The Banks and Orwell

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I continue to be amazed at the bank cheerleading in the press.

Admittedly, article writers are not responsible for headlines, so I do not know who to hold responsible for this New York Times item, “As Stress Tests Are Revealed, Markets Sense a Turning Point.”.

How much have bank stocks rallied since March 9? Declaring the up move today a turning point is nearly two months late.

And while writer Eric Dash does cite a litany of possible positives, as well as some cautionary notes, a more realistic assessment comes from reader Dean:

What I don’t understand is market reaction. We now know that the main motivator is for government to avoid further TARP infusions if they can be avoided.

Message #1 from government: if real trouble appears it would not be politically easy to provide additional support; a less refined version of the same message is “banks you are on your own”.

Message #2: Conversion of preferred to common. Taxpayer conversion from lender status to a partner status assuming both risks and rewards (mostly risk). The message here is that existing stockholders will take a hit through dilution…unless…banks sell assets or raise private placement equity. For such to occur you need optimistic markets and financials rallying.

Am I the only one who sees the blatant manipulation? How can this be good for existing stockholders? So why are financials rallying? The regulator has become a stockholder.

One characteristic of the moves to shore up the banking industry to date is that (when they are deliberate) they have been based on undue optimism (Bernanke’s ‘subprime is contained”, the belief after each of the first three acute phases that the interventions were successful and no more needed to be done, the assumpton that non-recourse loans will induce investors to overpay markedly for bad assets) followed by panicked overshoot when things got bad (75 basis point rate cuts, TARP, letting AIG put up full collateral for counterparties).

So my best guess is that this is a quite deliberate effort (there are credible reports of active efforts to squeeze short sellers) to pump up the bank stocks to facilitate their fundraising. John Dizard had urged central banks sponsoring road shows nearly a year ago to help them raise the needed equity. I’d prefer an open sales effort to this mingling of hucksterism with supposed regulatory policy. And they have clearly been intermingled. Note how the prime objective of the stress tests has been above all to restore confidence. Huh? The most important aim should be to assess their condition so as to determine what if anything needs to be done. To subordinate proper regulatory action to reassuring “the markets” is backwards. If the public had faith in the integrity of the process, the need for a confidence exercise would vanish.

And pretty much no one who has thought about them likes this exercise. The New York Times sponsored a mini op-ed on the stress tests. I’m sure they would have liked to get a spectrum of views, but everyone they got to opine either hated them or damned them with very faint praise.

A separate Orwell sighting is the degree to which otherwise sensible people have fallen for the idea that banks are above the law, From Felix Salmon:

I fear that in the wake of these stress tests, Treasury will have created an atmosphere of antagonism and mistrust which is going to make it almost impossible to push through the kind of root-and-branch regulatory reform that’s desperately needed. Without the banks’ buy-in, no new regulatory structure is going to work — but right now the banks have every incentive to hide things from Treasury and the regulators, rather than to work with them to strengthen the system as a whole. The stress tests might end up improving the banks’ TCE ratios — but that doesn’t mean they will end up improving the health of the financial system as a whole.

Since when do the regulated get a vote on how they are regulated? Only in our modern world of a banking lobby that runs Washington, but this is NOT how regulation is supposed to operate. A regulator has the power of life and death over its charges. If he pulls their license, they are out of business. This idea that the regulated can negotiate as equal partners is truly bizarre.

I e-mailed Felix’s paragraph to Marshall Auerback, who replied:

He’s completely wrong. If you read Michael Perino’s account of the Pecora hearings, you’ll see that the banks fought this tooth and nail the whole way. Perino is a professor of law at St. John’s, currently writing a book on this right now. He was on Bill Moyers’s show a few weeks ago and said this:

MICHAEL PERINO: Glass-Steagall, or the idea behind Glass-Steagall, to separate the commercial banks from the investment banks, had been an idea that was floating around since at least 1930. And essentially, the political bias toward keeping everything the way it was, was sufficiently strong that the idea went nowhere until Pecora showed all the things that the securities affiliates were doing that were improper. And within six months, Glass-Steagall was passed.

