Looking for Bagholders?

This week has been great weather wise! 60 degrees and sunny all week and it could hit 70 on Saturday. I have a brand new grill to get seasoned and I hope to get it done this weekend and maybe attempt my first cook with The Big Steel Keg. Being new to charcoal cooking this could get funny in a hurry!

I had a post in mind all day and I will get to it but there was plenty of other stuff that caught my eye that will make it on tonight no matter how late it goes. I am done the boxing workout so I am ready to roll. Get requests in for Friday night entertainment as well!

The "Motor City Cobra" in Foreclosure?
Regular readers know I am a huge boxing fan so when I caught this post over at Tim Iacono's site (updated the bookmark in the blogroll, but I prefer the old site!) I knew I was going to write something on it:
"Hit Man" Thomas Hearns Now in Foreclosure
You can read the details if interested.

Thomas Hearns started with the nickname "Motor City Cobra" and switched to "The Hit Man" after recording big knockout wins. His fight versus Marvin Hagler is one of the best all time, second only to Alexis Arguello vs. Aaron Pryor I in my mind. Thanks for the great find!

Banking Reserve Requirements; Useless or Need to Grow?
Last night I posted a quick piece on FED head Ben Bernanke offering that banking reserves could go to zero in the future, via The Economic Collapse. Again, key take away:

The Federal Reserve believes it is possible that, ultimately, its operating framework will allow the elimination of minimum reserve requirements, which impose costs and distortions on the banking system.

Kid Dynamite, who survived the rainy downpours here in the northeast, had some thoughts on this (and gave a cool hat tip over here as well):
Reserves? We Don't Need No Stinkin' Reserves!
KD's thoughts:

Now, it's been brought to my attention that there are several countries who currently operate banking systems without reserve requirements. The real question is, is Bernanke suggesting that we don't need reserve requirements because in a rational free markets world, banks would hold adequate reserves anyway, and thus don't need more expensive restrictions imposed on them? I think that claim can be easily refuted by saying "See: U.S. Banking System 2007-2009." The alternative, then, is that Bernanke really believes that banks don't need to hold reserves at all.
Ben Bernanke's expertise in banking is greater than mine. That much is given - although I wasn't riding shotgun next to Alan Greenspan as the metaphorical car that is the U.S. Financial System was driven off a cliff. However, I literally do not understand how zero-reserve fractional reserve banking can work. If, in reality, banks lend out every dollar of deposits, with no allowance for depositor redemptions or decline in collateral (read: LOAN) value, isn't the system guaranteed to fail?...

Anyone care to explain this? Anyone? I'm looking for someone who can explain to me the rationale, even in theory, for how banks could operate with no reserves. My specific questions: most importantly: if you have no reserves, and the price of your assets (loans you have made) declines, aren't you instantly insolvent? Also, if you have no reserves, how do you handle depositor requests for redemptions? Is the answer simply that the Federal Reserve is there to backstop insolvencies arising from these two situations? That's not really an answer. Maybe the answer is that the Fed backstops "temporary" insolvencies until they can recover and right themselves - until the value of the assets "comes back." Extend and pretend! What if the value doesn't come back though?

Great points and indeed there was plenty of great debate in the comments section for this post. Stuck at work I could not really participate!

An Anon poster (of course) seemed to think the system was so solid this was all fine because banks always have so much collateral to save themselves from losses. I know, funny stuff. He did make several good points but in the end I felt he was too theoretical and was ignoring reality. I would encourage you to read the dialogue from the comments section and make observations here. My take in the comments section:

Well I am at work and thus cannot be involved here to much degree but the conversation to me seems to boil down to theoretical debates vs reality. In reality the banks have abused fractional lending and made poor loans that are so bad it has toppled the pyramid, which in theory could not be toppled. That seems to be Anon's point, nothing KD (or I) says about solvency has any meaning because it cannot happen, well except that it just did.

