The Bankwatch

Off topic for this blog, but I have been watching Microsoft for so many years, and watch them stagnate.  The answer is clear.  Ballmer must go.  Bring in a fresh face, and pull a Steve Jobs … not what everyone thinks, meaning UX creativity.

Microsoft reports modest gains

Microsoft’s quarterly profit increased by a modest 6 per cent from a year earlier as sales of its flagship Windows operating system were depressed by flagging growth in the PC industry.

The world’s largest software company by revenues said sales in the fiscal first quarter rose 7 per cent to $17.37bn, held back by a mere 2 per cent gain on Windows to $4.87bn. The division including Office software grew by 8 per cent to $5.62bn.

 

Time to pull Microsoft apart, and break it down to its roots.  Microsoft was about an operating system.  Everything else they have tried with the exception of games has been a loss.  The 10 year stock price tells the tale.

Jobs took Apple from 13 pc’s down to 1.  He eliminated Apple printers.  He pulled Apple down to the niche that was the then current reality.  It involved enormous layoffs. The rest is history.

Microsoft needs to dramatically refocus and reduce back to their core competency.  Ballmer will not let that happen so it needs new leadership.  Once you get Microsoft back to, lets say 1/3 of current size, then lets see what can be done with a company that will still create similar profits to today, but with a very focussed smaller group.  Its called strategy 101 and why the board are not asking for this is beyond me.

Rogoff is one of the clearest thinkers out there when it comes to understanding the current western economic situation following the financial crisis of 2008.  If you don’t have the time to read “This Time is Different” or this paper (written early in 2008 before Lehmans), but want to understand why the US and Europe are in such rough shape a mere 3 years later, then read this interview transcript. 

Understanding the Second Great Contraction – Rogoff

Kenneth Rogoff: The historical experience gives a very clear view that the aftermath of a financial crisis brings  slow and halting growth, sustained high unemployment, and surging public debt—with the overhang of public and private debt being the most important impediment to a normal recovery from recession.

It has been utterly remarkable how the United States has been tracking the averages of postwar deep financial crises across a broad range of indicators. On average, it takes four and a half years to get back to the same per capita GDP where you started out and about the same amount of time for unemployment to stop rising.

Indeed, we haven’t yet gotten back to the same per capita GDP where we started. Our perspective is that we have never left the recession; we’re still very much in it. I hope in another two or three years things will be feeling more normal. But there are a lot of difficulties to traverse before we get there.

pdf

Bank of America continues with apparently moves that can only be characterised as desperate.  This one involves some $70 Trillion in derivatives.  Yes that number is correct, with a “T”, and it could (to be confirmed) represent some 10% of all derivatives in the world.  This is astounding.

BofA Said to Split Regulators Over Moving Merrill Derivatives to Bank Unit | Bloomberg

Bank of America Corp. (BAC), hit by a credit downgrade last month, has moved derivatives from its Merrill Lynch unit to a subsidiary flush with insured deposits, according to people with direct knowledge of the situation.

As commented over at Naked Capitalism:

Bank of America Deathwatch: Moves Risky Derivatives from Holding Company to Taxpayer-Backstopped Depository

If you have any doubt that Bank of America is in trouble, this development should settle it. I’m late to this important story broken this morning by Bob Ivry of Bloomberg, but both Bill Black (who I interviewed just now) and I see this as a desperate (or at the very best, remarkably inept) move by Bank of America’s management.

The news about BofA has turned remarkably negative in the last few months.  It began when Warren Buffet chipped in with $5 Bn which was an odd and awkward moment.

BofA did not look good during the crisis, but the shifts they are going through now, including write downs and moving things around amongst subsidiaries, project BAC, none of which is a healthy sign and points to increasing signs of desperation and running out of options for some inevitable end.

http://thebankwatch.com/?s=%22bank+of+america%22

http://www.google.com/search?tbm=blg&hl=en&q=%22bank+of+america+corp%22

Phase 2 of the banking crisis continues to circle.  We already know about the sovereign risk issues in Europe and now the soft employment and economy in the US is showing as deteriorating consumer credit signals warning of more bad debts for US Banks.

Improvement in US mortgage delinquencies ends

The penny has dropped.  We are in a period where the only way out is deleveraging otherwise known as debt reduction.  Yes it will be painful but its more painful watching bankers whining to governments to protect themselves.  We are in a state of flux where the only solution is debt reduction.  This can happen in only one of a couple of ways.  One is debt write offs and the other primary one is inflation.  However all countries cannot inflate at the same time.