Pecora’s hearings basically discredited the Wall Street chieftains and created the political conditions to regulate them properly, which is why this is being resisted so aggressively this time by Wall Street. M. Rodgin Cohen [managing partner of Sullivan & Cromwell] is already leading the fightback. Yesterday, he even had the gall to say that the system as currently constituted was fundamentally sound. Yes, for him and a handful of Goldman partners, I’m sure that’s true, but on planet earth, it’s a bit of a different picture.

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  1. Steve

    BoA, Citi, and the lesser zombies can’t sell term debt without a government guarantee. They can’t sell commercial paper period, except to the Fed. They won’t be selling common until Treasury’s stakes are gone. This is going to continue the same for years. And one awful trading quarter–or another round of write-downs by European banks–and the fun will be on again.

  2. Sukh Hayre

    Unfortunately, zombie banks will be the only acceptable option, if global trade as we know it, is to survive.

    In order for globalization to survive, I don’t think a haircut for bank bondholders is even an option.

    If push comes to shove, the good bank, bad bank option would be the only alternative. In that case, the bondholders will get a crew cut and ownership of the good banks will remain in US hands.

    Now, if this where to happen, this would be the last straw and globalization would come to a grinding halt.

    Going forward, global trade will be done at a government level and will only involve trading goods for goods (oil/energy, hard and soft commodities, manufactured goods).

    The huge wildcard would be, how would nuclear energy technology be traded?

    And finally, currency rates (fixed or floating) will become meaningless.

  3. Richard Kline

    The idea that one needs to ‘restore confidence’ in the present context presupposes that things are seriously wrong indeed within the vaults of many big financials (which they are). If there were really no problems, one simply takes a look at the assets and publishes the result, more or less. Well we can’t do that because . . . Houston, we have a problem. So, all these moves to ‘restore confidence games.’

    Yves: ” . . . another Orwell sighting.” That’s choice, a phrase of the times in the making.

  4. Jesus

    Stress test results are doubleplus good. All is well, there will be no two minutes of hate today towards Emmanuel Goldman-Sachs.

  5. ndk

    I’m very intrigued by the trends in the credit and structured product markets right now. The CDX HVOL series is in essentially a parabolic curve upwards. There were also some sharp tightening jerks in the higher rated tranches of the CMBX/ABX in the last couple days, following a long basing pattern that had persisted despite the equity rally.

    This is the first time we’ve gone into a downturn with such robust CDS markets. As a result, I think we’re witnessing the first short squeeze in credit.

    It’s a little exciting.

  6. Osprey

    I have a banking & finance background. Orwellian is right, as well as a sense of disconnect by me over this whole financial system crisis and the stock markets. So be it, I'll trade accordingly as the market goes up or down. Ultimately, I don't see any of this ending well. I hope I'm wrong.

  7. Anonymous Jones

    I’m skeptical that the government has the ability to truly move the markets the way the PPT theorists suggest. I’ve been very surprised about the market upswing these last two months (and it’s not just banks, certain tech stocks are at 52 week highs!), but I’m starting to finally come around to the following idea.

    1. Huge liquidity infusions by the FedTreasury are causing huge amounts of cash to slosh around.

    2. The banks don’t want to sell their toxic assets/loans/securitized crap to others because they are holding out for the gov’t to buy at 100 cents on the dollar. These are not even really for sale, and as such, the liquidity cannot be used for them.

    3. Very few banks want to use this liquidity make new loans because there are very few creditworthy borrowers.

    Thus, there isn’t much left for this liquidity to go to other than Treasuries and equities. Add to this that most trading strategies are driven by momentum theories.

    The gov’t could never pull this off surreptitiously. It doesn’t have enough hidden funds to move markets this large.

    But the gov’t *could* do this by creating a new $1 trillion plus in liquidity, dumping TARP funds on the banks and guaranteeing loan issuances by the banks.

    As for short squeezes, these happen far, far less than one would believe by the amount of times you read about them.

    Just a theory…

    (and oh, by the way, these stress tests are such an enormous joke, I don’t even know where to begin. Let’s see. You have a small margin business in which you pay out almost all your profits as bonuses and/or dividends, but now you have a catastrophe in which a large number of your assets are impaired 30% to 80%. How in the world could you be even close to solvent? It is technically impossible. Seriously. It is actually technically impossible.)

  8. ndk

    “As for short squeezes, these happen far, far less than one would believe by the amount of times you read about them.”

