canadian dollar 400Continuing my series of banks ready to "Cyprus" their depositors, I offer this reader contribution from Don from Canada 2013-03-29 23:11:

As part of the 2013 budget in Canada, the Minister of Finance tabled the Economic Action Plan 2013 which included the newest buzzword 'bail-in'.

Source: budget.gc.ca/.../...
Page 145
“The [Canadian] Government proposes to implement a “bail-in” regime for systemically important banks. This regime will be designed to ensure that, in the unlikely event that a systemically important bank depletes its capital, the bank can be recapitalized and returned to viability through the very rapid conversion of certain bank liabilities into regulatory capital. This will reduce risks for taxpayers. The Government will consult stakeholders on how best to implement a bail-in regime in Canada. Implementation timelines will allow for a smooth transition for affected institutions, investors and other market participants. Systemically important banks will continue to be subject to existing risk management requirements, including enhanced supervision and recovery and resolution plans.
This risk management framework will limit the unfair advantage that could be gained by Canada’s systemically important banks through the mistaken belief by investors and other market participants that these institutions are ‘too big to fail’.”

A depositor is an unsecured creditor to a bank. The Canadian government presents its position to be one of shielding the taxpayer from the need to pay for bailing out a failing bank. As a taxpayer that is comforting. 
However as a depositor, the phrase “rapid conversion of certain bank liabilities into regulatory capital” concerns me. My deposit is the bank’s liability. Could depositors’ funds fall under the definition of ‘certain bank liabilities’? 
I searched the entire 442 page document and I cannot find where the term ‘certain bank liabilities’ is defined.
The prudent approach I believe would be to assume that under certain conditions, certain bank liabilities will include depositors’ funds; at least those funds in excess of CAD 100,000 which is our so-called insured amount.
Even if it has noble intentions now, under a credit and derivatives collapse scenario, it is conceivable that the Canadian government could be coerced or bullied by external agents into grabbing depositors’ funds just like what is happening in Cyprus.
I find the newest ‘bail-in’ term being used since the Cyprus debacle quite amusing. It reminds me of the ‘sit-in’ and ‘love-in’ terms of the peace/hippie generation.
We all seem to be floating on the bathwater of fiat currency liquidity. The tub is being drained at the opposite end from where we are floating. The EU is circling the drain. The central banks are feverishly trying to replenish the tub with thimbles full of water, but it appears inevitable that some will go down the drain, whilst others will be left high and dry. The central bankers only have thimbles, not a drain stopper.
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Now, tell me if this looks even remotely familiar... from an article publsihed in the Financial Times on February 10, 2013 which clearly, accurately and timely foretold the events to unfold over the following 45 days or so :
A radical new option for the financial rescue of Cyprus would force losses on uninsured depositors in Cypriot banks, as well as investors in the country’s sovereign bonds, according to a confidential memorandum prepared ahead of Monday’s meeting of eurozone finance ministers.

The proposal for a “bail-in” of investors and depositors, and drastic shrinking of the Cypriot banking sector, is one of three options put forward as alternatives to a full-scale bailout. The ministers are trying to agree a rescue plan by March, to follow the presidential elections in Cyprus later this month.

By “bailing in” uninsured bank depositors, it would also involve more foreign investors, especially from Russia, some of whom have used Cyprus as a tax haven in recent years. That would answer criticism from Berlin in particular, where politicians are calling for more drastic action to stop the island being used for money laundering and tax evasion.

Labelled “strictly confidential” and distributed to eurozone officials last week, the memo says the radical version of the plan – including a “haircut” of 50 per cent on sovereign bonds – would shrink the Cypriot financial sector, now nearly eight times larger than the island’s economy, by about one-third by 2015.

Senior EU officials who have seen the document cautioned that imposing losses on bank depositors and a sovereign debt restructuring remain unlikely. Underlining the dissuasive language in the memo, they said that bailing in depositors was never considered in previous eurozone bailouts because of concern that it could lead to bank runs in other financially fragile countries.

But the authors warn such drastic action could restart contagion in eurozone financial markets...

Oh, and it can get worse. Zerohedge reports, via Reuters, that there will be absolute wipeouts for some big depositors in Cyprus:

In what appears to be drastically worse than many had hoped (and expected), uninsured depositor in Cyprus' largest bank stand to get no actual cash back from their initial deposit as the plan (expected to be announced tomorrow) is:

    • 22.5% of the previous cash deposit gone forever (pure haircut)
    • 40% of the previous cash deposit will receive interest (but will never be repaid),
    • and the remaining 37.5% of the previous cash deposit will be swapped into equity into the bank (a completely worthless bank that is of course.)

