Banks on the brink

[moonman]

Bill Feckenstein writing for msn money reports exactly what I've been reporting with onw exception. Feckenstein fails to comment the problems with our USD.

The salient points he makes in the following is what I've been posting. The banks put commercial paper off the books in conduits or special investment vehicles. You are with off book special investment vehicles if you followed the Enron story. What mainstream media and touts have been callling 'liquidity' is merely a mirage. Feckenstein shows that this liquidity is is leverage reporting as cash.

Banks' dark off-balance-sheet world
Financial institutions have been running virtual savings and loans through special-purpose entities with flexible accounting and little oversight. No wonder they're in trouble now.

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E-mail to a friendTools IndexPrint-friendly versionSite MapDiscuss in a Message BoardArticle IndexBy Bill Fleckenstein
With all of the problems that we have experienced thus far in structured credit, one might think that there would be more people scratching their heads about why there are so many off-balance-sheet entities in the financial community in the first place.

I wish I had a good answer. It's pretty obvious that little attention had been paid to these entities, at least from the perspective of potential problems.

Daylight: Enemy of chicanery
Of course, the fact that conduits, and special-purpose entities generically, reside off balance sheets is a reason why everyone has been caught by surprise. Because if mountains of this paper are away from plain sight, potential problems can't be anticipated, as you can't attempt to understand what you can't see.

For instance, Jim Grant of Grant's Interest Rate Observerreports that in the most recent 200-page annual report to the Securities and Exchange Commission from State Street (STT, news, msgs), only three paragraphs are devoted to the commercial-paper conduit that has caused it so much grief recently.

In any case, with the spotlight now trained on the structured-credit arena, institutional investors have become choosier about what paper they're willing to own, thus creating the illiquid environment that the short-term money-market funds and the banks currently find themselves in.

For the banks, this comes at an inconvenient time because they're trying to figure out how to deal with the $300 billion-plus of leveraged buyouts they've committed to finance. Conduits tend to roll at the same time. And last week was one of those occasions when a considerable amount -- more than $100 billion -- of asset-backed commercial paper needed to be rolled, meaning that the debt required refinancing.

Centauri, dorada, yada yada yada
Meanwhile, though London appears to be the epicenter of conduit angst these days, our homegrown Citigroup (C, news, msgs) appears to have plenty of exposure. That's according to a friend who in an e-mail to me rattled off the following list of its structured investment vehicles, or SIVs: Beta Finance, Centauri, Dorada, Five Finance, Sedna Finance, Vetra Finance and Zela Finance. He was able to obtain a portfolio commentary for Beta Finance, in whose summary I found three interesting items.

First of all, for those folks who can't quite wrap their arms around what an SIV, an SPIV (special-purpose investment vehicle) or a conduit is, those names all stand for pretty much the same thing: special-purpose entities that reside off balance sheets. Think of them as virtual savings and loans that can be quite sizable. There are no real rules that govern what they can buy. And because they're off balance sheets, they operate with little regulation.

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Citigroup notes that the leverage in this particular vehicle, Beta Finance, is "only 14.24 times." Thus, Citigroup, a leveraged entity, owns a gaggle of leveraged S&Ls. That helps illustrate a point I've made many times: that the well of liquidity that bulls were citing two months ago as a reason to be bullish was just a wall of leverage. (It's worth noting that the net asset value of Beta Finance has declined 19% from its high and that Citigroup's other conduits are apparently down a similar amount.)

What lives beyond the adjectives?
Next, Citigroup says: "We highlight that all U.S. CMBS exposure is supersenior." What I find interesting in that comment: The company has taken pains to note that its CMBS, or commercial mortgage-backed paper, carries the highest rating -- implying that there might be a problem with lesser-rated tranches of commercial mortgaged-backed paper.

That echoes a data point provided by someone wishing to remain anonymous who resides near the top of the lending food chain at one of the world's largest banks. The source indicated to me that commercial mortgage-backed securities will also see problems. Though I did not get the impression from her that the timing was imminent, the weakness in the commercial version of the ABX index indicates that some pain is already being dispensed, even if little ink has been spilled on this subject.

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Singing an ode to opacity
It just boggles the mind how much leverage is employed by financial institutions and how little knowledge the world has of their workings.

As to why these infinitely leveraged black boxes (with extremely flexible accounting and disclosure rules) exist in the first place, I think we know the pat answer: so that financial institutions can employ them and utilize even more leverage than they are legally allowed to.

Which makes one wonder: Since these entities are designed specifically to circumvent the rules, why have they been countenanced by the rule makers?

At the time of publication, Bill Fleckenstein did not own or control shares of any of the securities mentioned in this column.

[disrupter]

Regular cash type deposits of savers in a bank are still insured,
but banking deregulation has allowed banks to expand into all sorts of non-traditional banking & finance.

I guess paying of FDIC insured loans is comparatively trivial[?],
presumably the fed is attempting to keep this whole OTHER finance structure afloat.
I am not sure if that is really a good thing or not.
Seems to me if people made bad or unlucky [however you want to see it] decisions is it the Fed's job to bail them out? No matter how big or massive they may be? It seems to me the people who profit from this for the most part are not really substantive contributors to the economy anyway.
Investing is risky.
If the fed removes virtually all risk for a lot of non-productive people at the high end, it removes it from reality & totally rigs the financial system as crooked.

Instead of the fed rewarding/protecting people with vision &/or insight, who asked relevant questions, it is protecting one-trick ponies who probably didn't give much forethought to what they were doing. Making the whole financial system inherently less intelligent.

Sometimes it is the distinct disruptions that allow the economy to make a sharp turn into a new & possibly better direction. Simply propping up the same old shit just keeps the economy going in a straight line, without re-examination, which would allow for critical analysis & potential improvement. Dead weight linear inertia rather than agile adaptation.
But it is the Fed, what else would you expect?

