Calculated Risk writes there will be many more bank failures, but probably not as many as there were in the 80s and early 90s. From 1982 to 1992, there was a minimum of 100 banks failing per year, with over 500 failing in 1989.
Furthermore, “Unlike IndyMac that failed mostly because of bad Alt-A mortgage loans, most of the coming bank failures will probably be small regional banks with too much exposure to Construction & Development (C&D) and Commercial Real Estate (CRE) loans.”
I believe this forecast to be in line with reality, as there are many states with banks that have contruction and development loans making up very high percentages of their core capital. More banks will fail, but they will be mostly smaller, regional banks. Those that don’t “fail” will be absorbed by better banks. I am starting to believe that a good indicator of an end to this mess will be after a fair amount of consolidation occurs in the regional banking sector.
A couple of days ago, the Resourceful Bear Blog pointed out an article entitled “Is Iceland the Canary in the Mineshaft of Global Financial Contagion?” The article addresses some serious financial issues that, if true, neither bodes well for the small, island nation, nor for the rest of the banking world.
The aforementioned article says that Iceland a Nordic hedge fund masquerading as a country with carry trades that are now unwinding and causing investment flight. Interest rate hikes and currency devaluations are now raising inflation; a credit freeze is also in effect due to highly leveraged bank portfolios gone bad. To me, it sounds like a grim situation.
There is also further news of the rising cost to protect the bonds of Iceland’s three biggest lenders from default. One alarming statistic is that “The financial sector’s net $35.3 billion of debt represents 211 percent of the country’s gross domestic product.”
Investment Application
The Resourceful Bear has some suggestions for investment application in this situation. Similar to previous advice, he suggests that one invest in the gold ETF GLD and use your margin to short any of Iceland’s three largest banks, which are Kaupthing, Glitnir, and Landsbanki.
I’ve already looked and none of these banks are traded on the major American exchanges. However, my broker Tradeking does allow me to buy Kaupthing (available on the pinksheets), but I can’t sell it short. Ho hum. It would be cool to sell short these Icelandic banks, but opportunities abound with pretty much any major financial institution these days.
Ben Bittrolff of The Financial Ninja provides more excellent analysis and commentary on the current crises in the financial sectors.
First, Bittrolff argues that the Fed has done nearly all that it can do to prevent a total collapse of confidence in the financial systems and markets when he writes, “The Fed has almost run out of ammo. Much like George Soros on Black Wednesday, when he ‘broke the Bank of England,’ global capitalists are damn near close to breaking the Fed. 60% [of the $700 billion in Treasury securities on his balance sheet] has been committed and it doesn’t seem to be working. Another push and things could unravel quickly…”
Second, it seems inevitable that Citigroup will be breaking itself up over the coming years. Bittrolf sees Citirgoup’s separation of its credit card business from its banking business is the first step of the pending dismantling of Citigroup.
But, what struck me the most is this simple statement: “It is truly humorous that the Socialists across the pond are the one’s considering taking the ‘laissez faire’ approach while the CHAMPIONS of Capitalism over here are pounding the table for mass intervention.” I don’t think there could be a more telling signal of the immense troubles of the financial sector.
The Financial Times on banks and regulatory backlash:
Wall Street crises have consequences. By 1932, John Maynard Keynes viewed financiers as “subhuman” and “of gangster mentality”. In 1933, at his inauguration, President Franklin Roosevelt told America that “the money changers have fled from their high seats in the temple of our civilisation”. The next two years saw the Glass-Steagall Act, which split commercial and investment banking, and the birth of the Securities and Exchange Commission.
The severity of the fallout from today’s crisis partly depends on the scale of loss borne by the public sector. So far central banks can, just about, present their activity as that of lenders of the last resort: lending to banks (and now dealers) in return for good collateral. Even the UK Treasury says nationalised Northern Rock’s assets exceed its liabilities.