So, theoretically this is 62.5% haircut but once everyone decides to 'sell' their shares to reconstitute some cash then we would imagine it will be far greater. Furthermore, at what valuation will the 37.5% equity be allocated (we suspect a rather aggressive mark-up to 'market' clearing levels).

Critically though, there is no cash. None. If you had EUR150,000 in the bank last week (net of insured deposits which may well be impaired before all is said and done) you now have EUR0,000 to draw on! But will earn interest on EUR60,000 (though we do not know at what rate); and own EUR56,250 worth of Bank of Cyprus shares (the same bank that will experience the slow-burn leak of capital controlled outflows).

In the post "EU Bank Depositors: Your Mattress Is Starting To Look Awfully Attractive - Bank Risk, Reward & Compensation", I offered a way to calculate what return you should expect to receive to take on the risk of a potential 40% haircut. The second tab offers what recent Cyprus bank rates were. Do you see a disparity??? To bring things up to date, up the haircut to 63% and you will find that no bank in the world will compensate you for the risk you assume in banking there. Banco Posturepedico shares: Strong BUY!!!!

Now that you see its just Cyprus - the perceived uber-conservative Canadian banks are prepping to Cyprus their depositors as well.
Oh, it gets worse. I will start posting a list of definitive bank names that I have apparently caught in some amazingly duplicitous and misleading capital schemes, at least as it appears to me and my staff. I know I wouldn't have MY money in them, particularly after reading the info above. The first bank name and a description of their actions are avialable to all paying subscribers right now in the right hand downloads column and in the commercial bank research section of my site. I will release a new bank expected to be "Cyprus'd" every 48 hours  to subscribers until I run out of definitive candidates. Yes it pays to be a BoomBustBlog member (click here to subscribe)
This Easter weekend, I will also release a PSA (public service announcement) to give a heads up to non-paying subscribers and readers who are too comfortable with their current banking arrangement.
 
As a reminder for those who wish to ignore my banking calls as a frivolous episode of Chicken Little, BoomBustBlog is the place that was the first to reveal:
  1. The collapse of Bear Stearns in January 2008 (2 months before Bear Stearns fell, while trading in the $100s and still had buy ratings and investment grade AA or better from the ratings agencies): Is this the Breaking of the Bear? 
  2. The warning of Lehman Brothers before anyone had a clue!!! (February through May 2008): Is Lehman really a lemming in disguise? Thursday, February 21st, 2008 | Web chatter on Lehman Brothers Sunday, March 16th, 2008 (It would appear that Lehman’s hedges are paying off for them. The have the most CMBS and RMBS as a percent of tangible equity on the street following BSC. 
  3. The collapse of the regional banks (32 of them, actually) in May 2008: As I see it, these 32 banks and thrifts are in deep doo-doo! as well as the fall of Countrywide and Washington Mutual
  4. The collapse of the monoline insurers, Ambac and MBIA in late 2007 & 2008: A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton, Welcome to the World of Dr. FrankenFinance! and Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion
  5. The ENTIRE Pan-European Sovereign Debt Crisis (potentially soon to be the Global Sovereign Debt Crisis) starting in January of 2009 and explicit detail as of January 2010: The Pan-European Sovereign Debt Crisis
  6. Ireland austerity and the disguised sink hole of debt and non-performing assets that is the Irish banking system: I Suggest Those That Dislike Hearing “I Told You So” Divest from Western and Southern European Debt, It’ll Get Worse Before It Get’s Better!
The problems that plagued Cyprus banks plague banks in much larger nations within, and around the EU. From Ovebanked, Underfunded, and Overly Optimistic: The New Face of Sovereign Europe you see institutions that are literally too big to be handled safely...

The Banks Are Bigger Than Many of the Sovereigns

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Ready! Set! Bank Run!!!