Furthermore, I thought getting loans from the FED was bad and had a stigma? Seems now the new theory is ultra low non-market based loans from the FED forever. This is quite possible but I think though forever may not be so long.

Later I added:

Good stuff everyone, and a good debate.
My only issue here is the assumption that the FED is now the permanent lending arm for the banking system from here to eternity and all that implies. If the system can only work at 0% rates and taxpayer backing for losses, how awesome is the system?

Worth a look.

Now not even a few minutes after writing the added comment, I see this over at Bloomberg:
Greenspan Says Banks May Need to Raise Reserve Capital by 40%
I mean, you cannot make this stuff up! Either zero or raised by 40%? What's the deal? From the piece:

Former Federal Reserve Chairman Alan Greenspan said regulators may need to compel banks to raise capital levels by as much as 40 percent, saying that’s a more effective way to ensure stability than new regulatory rules targeting risk.
“The most pressing reform that needs fixing in the aftermath of the crisis, in my judgment, is the level of regulatory risk-adjusted capital,” Greenspan said in a paper prepared for a Brookings Institution conference today. “Adequate capital eliminates the need for an unachievable specificity in regulatory fine-tuning.”
Banks may need to hold capital equal to 14 percent of their assets, compared with about 10 percent in mid-2007 before the financial crisis, Greenspan said.

We have a serious disagreement here! Obscure movie quote: "Stir the Tiles! Stir the Tiles!".

Now of course Greenspan had his entire tenure at the FED to make these kinds of overtures but instead lobbied hard (at the time) for a bare minimum of regulation and reserves. While this may be a way for him to try and regain some semblance of credibility (impossible?) it does make sense. Of course what's 14% as opposed to 10% really?

I do not have time to open a big debate on this tonight. Suffice to say that I think reserves are both necessary and should be large given what we have seen.

Looking for Bagholders?
I read a post over at The Big Picture today that I wanted to discuss all day long.

The post, titled "Household Equity Exposure", uses a great chart from Ned Davis Research to show "Stocks as a Percentage of Household Financial Assets (Adjusted for Pension Funds)". It is quarterly data from 1952-present. I would LOVE to post the chart but could not secure clear permission and unless you want a tip jar installed, the usage price is a bit more than I want to go for!

So please open the post above and use the chart as the visual aid. In reality one look over should do to follow what I am going to offer here.

Barry notes:

Household balance sheet data is accumulated by the Fed, and no one makes it look prettier than Ned Davis Research. Using the Federal Reserve data, NDR shows that households are now fully invested, roughly equivalent to 1972 (when rates were much higher)

Not to differ with NDR, but the present levels are only modestly over-exposed to equities — nowhere near 2000, and still a good ways below 2007 peak.

I am not sure we can say the US household is “All In” just yet. Somewhere in the 1200- to 1250 range should get us pretty close . . .

And this stuck with me all day.

Up front, I think Mr. Ritholtz is a great writer and he seems to have a firm grasp on all things Wall Street. This post, to me, really seemed a bit off for him in regards to main street though.

Looking at the chart household exposure to stocks was highest at the Tech Boom Bubble top in and around 2000. Of course the bagholders on that collapse were regular people as Wall Street unloaded all their shares to the public right before the meltdown. Weird coincidence, yes? I have talked about this time and again. No bailout for the regular Joe's that stocked up on Yahoo and Red Hat that crashed, they got what they deserved, right?

Another top was right at the peak of the housing/stock market top in 2007. This time the collapse was tied closely with Wall Street and things like mortgages and credit vehicles that only Wall Street held in large amounts. Of course household stock holdings fell as well but they were much less invested this time and this is where I want to focus.

First off most regular people, which are the only kind I know, never got over the tech collapse. Stocks may never capture their large scale attention again. Never. They did fall in love with real estate however, due to it's perceived "safety". As that has now been smashed that makes the trifecta of finance vehicle collapse; stocks 2000, homes 2007-present, stocks 2007-2009.