    AIG CDS narrowed by 604 bps on the day, and CMBX spiked by 2.33% of par. The Counterparty Risk Index collapsed too. This is wild, and I can’t help but believe there’s a little forced buying in the move.

  9. Anonymous Jones

    ndk — I was actually referring to the mention of squeezes in the main post. Squeezes definitely do happen, and they may be occurring here. Often, however, at least in my experience, shorts are more prone to panic covering because of asymmetric risk/reward (limited gain/unlimited losses). Panic covering definitely spikes prices higher but is not really a squeeze. Also, shorting is a margin activity, encouraging over-extension; so obviously margin calls force covering, but again, this is not a true squeeze either (just as margin calls on longs is not a “long squeeze”).

    Nevertheless, true squeezes do occur, and you may have found one. The evidence is definitely wild.

  10. carol765

    The US government and FED, thinking about the banks books, and the interconnectness of the financial system (banks, insurance companies, pension funds, both within US and internationally), aided by the quiet coup — Simon Johnson´s May article in the Atlantic — have decided that they will do whatever it takes to keep the system afloat.

    – try to influence the housing price (prevent it from falling all the way down to the Case-Shiller trendline): buy up significant amounts of MBS

    – try to influence the long term interest rate (getting it down so mortgage rates get to historic lows, stimulating buying of houses; reducing other borrowing costs, so people/companies keep borrowing): buy up treasuries

    – try to influence confidence: buy up equities, e.g. with all the liquidity given to bank holding companies, as Anon Jones above said. GS now does 55% of all prop trading on NYSE.

    From the Financial Times:
    ¨Japan plans emergency share purchases
    Japan’s ruling Liberal Democratic Party on Friday [April 17, 2009] unveiled details of its proposed Y50,000bn scheme to allow the government to buy shares from the market if share prices fall to an extent that is seen as an economic emergency. ¨

    For all we know the US treasury/FED is already doing this (just as they are involved in MBS and treasuries markets)
    Equity market behaviour is as much or even more about emotions as about ¨fundamentals¨.
    Wall Street and WashingtonDC need the positive feed back of positive stock market (with best-rally-in-history-headlines) –> growing consumer confidence –> more borrowing (good news for banks with the current huge spreads) –> more spending (good news for Main Street) –> better business results –> less job losses –> less defaults → less loan losses on the banks books, etc. Summers et al. have said many times that they believe that it is all about confidence.

  11. Yves Smith


    Your little series may be what the powers that be think they can create, but there are a few problems:

    1. Much of the increase in consumer confidence is the stock market rally (no joke, it’s an input in the formula).

    2. Commercial banks are cutting consumer credit lines

    3. Consumers are suffering flat to falling wages

  12. Carrick

    @Sukh Hayre

    re: “Now, if this where to happen, this would be the last straw and globalization would come to a grinding halt.”

    I hear this sentiment frequently and it never sits right with me. Decreasing global trade would likely probably most economies’ growth prospects, but its not the dark isolation that it used to be. As corny as it sounds, the Internet (peer to peer instant communication) has changed things.

    Even if we were to retreat into economic isolation, it’ll be much harder for nations to pit their young against each other in organized war, IMHO. It’s going to get harder to convince 18 yr old boy-men that they should kill each other, when they can watch video/webcam chat with one another and learn that they’re similarly primarily concerned with girls, increasing their independence (car, money), and getting their parents off their backs. I don’t think decreased global trade implies the dark lonely uncertainty that it used to. At the very least, we don’t need to recklessly implement ill-conceived/ill-suited free market policies.

  13. Glen

    After all the controlled ‘leaks’, Bloomberg now reveals that “Fed’s Bank Results ‘Reassuring,’ Show No Insolvency”. Hmm, interesting how the requirements for any additional capital for these banks neatly fits in with the balance in the TARP account. Realsising that the pitchfork banding public will impale them should they need more cash, the banks and Fed happily walk away with what’s left in the account with all looking good and saved they day. I feel sick.

