Financial, Real Estate, Stock Markets Trends and Current Affairs

UPDATED -It is beyond a hallucinogenic-induced pipe dream to even consider that the Eurozone will come out of this attempt at replicating the US "extend and pretend" policy intact and unscathed. The mere concept of global equity rallies should have macro traders and fundamental investors chomping at the bit. The US won't even get away with it, and we have the world's reserve currency printing press in our basement running with an ink-based, inter-cooled, twin-turbo supercharger strapped on that will make those German engineers green with envy, not to mention green with splattered printer ink as the presses go berserk!

In part 2 of my series on the Pan-European Sovereign Debt Crisis, we will review Italy and Ireland in comparison to the whipping child of the media - Greece (see "The Coming Pan-European Sovereign Debt Crisis" for part one covering Greece and Spain along with tear sheets for the Spanish banks at risk for subscribers).

A knowledgeable reader, who is currently a sell side analyst, questioned me about using book value to value Goldman and investment banks in general. He proposed using a formula that entails revenues as well due to the fact that the main concern during the crisis was breakup value while revenue visibility is clearer now that the crisis is over.

Without going into the merits of his valuation suggestion (I am allowing him to make a more compete argument with me), this suggestion does bring up several pertinent points. For one, while the crisis may be over, the root causes of the crisis have went nowhere, and the counterparty risk concentration is actually much worse than before. In addition, not only is it political suicide to attempt to bailout another bank, I think it is poor economic policy as well. Combining these two assertions, it is not clear that we will not see anymore bank failures. The probability of such has dropped considerably though.

sen._corker.jpgSenator Corker challenged Mr. Volcker's stance in today's congressional hearings on the Volker Rule by saying that no financial holding company that had a commercial bank failed while performing proprietary trading. It appears as if Mr. Cofker may have received his information from the banking lobby, and did not do his own homework.
Let's reference the largest commercial bank/thrift failure of the all. First off, a little historical reference courtesy of WSJ.com:

WaMu Is Seized, Sold Off to J.P. Morgan, In Largest Failure in the History of the US!!!

In what is by far the largest bank failure in U.S. history, federal regulators seized Washington Mutual Inc. and struck a deal to sell the bulk of its operations to J.P. Morgan Chase & Co...

The collapse of the Seattle thrift, which was triggered by a wave of deposit withdrawals, marks a new low point in the country's financial crisis...

Volcker is correct in that banks conflicts of interests need to be stemmed. One would not have to worry about over regulation if one does not attempt to regulate every single act or attempt to guess what might go wrong. What needs to be done is to use regulation to disincentivize banks from engaging in activities that engender systemic risks and/or harm clients. By putting everybody on the same side of the table, you don't have to worry about outsmarting the private sector.

From CNBC:

The lead story this morning of ZH is "The Only Thing Better Than A Zero Hedge? Wells Fargo's "Never Lose" Economic Hedge", explaining more accounting shenanigans (if you read the links below, you will see that I have caught Wells in a few rather aggressive interpretations) related to MSR's. One thing that was noted was the inputs for valuing MSRs using interest rates as was extolled by management. Well...

The biggest input for MSRs are foreclosures, not interest rates. The interest rate argument is academic (assuming a refinance, that may or may not happen when few can qualify) while the foreclosures are happening at a much more rapid and prevalent clip and are much more likely to happen. The foreclosures are also a guaranteed end to MSR income. You can't service a loan on an REO, now can you? So while interest rates are remaining steady and can be put into an MSR valuation formula for a positive GAAP dollar generating result, foreclosures are on the rise and will continue to be, which will (and rightfully so) drive down the values of MSRs. This is probably why (the more academic) interest rates are used for inputs in lieu of a straight pipe to the foreclosure rates.

For those who haven't read my take on Well's Q4, you can read it here: http://boombustblog.com/Reggie-Middleton/1293-The-Wells-Fargo-4th-Quarter-Review-is-Available-and-Its-a-Doozy.html.

This is also a reason why assets need to be market to market, and not to model. Outside of the possibility of the models actually being faulty or just plain old wrong, they are subject to bias and fraud. If one were to simply force he banks to reveal cash flows and yields on the MSRs, as in raw revenues less all expenses divided by acquisition costs, I am sure you will find an inverse relationship with localized foreclosure rates, much tighter than that of interest rates. You will also find that, on a discounted basis, these MSRs are highly overvalued on bank's books. Unfortunately, banks don't do this so the easiest way to get to the values is to let the market set it.

I have decided to release a significant amount of opinion on Wells to the public, and have created an extended version of the report for subscribers with geo-specific charge-off estimates stemming from the FDIC/NY Fed model that we have created in house. A rather comprehensive piece of work. It appears that much of the sell side community is much, much more optimistic on the prospect of Wells than I am. It must be the Warren Buffet investment...