Lost in this is that I know many people (regular types) that borrowed large amounts from their 401k's to buy homes and now have the great pleasure of being underwater on their homes and paying back their downward adjusted 401k account at par.

What I am trying to get at here is I am not sure what The Big Picture post meant. Is an influx of household money into stocks after a run up of 60% or more from the lows a good investment idea? If it is, is it good for households in general or private paying clients?

My prediction is that regular money will not be making it's way into the stock market any time soon. The low volume melt up done by banks bidding futures up to each other will have to carry the boat. What if the algos have no bagholder to unload on? I guess another bailout will be on the way for them.

My friend who runs the Housing Time Bomb had a great post on this a while back:
Is America Losing Interest in the Stock Market?
The post fits in well here. I commented at the time:

I think money is going into bonds but anything with the "real estate" tag will be left out. We will see the FED step back in in that space. Many regular investors got smoked in the dot com bust and I think most felt they got in over their head. They switched to real estate and vanilla S&P index type funds and low and behold they got smoked on two fronts once again. At this point I think return OF capital is more important to main street than return ON capital. Too bad our whole system is based on juicing things into bubbles.

I stand by that.

Best comment from the post at TBP? A guy that sees what's coming:

scharfy Says: @ March 18, 2010 at 4:20pm
Awesome chart.
I dunno, lot of bears on this board. The market seems comfortable with current multiple (15 times 2010 earnings) plus 2 percent dividends which will likely grow due to record corporate cash from lack of capex spending/hiring…. Should earnings grow to 100 your are lookin at 1500 in the S&P….

The natural question would be how the hell can they grow earnings with their customers not working and in bad shape?

Thats where I am open to the “decoupling” of corporate America from the working stiffs. Bottom line, they will squeeze us. We will still eat at McDonalds, buy an ipod, watch TV, search on Google, buy gas from Mobil , Bank at Chase and pay our mortgage. We just won’t save a lot or have a lot. This is how the poor have done it for eons and now the middle class can have a turn.

But this doesn’t mean that Corporate America will die a painful death. They might just keep right on truckin.

Sharp.

I have argued that the crap will hit the fan with the stock indices at all time highs and Unemployment at 9% and everything else that is wrong now is still wrong. Hard to explain that one, yes?

Of course it helps when you have the might of the full Federal Government behind you as well as the FED and the Treasury. They just do not have our backs. Be careful.

Have a good night.

Lend Your Way Out of Debt

I remember when I was in school (elementary and high school) and the time span between Thanksgiving and Christmas used to seem like a year. As an adult it seems the very same time span lasts about 15 minutes. I am a little behind this year due to a busy work schedule, and Christmas is right around the corner!

Lend Your Way Out of Debt
During the whole inflation/deflation debate the same chart is always discussed: Bank Reserves. Banks have stashed cash either in their vaults or at the FED in record amounts. Deflation siders say this cash has not entered into the money supply and thus does not "exist" in a monetary sense and they are 100% correct on that. Now.

Inflation siders point to that cookie jar and cast their minds to a time where the banks may well feel emboldened to put that cash to work on a grand scale. This has not happened and thus far there are few signs it will in the near term.

I am always on the lookout for the switch to happen as I think smug banks fresh off getting their butts saved are none too shy about chasing returns like in the old days. All they need is a wink and a smile. Maybe this is starting.

Today's big story was the White House hosting a meeting with top bankers (the ones that could make it that is!) in an effort to guilt them into taking risk. From Yahoo Finance:

Obama implores top bankers to increase lending
WASHINGTON (AP) -- President Barack Obama implored top bankers Monday to help keep the fragile recovery from faltering by boosting lending to small businesses and getting behind an overhaul of financial regulation. "We rise and fall together," Obama declared.

We rise and fall together? I think that was line which is going to come back later! Who fell exactly? The 10 plus percent unemployed or banker bonus amounts? Just checking. Moving on:

Obama called his message a simple one: "America's banks received extraordinary assistance from American taxpayers to rebuild their industry, and now that they're back on their feet, we expect an extraordinary commitment from them to help rebuild our economy."