Cyprus contagion raw

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Maurice Greenberg, the ousted CEO, Chairman, and founder of AIG who remains a major investor in the company, filed suit in 2011 on behalf of fellow shareholders against the government. He has urged A.I.G. to enjoin which should pressure the government into settlement talks - that is if the powers that be don't start distending the law. NY Times Dealbook looks at it this way:

Should Mr. Greenberg snare a major settlement without A.I.G., the company could face additional lawsuits from other shareholders. Suing the government would not only placate the 87-year-old former chief, but would put A.I.G. in line for a potential payout.

Yet such a move would almost certainly be widely seen as an audacious display of ingratitude. The action would also threaten to inflame tensions in Washington, where the company has become a byword for excessive risk-taking on Wall Street.

Some government officials are already upset with the company for even seriously entertaining the lawsuit, people briefed on the matter said. The people, who spoke on the condition of anonymity, noted that without the bailout, A.I.G. shareholders would have fared far worse in bankruptcy.

“On the one hand, from a corporate governance perspective, it appears they’re being extra cautious and careful,” said Frank Partnoy, a former banker who is now a professor of law and finance at the University of San Diego School of Law. “On the other hand, it’s a slap in the face to the taxpayer and the government.”

AIG has every right and responsibility to sue the US for excessive interest payments on it's bailout! Yes, the company failed in execution. Yes, the company would have went bust if the government didn't rescue it. But that is besides the point. If the government wanted market forces to reign supreme they would have let AIG collapse. The fact is they didn't. The reason is because the government was bailing out the banks, namely the most politically connected publicly traded entity in the entire world. The Vampire Squid! Goldman Sachs! As excerpted from the NY Times:

At the end of the American International Group’s annual meeting last month, a shareholder approached the microphone with a question for Robert Benmosche, the insurer’s chief executive. “I’d like to know, what does A.I.G. plan to do with Goldman Sachs?” he asked. “Are you going to get — recoup — some of our money that was given to them?

As a condition of AIG's bailout, the government "insisted" on paying Goldman et. al. 100 cents on the dollar of its CDS written with AIG, something that wouldn't have been necessary if Goldman had prudently underwritten counterparty and credit risks that it was taking. Apparently, the US government believes that it didn't. In addition, it's somethng that wouldn't have been possible if the government didn't intervene on behalf of the banks, forcing the AIG shareholders to take a hit, but shielding the Goldman, et. al. shareholders. As my grandma used to tell me, what's good for the goose is good for the gander! It's not as if these credit/counterparty risks were invisible, I saw them as far back as early 2008 - reference I won't say I told you so, again. This page also happened to of shown the credit risk concentration of every bank granted a reprieve by the government after the fact. As a matter of fact, there's still more than a modicum of risk present, as clearly illustrated in...

Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To Be Ignored?Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To Be Ignored?  

Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To Be Ignored?

Welcome to part two of my series on Hunting the Squid, the overvaluation and under-appreciation of the risks that is Goldman Sachs. Since this highly analytical, but poignant diatribe covers a lot of material, it's imperative that those who have not done so review part 1 of this series, I'm Hunting Big Game Today:The Squid On The Spear Tip, Part...

 

Hunting the Squid, part 4: So, What Else Can Go Wrong With The Squid? Plenty!!!Hunting the Squid, part 4: So, What Else Can Go Wrong With The Squid? Plenty!!!  

Hunting the Squid, part 4: So, What Else Can Go Wrong With Goldman Sachs? Plenty!

Yes, this more of the hardest hitting investment banking research available focusing on Goldman Sachs (the Squid), but before you go on, be sure you have read parts 1.2. and 3:  I'm Hunting Big Game Today:The Squid On A Spear Tip, Part 1 & Introduction Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To...

Now, AIG's shareholders are being forced to finance the bailout of Goldman Sachs. To not combat that should open AIG management up to shareholder lawsuits, for they are not acting as a fiduciary of the shareholder capital if they let this slide. It's one thing to pay for the AIG bailout, but its another to pay for the Goldman bailout. In addition, this forced bailout that refused to force AIG creditors not to take haircuts runs counter to the ideology the government used when it forced the Chrysler's creditor's to take massive haircuts.

When the government began rescuing it from collapse in the fall of 2008 with what has become a $182 billion lifeline, A.I.G. was required to forfeit its right to sue several banks — including Goldman, Société GénéraleDeutsche Bank and Merrill Lynch — over any irregularities with most of the mortgage securities it insured in the precrisis years.