EU banks could shrink to hit capital rules | ft.com

Another top banker said: “It’s fundamentally wrong to increase capital at the moment. Deleveraging needs to happen.”

However, the banks’ “shrinkage” strategy is likely to prove controversial with politicians and regulators if it led to bankers lending less money to customers, jeopardising the eurozone’s fragile recovery, analysts warned.

http://graphics.thomsonreuters.com/11/07/BV_STRSTST0711_VF.html

Simon Johnson , who served as chief economist at the International Monetary Fund in 2007 and 2008 writes on how we have learning nothing nor is the financial system improved in any way since 2008.  The changes including the US Dodd-Frank law do nothing to solve Too Big to Fail (TBTF).

Johnson asks one question, yet leaves the answer hanging …  Who would lose money in a bank liquidation?

Lets look at Bank of America who open that door nicely with their promise of a ‘fortress balance’ sheet.  But rest assured, this same analysis works for any bank as you will see when we get to the punch line.

2010 Annual Report ($ billions)

_________________________

Balance sheet categories:

Total Loans incl debt secs (assets)              1,236

Securities (fed and others owe to BoA            404

Other Assets (real estate etc)                         624

Total Assets                                   2,264

Total Deposits (liabilities)                            1,010

Securities  (liabilities to fed and others)       1,327

Total Liabilities                                2,037                               

Capital                                               228

Off Balance sheet Notes                                    25

First the good news.  BofA has assets that exceed liabilities by 228 billion.  Big cushion, right?  Of course not and here is why.

In a liquidation scenario, you can bet 100% of the holders of liabilities will want all their money, all $2,037 billion.  Especially the Fed who need it to bail everyone out!  But what about the assets?  When BofA go calling on those debt holders, what % will they get … 90% ?  50% ?  25% ? 

Suddenly the $228 billion is not so large.  Lets assume 75% pay up.  BofA gets $927 billion.  For fun lets assume the Fed pays 100% or $404 Bn.  Real estate will plummet in a fire sale, but lets say Warren Buffet steps in and pays 75 cents on the dollar or $468 bn.

BofA collects $1,799 but pays out $2,037 – short 238 Bn.  Suddenly the capital is down by $466 bn ( that’s 1/2 a trillion)

That was a pleasant scenario because we assumed the loans would attract a 75% return.  There were $1.1 trillion in Countrywide mortgages sold off as derivatives between 2004 and 2009.  Its hard to value the liability from the balance sheet but it is still out there based on the numerous justifications and positive mentions.  In a liquidation, a safe additional $500 bn shortfall could be safely projected.

The impact of depositor insurance, both real and implied:

But you may ask, all of this is meaningless because the Federal Government will step in on liquidation and guarantee all the deposits therefore loan shortfalls do not matter, right?  Wrong again. 

This is precisely where the TBTF rubber hits the road.  When that happens, the government has no choice but take over the bank, with these implications on liquidation, yes liquidation means this happens on a Sunday afternoon and is complete before markets open Monday:

1. common stock value goes to zero.  Stock disappears from NYSE
2. government adds $ trillions to its balance sheet both assets (now worthless loans) and full value deposits (new government liabilities to citizens)
3. GBoA (Government Bank of America) begins Monday morning calling up debtors (loans) and asks nicely if they wouldn’t mind continuing to pay down, repay their loans.
4. Asset values crash as the largest creditor in the country now considers foreclosures and bankruptcy proceedings on a mammoth scale never seen before
5. or … 4 becomes the largest debt write off seen in the countrys history with repercussions on currency and real estate values wiping off decades (centuries) of value.
6. Tuesday … Wells Fargo, Citibank and others follow suit as the market freeze refuses to budge and no other country will deal with any American bank.

Who loses in a bank liquidation?

So who loses in a bank liquidation;  unfortunately everyone.  This is reflected in stock values, asset values and price increases for normal everyday items from currency gyrations and mammoth speculation.  There would be societal implications on the streets, chaos everywhere.  The concept of a bank disappearing is unforseen, and frightening.

The socialisation of bank liabilities by governments both in US and elsewhere, means they are de facto nationalised.  There is no difference between a well run bank and a poorly run bank for that reason alone.  In a liquidation scenario it is truly all for one and one for all.