He urged bankers to "explore every responsible way" to boost lending and to "take a third and fourth look" at every loan application.
The bankers said they got the message.

What could go wrong? So what about the banks, what kind of incentive do they need here:

But they (banks) also insisted they are getting conflicting messages from Washington when they do try to make more loans. While the White house presses for more lending, regulators are cracking down on banks to lend more prudently and forcing them to keep larger cushions of capital to protect against future losses. That means there's less money available to lend.

Step one: remove any check on capital reserves. Check. What else?:

"He didn't call us any names" during Monday's session lasting just over an hour, said U.S. Bancorp CEO Richard Davis.

Davis called the meeting "very productive" and acknowledged banks haven't done as good a job as they could in resuming lending. He said he and fellow bankers understood the public outcry over compensation and said they agreed to "make sure we are doing the job of banking, which is lending."

"And we should get paid for that when we do it," added Davis, who is incoming chairman of the Financial Services Roundtable.

The set of brass ones on this guy is amazing. First off banking is many things and not just lending out money hand over fist. Second, see the move here to remove pay limits on any banks going forward. Smooth operators. Wrapping it up:

Using a sports analogy, Obama told the bankers Americans might be more sympathetic to outsize pay if those who got it were in the equivalent of a financial World Series, according to a senior administration official who lacked authorization to speak publicly and spoke on the condition of anonymity.

The bankers told Obama they are shifting from cash bonuses to longer-term payouts such as stock, but Obama said that was not good enough because the public was likely to still see it as excessive, this official said.

The bankers have said the amount of lending is limited by factors beyond their control: The sluggish economy and tighter oversight by regulators. The slow economy has businesses reluctant to expand -- and makes banks more grim about their prospects. Loan applications are down.

I have no idea what was meant by "World Series" in finance! Again the tighter oversight is pointed out by the banks.

So where does this leave things? The engineered recovery has not been good enough to allow a return to old habits thus far. The banks now have on their resume an explicit guarantee on their actions and this is big. I think is just pure dumb luck that there are no areas to plow money into right now or the banks would be doing it.

On a related note I was surprised at a comment that Barry Ritholtz made today on a post about bank lending. Here is the relevant section:

Low, Low Rates
...That is the problem with an abdication of lending standards — as we saw from 2002 – to 2007. After the collapse, the over-reaction sends the pendulum swinging too far the other way. Lending standards become too tight.

If only we monkeys could learn anything from history . . .

Now understand that Barry is as sharp as they come so when I disagree it is both not normal and means I am wrong!

That said, I would be interested to know what kind of lending standards Ritholtz sees as too tight? Maybe business loans, but certainly not mortgage loans. Of course banks do not write home loans anymore, they allow the FHA/FNM/FRE the honor of doing that! The current loan standards for FHA are anything but tight.

If banks are looking for options for loans and are having problems maybe they are on to something. Headlines form today:
Mexico’s Credit Rating Downgraded One Level by S&P
Looks like Mexico is out.

Abu Dhabi Bails Out Dubai!
Dubai will be a sick joke punch line for years to come.

Greece Enters Twilight Zone As It Announces 90% Banker Bonus Tax Plans, Expectations For Sub 3% Deficit By 2013
How is that for business friendly? Looks like Greece is a no go.

China is taking care of their own lending by ramping stimulus to the moon, so they are out. The FED MBS program ends in Spring 2010 (yeah right!) and nobody is going to go to a bank for a mortgage when they can get the FHA low rate loan from fantasy land.

It is my contention that the reason all the money created over the past 2 years has not led to inflation (hyper or only kinda) is that there are no good options for loans and not many that are even just poor risks. We can all be thankful about that.

I have a poll up tonight about where the next best loan pool will be, so please vote.

Have a good night.