But after the Securities and Exchange Commission’s civil fraud suit filed in April against Goldman for possibly misrepresenting a mortgage deal to investors, A.I.G. executives and shareholders are asking whether A.I.G. may have been misled by Goldman into insuring mortgage deals that the bank and others may have known were flawed.

The anger here should be directed at Goldman, et. al., and not AIG. AIG's management is doing its job, something that our government officials failed to do in making Goldman, et. al. whole during the bailout. Can anyone say regulatory capture?  Goldman et. al.'s transgressions against its clients and counterparties in terms of misrepresentation and what appears to this lay person as outright fraud have been downright egregious, as clearly articulated in Goldman Sachs Executive Director Corroborates Reggie Middleton's Stance: Business Model Designed To Walk Over Clients, it's just that this time, the US taxpayer AND the AIG shareholders are the "Muppets"! The Abacus deal was particularly atrocious, Paulson, Abacus and Goldman Sachs Lawsuit. How about Morgan Stanley's CRE deals on behalf of their so-called clients? Wall Street Real Estate Funds Lose Between 61% to 98% for Their Investors as They Rake in Fees!

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 If Goldman, et. al. were allowed to swim solely at the mercy of the free markets, it (they) would be sinking, Goldman Sachs Latest: Vindicates BoomBustBlog Research ...

... documents also indicate that regulators ignored recommendations from their own advisers to force the banks to accept losses on their A.I.G. deals and instead paid the banks in full for the contracts. That decision, say critics of the A.I.G. bailout, has cost taxpayers billions of extra dollars in payments to the banks. It also contrasts with the hard line the White House took in 2009 when it forced Chrysler’s lenders to take losses when the government bailed out the auto giant.

Regulatory capture! Banks simply lobby harder and pay more to the government than auto companies. How many auto company execs are embedded in government leadership seats worldwide?

As a Congressional commission convenes hearings Wednesday exploring the A.I.G. bailout and Goldman’s relationship with the insurer, analysts say that the documents suggest that regulators were overly punitive toward A.I.G. and overly forgiving of banks during the bailout — signified, they say, by the fact that the legal waiver undermined A.I.G. and its shareholders’ ability to recover damages.

“Even if it turns out that it would be a hard suit to win, just the gesture of requiring A.I.G. to scrap its ability to sue is outrageous,” said David Skeel, a law professor at the University of Pennsylvania. “The defense may be that the banking system was in trouble, and we couldn’t afford to destabilize it anymore, but that just strikes me as really going overboard.”

“This really suggests they had myopia and they were looking at it entirely through the perspective of the banks,” Mr. Skeel said.

Nahh? It's called the Federal Reserve Bank, not the Federal Reserve Insurer, nor the Federal Reserve Taxpayer! Who the hell do you think they will back in a crunch?

About $46 billion of the taxpayer money in the A.I.G. bailout was used to pay to mortgage trading partners like Goldman and Société Générale, a French bank, to make good on their claims. The banks are not expected to return any of that money, leading the Congressional Research Service to say in March that much of the taxpayer money ultimately bailed out the banks, not A.I.G.

Of which the interest of about 50% of which should be refunded to AIG shareholders. Without the AIG bailout, these banks would have recieved ZILCH, NOTHING, NADA, Bull Sh1t!

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While perusing the news today, I came across this most interesting article in Bloomberg, Swaps ‘Armageddon’ Lingers as New Rules Concentrate Risk'. Before we delve into it, I want to review how vehemently I've sounded the alarm on this topic over the last 6 years. Let's start with So, When Does 3+5=4? When You Aggregate A Bunch Of Risky Banks & Then Pretend That You Didn't?, where I've aggregated my warnings into a single article. In a nutshell, 5 banks bear 96% of the global derivatives risk. The argument to defend such ass backwards risk concentration is "but it's mostly hedged, offset and netted out". Right! You know that old trader's saying about liquidity? It's always available, that is until you need it!

Even though I've made this point of netting = nonsense multiple times, I must admit, ZH did a more loquacious job, as follows:

..Wrong. The problem with bilateral netting is that it is based on one massively flawed assumption, namely that in an orderly collapse all derivative contracts will be honored by the issuing bank (in this case the company that has sold the protection, and which the buyer of protection hopes will offset the protection it in turn has sold). The best example of how the flaw behind bilateral netting almost destroyed the system is AIG: the insurance company was hours away from making trillions of derivative contracts worthless if it were to implode, leaving all those who had bought protection from the firm worthless, a contingency only Goldman hedged by buying protection on AIG. And while the argument can further be extended that in bankruptcy a perfectly netted bankrupt entity would make someone else who on claims they have written, this is not true, as the bankrupt estate will pursue 100 cent recovery on its claims even under Chapter 11, while claims the estate had written end up as General Unsecured Claims which as Lehman has demonstrated will collect 20 cents on the dollar if they are lucky.

