s Losses Grow, Its Survival Options Shrink New York Times

The Bernanke rally Jim Hamilton

Bernanke – the pot calls the kettle black Bruce Krasting

German CDS debt spreads hit record as economy crumbles Telegraph

The Inevitability of U.S. Debt Repudiation Paul Kedrosky (hat tip reader Dwight)

Antidote du jour (hat tip reader Rob):

Tech layoffs: The scorecard CNet (hat tip reader John)

Shiller: House Prices Still Way Too High Clusterstock

U.S. Consumers Driven Away From Drink Spending: Chart of Day Bloomberg (hat tip reader John). Gee, I am not part of this trend, although it would be better if I were.

US natural gas prices could hit $2/MMBtu this year: analyst Platts (hat tip reader Michael) $4 was not too long ago considered an uber bearish forecast.

The right way to create a good bank and a bad bank Financial Crisis and Reform (hat tip reader Paul). Clever, and I’ve only looked at this superficially, but I am suspicious of any arrangement where equity depends to a significant degree on cross shareholdings. That helped rationalize rampant overvaluation in Japan. I’ve also seen it create useless accounting within companies (Citi was a prime example) where double counting lead to the sum of profit center earnings (the internal business unit profit measure) being two or three time reported profits.

American Express Wants To Help You ‘Simplify Your Finances’ — Will Pay You $300 If You’ll Close Your Account Credit Matters

Lawmakers Aim at Fine Print in Financial Agreements Bloomberg

Antidote du jour:

Sports fans, your humble blogger earnestly endeavors to keep up with the machinations of of big financial firms to extract rents from the poor chump taxpayer, usually by invoking scary images of the financial version of nuclear winter. Since we seem to be heading there anyhow, I’m at a loss to explain why these tactics should have such sway with the officialdom, save that they labor under the delusion that their efforts are having a positive effect.

The latest canard is the pretense at negotiations with AIG. If you recall, AIG, which is regulated by a host of countries at the insurance subsidiary level, came begging to Uncle Sam because it had a credit default swaps unit at the holding company level that had written unhedged policies that looked pretty certain to crater the parent company. Even though the subsidiary companies are well regarded (in many cases very well regarded) they cannot readily upstream cash to the parent. The only way to realize value is by selling them, and this isn’t a great environment for doing that.

What has been appalling about AIG is that Uncle Sam initially imposed a suitably puntitive deal but then for reasons that remain a mystery, relented . Since the federal government is NOT a regulator of AIG, there was no reason to expect the authorities to step in, save Ben Bernanke and Hank Paulson’s attentiveness to the needs of the financial sector generally. AIG has globe-spanning operations, and there is no good reason why the US public should be stuck with the consequences of their lousy risk management decisions. But not only did AIG get considerably more in loans in version 2.0 of its deal with the US government, but the terms on its initial loans were improved considerably.

I have to tell you, in all my years of private sector dealings, when a company comes back for more money, particularly when it has missed targets (as AIG did, it claimed the initial loan would be sufficient), the new money, be it debt or equity, comes on vastly more costly terms. And it is simply unheard of to revise an initial deal to be more company friendly. I do not know why the travesty of the kow-towing to AIG’s faux needs has not resulted in more ridicule.

And it only gets worse. AIG is on the verge of getting even more fawning treatment from a “sympathetic” government. Do little guy deadbeats get such kid glove treatment?

From Bloomberg:

American International Group Inc., the insurer bailed out by the U.S., may restructure its rescue package for the second time in four months as the recession drains the value of mortgage-backed bonds and corporate debt.

AIG may announce that it is converting the government’s preferred shares into common stock to relieve pressure on the New York-based firm’s liquidity, a person familiar with the situation said yesterday. AIG pays a 10 percent dividend on preferred stock, and none on common shares

Yves here. What moron negotiated this deal? Why does AIG have an option? AIG is a ward of the state, it really ought to be nationalized, but instead we preserve the fiction that it is a private entity, which means it can loot the public by paying large numbers of executives “retention bonuses”. The US debt per AIG employee is $1.4 million. With that level of required repayment, AIG should be on a choke hold. But instead, we allow them latitude that seems completely unwarranted.