The best solution that I can think is the UK ring fence, or full imposition of the Volker rule.  This will at least force the separation of your money from speculative money in the above calculations, and while not perfect that has to be a start.  While potentially chaotic, the liquidation of an investment bank does not directly impact day to day commerce, nor commercial business deposits.

And that needs to happen in weeks, not years as is proposed on both sides of the Atlantic.  Otherwise we are literally in the situation whereby the above can be likened to the Big Red Button of the Cold War, and we are constantly reminded of how it could be pushed in error.  It happened with Lehmans and AIG and could happen again as we watch events unfold in September 2011.

Thoughts on other solutions welcomed.

Few were paying much attention to OccupyWallStreet including mainstream media until … the politicians and others stepped in with poorly timed and badly framed criticism.

The oddest was surely Rand Paul, US Senator.

“I see it as inflaming this Paris mob that I hope doesn’t result in a lawlessness where they say, ‘Well, gosh, those nice iPads through the window should be mine and why don’t I throw a brick through the window to get them because rich people don’t deserve to have them when I can’t have one,’” Paul said.

He appears to believe the world will run out of ipads and the ‘mobs’ will keep them all for themselves thus stopping the Pauls of the world from enjoying them!??!

Anyhow, I have been resisting any attempt to comment on OccupyWallStreet given the potential for rhetoric, and obvious comparisons that would create terms such as Banker Spring which shockingly has not turned up yet.

In any event I will leave it for now to Paul Krugman who wonderfully sums up the inherent hypocrisy contained in the criticism so far that as he says attempt to defend the indefensible.  Think derivatives while reading this and the reality that the value of trade in money exceeds actual international commerce by a factor of many times over (10 times to be exact).  This purely speculative activity results in enormous sums owed between banks, that cannot be properly valued, and that is a large part of why banks suffer from such crisis in confidence both in Sept 2008, and Sept 2011 and they refuse to trade with each other.

Sub prime mortgages, and Euro sovereign debts are mere catalysts … this is the root problem with banks.  OccupyWallStreet senses this weakness and the moral indefensibility Krugman illuminates.

Here is Krugman, and its very lucid and clear read if you click through.

Panic of the Plutocrats | NY Times – Krugman

What’s going on here? The answer, surely, is that Wall Street’s Masters of the Universe realize, deep down, how morally indefensible their position is. They’re not John Galt; they’re not even Steve Jobs. They’re people who got rich by peddling complex financial schemes that, far from delivering clear benefits to the American people, helped push us into a crisis whose aftereffects continue to blight the lives of tens of millions of their fellow citizens.

Yet they have paid no price. Their institutions were bailed out by taxpayers, with few strings attached. They continue to benefit from explicit and implicit federal guarantees — basically, they’re still in a game of heads they win, tails taxpayers lose. And they benefit from tax loopholes that in many cases have people with multimillion-dollar incomes paying lower rates than middle-class families.

It is assumed by many that China will automatically take over from US in time.  Well that may or not be the case.  In any event we can assume the direction being followed in China will be a rocky one. 

Here is one of those quotes, relative to banking,  that makes you look twice about China.

China realty goes BOGOF MacroBusiness

In the epicentre, Wenzhou, QQ.com reports that 90% of families in Wenzhou are involved in underground banking in one way or another.

And some more detail, including analysis by Credit Suisse.

In the face of high inflation and low deposit rates in the formal banking system, large number of these families are seeking higher yields, thus their money has found its way to the shadow banking system.  As monetary tightening made credit less available in the formal banking system, businesses were forced to borrow from this underground credit system (which includes stuff like loan sharks and pawn shops).

Although the current epicentre is in Wenzhou, these activities exist everywhere in China. Last week, Dong Tao of Credit Suisse wrote in a note that the underground banking system is a time bomb, and poses a potentially serious problem to the Chinese economy:

We consider the informal lending market as the most likely short-term time bomb for the Chinese economy, possibly more abruptive and explosive than the local government debt situation. Given its underground nature, it is unclear when this time bomb may explode, but something is likely to happen over the next 12 months. Either Beijing takes pro-active and decisive measures to deal with the issue, or a mini-credit crisis is likely to emerge, in our judgment.

These announcements on the same day are telling.  (Note:  US population = 307 million/  Canada population – 34 million)

US economy adds 103,000 jobs – ft.com

The Canadian economy   churned out 60,900 jobs last month  (Globe & Mail / Stats Can)

Put another way, if the US was creating jobs in this month at the Canadian pace their number would be 550,000.