The point of this detour being that if any of these four banks fails, the repercussions would be disastrous. And no, Frank Dodd's bank "resolution" provision would do absolutely nothing to prevent an epic systemic collapse. 

Hey, there ain't no concentration risk in US banks, and any blogger with two synapses to spark together should know this... From An Independent Look into JP Morgan.

Click graph to enlarge

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Cute graphic above, eh? There is plenty of this in the public preview. When considering the staggering level of derivatives employed by JPM, it is frightening to even consider the fact that the quality of JPM's derivative exposure is even worse than Bear Stearns and Lehman‘s derivative portfolio just prior to their fall. Total net derivative exposure rated below BBB and below for JP Morgan currently stands at 35.4% while the same stood at 17.0% for Bear Stearns (February 2008) and 9.2% for Lehman (May 2008). We all know what happened to Bear Stearns and Lehman Brothers, don't we??? I warned all about Bear Stearns (Is this the Breaking of the Bear?: On Sunday, 27 January 2008) and Lehman ("Is Lehman really a lemming in disguise?": On February 20th, 2008) months before their collapse by taking a close, unbiased look at their balance sheet. Both of these companies were rated investment grade at the time, just like "you know who".

So, the Bloomberg article that got this rant started basically says that the risk is being shifted from the banks to clearing houses, who demand above board, translucent collateral for transactions. This should solve the problem, right? Hardly! You see, the Fed and US banking regulators have made it legal and acceptable for banks to outright lie about the qualit of their collateral and the condition of their finances. It all came to light with my research on Lehman (and Bear Stearns, amonst others). These mistakes are so repetitive of the ones made in the past, I literally do not have to right any new material, let's just re-read what was written several years ago:

Lehman Brothers and Its Regulators Deal the Ultimate Blow to Mark to Market Opponents

Let's get something straight right off the bat. We all know there is a certain level of fraud sleight of hand in the financial industry. I have called many banks insolvent in the past. Some have pooh-poohed these proclamations, while others have looked in wonder, saying "How the hell did he know that?"

The list above is a small, relevant sampling of at least dozens of similar calls. Trust me, dear reader, what some may see as divine premonition is nothing of the sort. It is definitely not a sign of superior ability, insider info, or heavenly intellect. I would love to consider myself a hyper-intellectual, but alas, it just ain't so and I'm not going to lie to you. The truth of the matter is I sniffed these incongruencies out because 2+2 never did equal 46, and it probably never will either. An objective look at each and every one of these situations shows that none of them added up. In each case, there was someone (or a lot of people) trying to get you to believe that 2=2=46.xxx. They justified it with theses that they alleged were too complicated for the average man to understand (and in business, if that is true, then it is probably just too complicated to work in the long run as well). They pronounced bold new eras, stating "This time is different", "There is a new math" (as if there was something wrong with the old math), etc. and so on and associated bullshit.

So, the question remains, why is it that a lowly blogger and small time individual investor with a skeleton staff of analysts can uncover systemic risks, frauds and insolvencies at a level that it appears the SEC hasn't even gleaned as of yet? Two words, "Regulatory Capture". You see, and as I reluctantly admitted, it is not that I am so smart, it is that the regulator's goals are not the same as mine. My efforts are designed to ferret out the truth for enlightenment, profit and gain. Regulators' goals are to serve a myriad constituency that does not necessarily have the individual tax payer at the top of the hierarchical pyramid. Before we go on, let me excerpt from a piece that I wrote on the topic at hand so we are all on the same page: How Regulatory Capture Turns Doo Doo Deadly.

You see, the banking industry lobbied the regulators to allow them to lie about the value and quality of their assets and liabilities and just like that, the banking problem was solved. Literally! At least from a equity market pricing and public disinformation campaign point of view...