And why does “liquidity” matter? This again goes back to the fiction that it is a viable entity. Liquidity in a business backstopped by Uncle Sam is an irrelevant concept. Since the taxpayer will pay whatever it takes to keep AIG afloat, niceties like ratings and liquidity are bogus concepts (if we were in an ideal world, someone at Treasury should have told the rating agencies to quit publishing ratings, but oh no, having no ratings to fall back on would lead to confusion and would hurt AIG. Anyone still owning AIG bonds post the bailout is an adult able to assess the risks, and are not entitled to special treatment. There has been plenty of time for widows and orphans to get out. Back to the article:

Details of a new rescue package may be announced when AIG posts fourth-quarter results, said the person, who asked not to be identified because talks with the government are private. Results may be disclosed next week…

The government is “sympathetic” to AIG’s circumstances and the turmoil affecting would-be buyers and may change rules governing the sale of assets, the person said.

Guess the continuing deterioration in the stock market is beginning to capture the attention of the financial regulators. The Treasury, FDIC, OCC, OTS, and Federal Reserve issued a joint statement just after 4:00 PM (hat tip reader Steve). Some key bits (boldface ours);

A strong, resilient financial system is necessary to facilitate a broad and sustainable economic recovery. The U.S. government stands firmly behind the banking system during this period of financial strain to ensure it will be able to perform its key function of providing credit to households and businesses. The government will ensure that banks have the capital and liquidity they need to provide the credit necessary to restore economic growth. Moreover, we reiterate our determination to preserve the viability of systemically important financial institutions so that they are able to meet their commitments.

Yves here. Rather amusing. The first sentence basically says the US needs a healthy banking system to start growing again, the second acknowledges it is on life support. We are still waiting for details on how the government “will ensure” that things will be OK. The fourth sentence is a “no more Lehmans” promise. Back to the piece:

We announced on February 10, 2009, a Capital Assistance Program to ensure that our banking institutions are appropriately capitalized, with high-quality capital. Under this program, which will be initiated on February 25, the capital needs of the major U.S. banking institutions will be evaluated under a more challenging economic environment.

Yves here. Translation: “We have a program, why are you guys so anxious?” Back to the announcment:

Should that assessment indicate that an additional capital buffer is warranted, institutions will have an opportunity to turn first to private sources of capital.

Yves here. Who do they think the audience for this is, morons? These banks have been desperately trying to raise equity, the last successful party was Goldman on rather punitive terms (the Buffet preferred stock also had very rich conversion rights). Sovereign wealth funds aren’t buying and TPG got burned on WaMu. And then Paulson gave much better deal than the least sick looking bank, Goldman, was able to extract. But you are seriously trying to tell us there might be private capital for banks at anything other than confiscatory terms? Back to the release:

Otherwise, the temporary capital buffer will be made available from the government. This additional capital does not imply a new capital standard and it is not expected to be maintained on an ongoing basis. Instead, it is available to provide a cushion against larger than expected future losses, should they occur due to a more severe economic environment, and to support lending to creditworthy borrowers.

Yves here. This wrinkle is new. So the powers that be are going to temporarily overcapitalize the banks, and pretend it is merely undue caution, rather than the required amount expected to cover unearthed or likely to be realized near term losses. Charming. More details:

Any government capital will be in the form of mandatory convertible preferred shares, which would be converted into common equity shares only as needed over time to keep banks in a well-capitalized position and can be retired under improved financial conditions before the conversion becomes mandatory. Previous capital injections under the Troubled Asset Relief Program will also be eligible to be exchanged for the mandatory convertible preferred shares. The conversion feature will enable institutions to maintain or enhance the quality of their capital.

Currently, the major U.S. banking institutions have capital in excess of the amounts required to be considered well capitalized…

Yves here. Yes, that’s how we got in this mess. The standards are inadequate given the risks these firms were taking. Pretty much no one in the private sector (except bank management on their more delusional moments) believes the large US banks have enough equity. Back to the release:

Because our economy functions better when financial institutions are well managed in the private sector, the strong presumption of the Capital Assistance Program is that banks should remain in private hands.

Yves again. The boldface verges on comedy. The financial firms HAVEN”T been well managed, but evidently you’ve been asleep for the past six plus years. And there is no acknowledgment of what you intend to do about deficient private management, save throw more money at it, which does not sound reassuring.

The markets want action, not more words, I doubt anyone with an operating brain cell will take much comfort from this.