  14. carol765

    Yves Smith said …
    Your little series may be what the powers that be think they can create, but there are a few problems:

    1. Much of the increase in consumer confidence is the stock market rally (no joke, it’s an input in the formula).

    2. Commercial banks are cutting consumer credit lines

    3. Consumers are suffering flat to falling wages

    Ad 1. Yes, but first there was the rally from March 9 onwards (starting with Citi´s ¨leaked¨ email), the PR talk about green shoots, which contributed to the ¨surprise¨ rise in consumer confidence in April, which then – indeed, as you say – fired-up the stock markets even more. This virtuous spiral may continue for some time.

    2. Yes, but from reading Meredith Whitney and comments from readers with their own credit card experiences: this mostly refers to the maximum amount you are allowed to get into the red, which most people hardly ever used. If you are allowed to use up $ 5000,-, but your negative balance has never been higher than $ 1500,-, and now the bank informs you that your credit line has been reduced to $ 1500,-, this will hardly change anything. Off course, in an emergency situation, one may be severely hampered by this reduction, but mostly it relates to unused balances (please correct me if i´m wrong).

    3. Yes, this is a real problem, which has been going on (in real terms) for many years, and could be handled by using the house as ATM. This is over! (Off course, the 33% of home owners without a mortgage could use their mortgage free house as ATM, but those are the people who most likely don´t need to.)
    That´s why it is so urgent to kick-start confidence, get people buying again, get companies seeing a brighter future, and hence firing less people. And horrible as the un(der)employment numbers are (U6 about 15%), that still leaves 85% employed, and probably still able to pay their rent/mortgage.

    So while for example the market value of a typical MBS may be very low, most of the mortgages are still being serviced. E.g. ING bank has an Alt-A MBS which does 60% in the market, while they claim that all mortgages are still being paid. So while they bought it as an investment, with mark-to-market they have to take a huge loss on paper, whereas the revenue stream is still fully intact.

    Yes, people, companies, many countries are deeply in debt, but US treasury and FED are trying to reduce the depth of this downturn, thereby allowing most people and companies to continue servicing their debt. As long as most are able to service their debt (i.e. just paying the interest, not paying down), the system can go on, they hope (the audacity of hope, so to say).

    For all clarity, I am not saying I agree with this process. On the contrary, what´s happening should be food for a revolution, but I do not see that happening, unless the forced generosity of future taxpayers will reveal itself as insufficient.

  15. Leo Kolivakis

    The best way to steal from a bank is to own one. Read my latest comment above on how private equity sharks are muscling their way into the U.S. banking system.



  16. frances snoot

    How have American workers profited from globalism? How have Indian farmers profited from globalism? Isn’t globalism just another word for greedy capitalist colonization?

    Look at the Smithfield pigfarms in Hungary as a proud example of US globalist interests.

  17. BB

    Yves: The Washington Post was worse, though I suppose that’s to be expected. Headline today is: “Stress Test Finds Strength in Banks.”

    Sub-head reads: “Uncertainty Remains, but Officials Say Most Have Capital to Outlast Recession.”

    Just silly.

  18. NicktheLame


    It will be helpful if you can start a discussion on how to address the “too-big-to-fail” argument. I am specifically looking for recommendations on breaking up all the major banks e.g., no commercial bank can have more than 1 million depositors for the depositors to avail of the FDIC guarantees. What are the legal ways in which banks can be broken up? What are the pros and cons of breaking up large banks. Hopefully, a debate on this topic will let us think more through the issues. Thanks

  19. Roger Bigod

    “Orwell sighting” is just wonderful. I once proclaimed Jane Hamsher the Princess of Snark, but I can see we have to arrange a tiara fitting for you as well.

  20. Harlem Dad

    Frances Snoot wrote:

    “Isn’t globalism just another word for greedy capitalist colonization?”

    A year and a half ago, Frances, I would have taken issue with that statement. Now I’m embarrassed that ever I thought that way.

    I agree with you 100%

    Tim in Sugar Hill

  21. VG Chicago

    BB said: Look at the Smithfield pigfarms in Hungary as a proud example of US globalist interests.How about Smithfield pigfarms in Mexico, where swine flu supposedly started?

    As far as globalization goes, you mean, there is anything wrong with exploiting people in developing countries, displacing people in developed countries, and trampling on human rights across the globe?

    Vinny GOLDberg (back in Chicago, and cursing at the dismal quality of the roads in this town. I used to complain about the roads in Romania, but now I realize they are infinitely superior).

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