A picture is worth a thousand words...

fasb_mark_to_market_chart.pngfasb_mark_to_market_chart.pngfasb_mark_to_market_chart.png

So, how does this play into today's big headlines in the alternative, grass roots media? Well, on the front page of the Huffington Post and ZeroHedge, we have a damning expose of Lehman Brothers (we told you this in the first quarter of 2008, though), detailing their use of REPO 105 financing to basically lie about their
liquidity positions and solvency. The most damning and most interesting tidbit lies within a more obscure ZeroHedge article that details findings from the recently released Lehman papers, though:

On September 11, JPMorgan executives met to discuss significant valuation problems with securities that Lehman had posted as collateral over the summer. JPMorgan concluded that the collateral was not worth nearly what Lehman had claimed it was worth, and decided to request an additional $5 billion in cash collateral from Lehman that day. The request was communicated in an executive?level phone call, and Lehman posted $5 billion in cash to JPMorgan by the afternoon of Friday, September 12. Around the same time, JPMorgan learned that a security known as Fenway, which Lehman had posted to JPMorgan at a stated value of $3 billion,was actually asset?backed commercial paper credit?enhanced by Lehman (that is, it was Lehman, rather than a third party, that effectively guaranteed principal and interest payments). JPMorgan concluded that Fenway was worth practically nothing as collateral.

Well, I'm sure many are saying that this couldn't happen in this day and age, post Lehman debacle, right? Well, it happened in 2007 with GGP and I called it -  The Commercial Real Estate Crash Cometh, and I know who is leading the way! As a matter of fact, we all know it happened many times throughout that period. Wait a minute, it's now nearly 2013, and lo and behold.... When A REIT Trading Over $15 A Share Is Shown To Have Nearly All Of Its Properties UNDERWATER!!!

Paid subscribers are welcome to download the corporate level valuation of PEI as well as all of the summary stats of our findings on its various properties. The spreadsheet can be found here - File Icon Results of Properties Analysis, Valuation of PEI with Lenders' Names. In putting a realistic valuation on PEI, we independently valued a sampling of 27 of its properties. We found that many if not most of those properties were actually underwater. Most of those that weren't underwater were mortgaged under a separate credit facility.   

PEI Underwater  Overly Encumbered Properties

What are the chances that the properties, whole loans and MBS being pledged by PEI's creditors are being pledged at par? Back to the future, it's the same old thing all over again. Like those banks, PEI is trading higher with its public equity despite the fact that its private equity values are clearly underwater - all part of the perks of not having to truly mark assets to market prices.  

 From Bloomberg: Swaps ‘Armageddon’ Lingers as New Rules Concentrate Risk

Clearinghouses cut risk by collecting collateral at the start of each transaction, monitoring daily price moves and making traders put up more cash as losses occur. Traders have to deal through clearing members, typically the biggest banks and brokerages. Unlike privately traded derivatives, prices for cleared trades are set every day and publicly disclosed.

And what happens when everybody lies about said prices? Is PEI's debt really looking any better than GGP's debt of 2007?

GGP Leverage Summary 2007

Properties with negative equity and leverage >80% 32
Properties with leverage >80% 44
% of properties with negative equity (based on CFAT after debt service) 72.7%

PEI Summary 2012

PEI Underwater  Overly Encumbered Properties

Both of these companies have debt that have been pledged by banks as collateral. Would you trust either of them? The banks then use the collateral to do other deals leading to more bubbles. What's next up in bubble land? I warned of it in 2009...

Check this out, from "On Morgan Stanley's Latest Quarterly Earnings - More Than Meets the Eye???" Monday, 24 May 2010:

Those who don't subscribe should reference my warnings of the concentration and reliance on FICC revenues (foreign exchange, currencies, and fixed income trading).  Morgan Stanley's exposure to this as well as what I have illustrated in full detail via the  the Pan-European Sovereign Debt Crisis series, has increased materially. As excerpted from "The Next Step in the Bank Implosion Cycle???":

The amount of bubbliciousness, overvaluation and risk in the market is outrageous, particularly considering the fact that we haven't even come close to deflating the bubble from earlier this year and last year! Even more alarming is some of the largest banks in the world, and some of the most respected (and disrespected) banks are heavily leveraged into this trade one way or the other. The alleged swap hedges that these guys allegedly have will be put to the test, and put to the test relatively soon. As I have alleged in previous posts (As the markets climb on top of one big, incestuous pool of concentrated risk... ), you cannot truly hedge multi-billion risks in a closed circle of only 4 counterparties, all of whom are in the same businesses taking the same risks.