But it is easy to imagine scenarios in which the public sector bears large and explicit costs. The collateral’s value could fall; central banks might feel obliged directly to prop up the prices of risky assets; bailouts of clearly insolvent banks might occur. High inflation might conceivably be tolerated to cut the real value of private debt – as Professor Niall Ferguson puts it, a re-creation of the 1970s to avoid the 1930s. Such public costs could render peripheral today’s regulatory debate. This is dominated by technical goals: making banks’ capital positions less pro-cyclical and boosting their liquidity. Faith in voluntary codes to reform bankers’ pay, such as that hinted at by Deutsche Bank’s Josef Ackermann, or credit ratings, might come to be seen as hopelessly naive.
Last week Barney Frank, chairman of the House committee on financial services, proposed a new US risk regulator. But the backlash could be more radical. Its objectives? Try these two. First, in an echo of Glass-Steagall, to prohibit some risky business lines at any institutions with implicit state guarantees. Second, to require central banks to take action to limit asset bubbles as well as conventional inflation. If the private losses “socialised” by the public sector do become drastic, so will the proposed remedies.
JPMorgan Chase Buys Bear Stearns for $240 Million:
March 16 (Bloomberg) — JPMorgan Chase & Co. agreed to buy Bear Stearns Cos. for about $240 million, less than a 10th of its value last week, after a run on the company ended 85 years of independence for Wall Street’s fifth-largest securities firm.
Shareholders of New York-based Bear Stearns will get stock in JPMorgan equivalent to about $2 a share, compared with $30 at the close on March 14, the two companies said in a statement today. The U.S. Federal Reserve will provide financing for the transaction, including support for as much as $30 billion of Bear Stearns’s “less-liquid assets.”
I’m not really sure whether this is a good or bad thing. Bear Stearns stock was trading in the low 30s last Friday. Does this severe depreciation of value mean than things are worse than we could have even imagined? Well, judging by the index futures as of this posting, things are looking bad, but who knows what things will be like next by the end of next week.
Here’s a list of some other recent articles on this mess I’ve been reading.
A top bankruptcy lawyer predicts that the retailing, real estate, and auto parts industries will be the hardest hit by the credit crunch and the downturn of the economy.
As companies begin to pile up bankruptcy protection — Sharper Image, Lillian Vernon and Plastech, just to name a few recent filings — Investment Dealers’ Digest went to Harvey Miller of Weil Gotshal & Manges, one of the nation’s most prominent bankruptcy lawyers — to get his take on what’s in store.
Mr. Miller, who spent some time at investment banking boutique Greenhill & Company before returning to Weil Gotshal last year, told the Digest that a long-delayed round of restructurings may finally be at hand.
Easily available refinancing helped paper over a multitude of sins in the last few years, but the credit has dried up. That is likely to leave many companies with few options, Mr. Miller said.
He said retailing, real estate and auto parts are some of the industries that may be hit hardest. He also predicted some pain at well-known private equity firms — although he didn’t name names. “Portfolio companies of very respectable and reputable firms are going to have some level of problems,” Mr. Miller told The Digest.
Real estate and retailing have already been hit pretty damn hard. I see this as another sign people are preparing for the worst and that the worst has yet to come.
Mack Frankfurter’s article entitled “Retrospective: The Mysterious Case of Massive Liquidity” is a small history of how the world has created the current, huge amount of liquidity and the types of problems such liquidity poses. The author compares liquidity to a drug addict, which I assume is meant to convey the seriousness of the situation.
The problem with liquidity is that it is like an addictive drug–initially it produces euphoria which then disappears with increasing tolerance. Once an economy is hooked it needs more and more in order to sustain itself and withdrawal can be difficult. The riddle is whether the central banks have succeeded in breaking the cycle, not the inflationary cycle which in fact it has enthusiastically subsidized, but the deflationary cycle. Has the sheer bulk of global liquidity forestalled the kind of contraction that paralyzed business activity in the Depression and demoralized speculative activity for a generation after that?
I recommend reading this if you’d like to try to gain a better understanding or additional perspective about current economic matters.