Well, it looks like Blankein, Dimon, et. al. really should have tried
harder to make that meeting with the President a couple of weeks ago.
It appeared as if he may have had something important to discuss. As my
readers and subscribers know, I have been very bearish on the big money
center banks since 2007, and quite profitably so. The last 3 quarters
saw a much larger trend reversal than I expected, that resulted in the
disgorgement of a decent amount of those profits - a disgorgement that I am still
beating myself up over. You see, as a fundamental investor, I don't do
well when reality diverges from the fundamentals for too long a period.
Luckily for me, fundamentals always return, and they usually return
with a vengeance. To keep things in perspective though, I am still up
on a cumulative basis many, many multiples
over the S&P (which is still negative, may I add) as well as your
average fund manager. Why? How was I able to do this? Well, its not
because I am supersmart, or well connected. It is because I keep things
in perspective. Those that look at the records that I publish say,
"Well he was down the last couple of quarters, so..." while
disregarding what happened the 8 or even 40 or so quarters before that.
Such a short term horizon will probably not be able to appreciate the
longer term perspective and foresight that enabled me to see this
entire malaise coming years ago and profit from it. No, I am not
perfect and I do mess up on occasion, but I also do pay attention to
the facts.

These facts pointed to a massive overvalutation in banks throughout the
bulk of last year, again! I made it clear to my subscribers that the
banks simply have too many
things going against them: political headwinds, nasty assets,
diminishing revenue drivers, over-indebted consumers, and a soft
economic cycle. I also warned explicitly that I didn't think Obama
would be nearly as lenient on the banks as Bush was. Well, the
headwinds are stiffening. On that note, let's take an empirical look at
just what this means in terms of valuation (note, I will following this
up with a full forensic re-valuation for all subscribers, incuding a
scenario analysis of varying extents of principal trading limits). Some
of these banks are I-N-S-A-N-E-L-Y overvalued
at these post bear market rally levels considering the aforementioned
headwinds. Methinks fundamental analysis will make a comeback in a big
way for 2010 as it meets the momentum and algo traders in a mutual BEAR
feast on the big investment banks cum hedge funds. I can't guarantee it
will happen, but the numbers dictate that it should. We shall see in
the upcoming quarters.

We have retrieved information about trading revenues for GS, MS, JPM and BoFA. We have also retrieved some balance sheet data to reflect the trend in investment holdings and the level of leverage, but I will address that in a future post for the sake of expediency. While the banks don't break out the P&L for principal trading, we can sort of back into it. Remember, traders are fed bonuses off of net revenue, not profit.

I have been advocating this limitation for some time.

• Banks' Size, Trading Would Be Limited in Obama Plan to Reduce
  
• Risk-Taking •Obama Says No Bank Should Have Proprietary Trading: Text of Announcement
• Obama Proposes New Curbs On Banks' Size, Risk-Taking

For those that listen to CNBC pundits knocking the separation of deposit taking entities from trading risk assuming entities, here are some common sense rebuttals.

This proposal would not have stopped the AIG failure

No, it would not have. It would have prevented deposit taking institutions such as Citibank and JP Morgan from trading on a speculative basis with AIG though. Theoretically, it would have allowed those that would have got jerked on the AIG to have sunk or swam on their own accord. We never had to stop AIG, we had to stop the repercussions of what an AIG would have caused.

A little more than a year and a half ago, I penned "A little more on HELOCs, 2nd lien loans and rose colored glasses",:

I syndicate my work across various sites on the web and occasionally go through the comments to see what people think. I get viewers of all types, from first time investors and the curious to multi-billion dollar portfolio managers and directors of analytical departments of the bulge brackets. It is the guy in the middle, the arm chair investor that seems to throw some of the wierdest comments, though. One of which was, "banks are more complicated than HELOC exposure and LTVs and it will take more than that to determine a bank short". Well, that comment is partially true. Today's banks are much more complex than LTVs and 2nd liens, but when these risky products on the downturn are multiples of your tangible capital, it really doesn't take more than that to start causing some severe solvency issues. You can have a trillion dollars in assets, but if you have $20 billion in equity with $100 billion in investments that will take a 50% loss, you are underwater by $30 billion. You can talk about these banks using terms such as "complicated", "complex", "fancy" and all of the other high falutin' adjectives that you can think of, but at the end of the day, if you lose more than you own you are insolvent. Now, that's a simple concept and it works quite well for my investment pursuits. This is coming from a guy who use to design offshore, option embedded structured products to fund illiquid private sector liabilities for things such retiree health care risks. Having some experience in the structured product arena, being an entrepreneur, and simply having to balance the family budget, I have come to learn - without a doubt - that complicated usually means less valuable. Either that, or it means an opportunity to charge the client more through lack of transparency in the pricing and profit structure.

Following the geographic default graph for HELOCs reproduced from the last posting, you see the two states that have been in the news the most lately have big spikes in my pretty little graph.

From Bloomberg: Mortgage-Bond Leverage Reaches 10-to-1, Markets Heal

Jan. 19 (Bloomberg) -- Wall Street firms are loosening terms of their lending to mortgage-bond investors as markets heal, an RBS Securities Inc. executive said.

Repurchase agreement, or repo, lending against the debt has expanded so much since freezing in late 2008 that some banks now offer as much as 10-to-1 leverage and terms as long as one year on certain securities backed by prime jumbo-home loans, said Scott Eichel, the Royal Bank of Scotland unit’s global co-head of asset- and mortgage-backed securities.