Click to expand!

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So, How are Banks Entangled in the Mother of All Carry Trades?

Trading revenues for U.S Commercial banks have witnessed robust growth since 4Q08 on back of higher (although of late declining) bid-ask spreads and fewer write-downs on investment portfolios. According to the Office of the Comptroller of the Currency, commercial banks' reported trading revenues rose to a record $5.2 bn in 2Q09, which is extreme (to say the least) compared to $1.6 bn in 2Q08 and average of $802 mn in past 8 quarters.

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High dependency on Forex and interest rate contracts

Continued growth in trading revenues on back of growth in overall derivative contracts, (especially for interest rate and foreign exchange contracts) has raised doubt on the sustainability of revenues over hear at the BoomBustBlog analyst lab. According to the Office of the Comptroller of the Currency, notional amount of derivatives contracts of U.S Commercial banks grew at a CAGR of 20.5% to $203 trillion by 2Q-09 from $87.9 trillion in 2004 with interest rate contracts and foreign exchange contracts comprising a substantial 84.5% and 7.5% of total notional value of derivatives, respectively. Interest rate contracts have grown at a CAGR of 20.1% to $171.9 trillion between 4Q-04 to 2Q-09 while Forex contracts have grown at a CAGR of 13.4% to $15.2 trillion between 4Q-04 to 2Q-09.

In terms of absolute dollar exposure, JP Morgan has the largest exposure towards both Interest rate and Forex contracts with notional value of interest rate contracts at $64.6 trillion and Forex contracts at $6.2 trillion exposing itself to volatile changes in both interest rates and currency movements (non-subscribers should reference An Independent Look into JP Morgan, while subscribers should referenceFile Icon JPM Report (Subscription-only) Final - Professional, and File Icon JPM Forensic Report (Subscription-only) Final- Retail). However, Goldman Sachs with interest rate contracts to total assets at 318.x and Forex contracts to total assets at 11.2x has the largest relative exposure (see Goldman Sachs Q2 2009 Pre-announcement opinion Goldman Sachs Q2 2009 Pre-announcement opinion 2009-07-13 00:08:57 920.92 Kb,  Goldman Sachs Stress Test ProfessionalGoldman Sachs Stress Test Professional 2009-04-20 10:06:45 4.04 MbGoldman Sachs Stress Test Retail Goldman Sachs Stress Test Retail 2009-04-20 10:08:06 720.25 Kb,). As subscribers can see from the afore-linked analysis, Goldman is trading at an extreme premium from a risk adjusted book value perspective.

bank_forex_exposure.pngbank_forex_exposure.png


Back to the Bloomberg article:

Disaster Scenario

The need for a Fed rescue isn’t out of the question, said Satyajit Das, a former Citicorp and Merrill Lynch & Co. executive who has written books on derivatives. Das sketched a scenario where a large trader fails to make a margin call. This kindles rumors that a bank handling the trader’s transactions -- a clearing member -- is short on cash.

Remaining clients rush to pull their trading accounts and cash, forcing the lender into bankruptcy. Questions begin to swirl about whether the remaining clearing members can absorb billions in losses, spurring more runs.

“Bank customers panic, and they start to withdraw money,” he said. “The amount of money needed starts to become problematic. None of this is quantifiable in advance.” The collateral put up by traders and default fund sizes are calculated using data that might not hold up, he said.

The collateral varies by product and clearinghouse. At CME, the collateral or “margin” for a 10-year interest-rate swap ranges between 2.89 percent and 4.06 percent of the trade’s notional value, according to Morgan Stanley. At LCH, it’s 3.2 percent to 3.41 percent, the bank said in a November note.

How Much?

The number typically is based on “value-at-risk,” and is calculated to cover the losses a trader might suffer with a 99 percent level of confidence. That means the biggest losses might not be fully covered.

It’s a formula like the one JPMorgan used and botched earlier this year in the so-called London Whale episode, when it miscalculated how much risk its chief investment office was taking and lost at least $6.2 billion on credit-default swaps. Clearinghouses may fall into a similar trap in their margin calculations, the University of Houston’s Pirrong wrote in a research paper in May 2011.

“Levels of margin that appear prudent in normal times may become severely insufficient during periods of market stress,” wrote Pirrong, whose paper was commissioned by an industry trade group.