Imagine if the trillions of housing dollars had been spent with a strong emphasis on energy efficiency? Buildings are the biggest user of energy around the world. The US could have made a first stride towards energy independence. Could have set an example & been a laboratory of ideas for the world. Instead, everything just plowed along unendingly as the same-old same-old because that was the trench that was cleared & dug.

Considering all the the fraud that the financial system has allowed to go on, with false promises made to mortgage re-finance customers, somehow now bailing out the profiters from this crime just seems like a double back-stab.

Fat cats get a bailout & homeowners are left to fend for themselves in a sea of mortgage broker sharks?
Homes built with 1950s or 1970s context in mind rather than homes built for a green, clean efficient future in mind?

Sounds like a system deserving of a collapse or at least a very severe shakeout.

The fed should back & support a world that can continue long into the future, not one that will lead to human & mass extinction.

[moonman]

Federal Deposit Insurance Corporation is funded by, gues who? You got it, disrupter. You & me and all the other taxpayers. Banks on the brink, USD has no value, sure they'll pay off in worhtless money.

I listenned to Greenspan on NPR today chatting about fiat money and he said what cetnral banks have tried to do with interest rates is create the stability we enjoyed under the gold standard in the 19th century.

I agree with Alan Greenspan on that but I disagree on a return to gold backed currency. I suggest energy backed currency.

[disrupter]

An expanding money supply is probably a necessary thing. Direct gold backing could make that problematic. Maybe some not one-to-one ratios, but some kind of branching/accordian type mechanism might work.

But that same expanding money supply MUST have some kind of give&take or feedback structure much like a roof truss has cross/triangle bracing.
Otherwise it becomes too liquid/flimsy & leads only to pointless corruption & ultimate collapse.

Checks & balances & complex rooting of financial operations,
when one leg becomes weak there are other legs that can carry the load in the interim.

All trees grow to the sky, but toothpicks will not suffice.

If no one minds the store the store gets robbed, inevitably.

I think the fed should be selective about which operations it attempts to keep solvent. Like pruning a tree of its dead, diseased & just too abundant foliage.
It has to make a few judgement calls.

Have you heard about the new book 'Are the Rich Necessary?'

[moonman]

That's a good metaphor disrupter. Sorry haven't heard about "Are the Rich Necessary" but will check it out at amazon.

IMHO the real problem in the real ecnomy in this post industrial, post modern information age is that all our business models, supply & demand for example, are based on the theory of scarcity. While scarcity generally was true up until the 20th Century, our challenge now is the distribution of an abundance.

I think this is our basic problem today. We have the ability to produce an abundance of virtually everything we imagine producing. The problem is money, there isn't enough of it becasue money supply is based on business models no longer appropriate or measured against the reality of abundance of goods and services.

In Las vegas alone they through out enough food every day to feed a few hundred thousand hungry people. I'm not sayin' turn Vegas into a grocery store for the poor, but I think you get my drift.

[disrupter]

I think the rich are currently acting like a sponge, soaking up the ballooning money supply.

One reason inflation is low is because the vast majority of the wealth being generated is going into the hands of the ultra rich. They only have a need for a limited number of loaves of bread, so their money doesn't add upward price pressure on bread or mundane commodities.
[unrelated note: i also think, illegal, lowpriced labor also keeps inflation at bay, because more, such as homes they produce can be purchased for less money.]

Oddly there is a 'high-end' inflation on art objects, collectibles, and extremely high-end consumables like designer fashion. They skyrocket to bizarre price levels. In some ways that might be ok, if it helps to preserve our cultural & technological artifacts & history. Exclusivity becomes the hallmark of desirability.

Just trying to describe the mechanics of it, & trying to set aside my ethical sentiments.

If accumulated wealth is used to invest in science, technology, infrastructure or to advance human culture i speculate it is possibly a good & likely a necessary thing.

If it is just left idle to squander on pure self-aggrandizing ego boosting splendors it becomes somewhat more questionable.
I suppose the general population, sort of gets inspired, by lavish displays of wealth, combined with the belief that they might acquire wealth themselves. So potentially it motivates people to acquire wealth, but problematically it is not restricted to construtive or productive means of acquisition, & likely includes corruption & criminality.

If there is not some shared value(s) of caring for humanity, its well being & progress, then i think we flounder as a species, like a ship without a rudder.

I think people need more than just shallow avarice.
It doesn't have to be completely alltruistic, but depth of strategy & purpose create a sensorial wealth of engagement that tinsil just can't match.

People who only go after shallow displays of wealth are possibly damaged people, Who have never experienced the excitement of discovery or embraced the many potentially fulfilling challenges of the mind.

To me if something is not about [reflecting] my mind then it is not really about me. Wearing fashion because that is what is considered to be the apex reflects someone else's artistry & some other people's opinion. Makes a person more of a doll or coathanger than an engaged, active mind that is pursuing their own path.

Maybe i am just more selfish. If it doesn't reflect my mind [or affect my person pretty tangibly] then i find things unenticing.

But that is just my opinion.

I think we have gone too far trashing all socialistic or communistic ideas.
Some things, that are absolutely necessary for survival, such as air, ground water & well being of the biosphere are inherently collectively owned. They are a shared resource. Those despoiling them must be held accountable to all the other owners of these things.

I think there may be other social values that must be shared by most of society to make it one worth living in.
If everyone disregards the law, they you end up living in a chaotic criminal realm where a lot of things become simply impossible.
I think markets perceived as honest tend to attract investment & those that people are convinced are crooked tend to scare money/investment away.
I realize you can go some distance simply deceiving people that a market is supposedly honest, but at some point people do catch up to reality, & once trust has been lost it is difficult to recover it.