Oh, but wait a minute? Didn't I clearly outline such a scenario in 2010 for French banks overlevered on Greek and Italian Debt (currently trading at a fractiono of par)? See The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs!

The problem then is the same as the European problem now, leveraging up to buy assets that have dropped precipitously in value and then lying about it until you cannot lie anymore. You see, the lies work on everybody but your counterparties - who actually want to see cash!

 

image012image012

Using this European bank as a proxy for Bear Stearns in January of 2008, the tall stalk represents the liabilities behind Bear's illiquid level 2 and level 3 assets (including the ill fated mortgage products). Equity is destroyed as the assets leveraged through the use of these liabilities are nearly halved in value, leaving mostly liabilities. The maroon stalk represents the extreme risk displayed in the first chart in this missive, and that is the excessive reliance on very short term liabilities to fund very long term and illiquid assets that have depreciated in price. Wait, there's more!

The green represents the unseen canary in the coal mine, and the reason why Bear Stearns and Lehman ultimately collapsed. As excerpted from "The Fuel Behind Institutional “Runs on the Bank" Burns Through Europe, Lehman-Style":

The modern central banking system has proven resilient enough to fortify banks against depositor runs, as was recently exemplified in the recent depositor runs on UK, Irish, Portuguese and Greek banks – most of which received relatively little fanfare. Where the risk truly lies in today’s fiat/fractional reserve banking system is the run on counterparties. Today’s global fractional reserve bank get’s more financing from institutional counterparties than any other source save its short term depositors.  In cases of the perception of extreme risk, these counterparties are prone to pull funding are request overcollateralization for said funding. This is what precipitated the collapse of Bear Stearns and Lehman Brothers, the pulling of liquidity by skittish counterparties, and the excessive capital/collateralization calls by other counterparties. Keep in mind that as some counterparties and/or depositors pull liquidity, covenants are tripped that often demand additional capital/collateral/ liquidity be put up by the remaining counterparties, thus daisy-chaining into a modern day run on the bank!

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I'm sure many of you may be asking yourselves, "Well, how likely is this counterparty run to happen today? You know, with the full, unbridled printing press power of the ECB, and all..." Well, don't bet the farm on overconfidence. The risk of a capital haircut for European banks with exposure to sovereign debt of fiscally challenged nations is inevitable.

You see, the risk is all about velocity and confidence. If the market moves gradually, the clearing house system is ok. If it moves violently and all participants move for cash at the same time against bogus collateral... BOOMMMM!!!!!!!

Back to the Bloomberg article...

Stress Levels

What’s more, clearinghouses can’t use their entire hoard of collateral to extinguish a crisis because it’s not a general emergency fund. The sum represents cash posted by investors to cover their own trades and can’t be used to cover defaults of other people.

Clearinghouses can turn to default funds to cover the collapse of the two largest banks or securities firms with which they do business. They have the power to assess the remaining solvent members for billions more, enough to cover the demise of their third- and fourth-largest members.

But wait a minute, the other members are only solvent because they have hedges against the insolvency of the insolvent members. If those hedges fail, then the so-called solvent members are insolvent too! Or did nobody else think of that?

After all, this circular reasoning worked out very well for Greece, didn't it? See Greece's Circular Reasoning Challenge Moves From BoomBustBlog to the Mainstream...

 

 


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Published in BoomBustBlog

The WSJ reports Corzine Rebuffed Internal Warnings on Risks:

MF Global Holdings Ltd.'s executive in charge of controlling risks raised serious concerns several times last year to directors at the securities firm about the growing bet on European bonds by his boss, Jon S. Corzine, people familiar with the matter said.

The board allowed the company's exposure to troubled European sovereign debt to swell from about $1.5 billion in late 2010 to $6.3 billion shortly before MF Global tumbled into bankruptcy Oct. 31, these people said. The executive who challenged Mr. Corzine resigned in March.

The disagreement shows that concerns about the big bet grew inside the company months ...

As I have hinted in "The Ironic, Prophetic Nature of the MF Global Bankruptcy Filing and It's Potential Ramifications" I knew the ex-CEO of MF Global, and in particular member(s) of in the internal audit staff - one of which I knew very well and trained. There is one glaring FLAW in the structure of internal risk management and audit in MF Global, and that was that it was WEAK! If internal audit answers to operational executive management, then how can it truly crack the whip on its own boss. Now, granted, this is not endemic to just MF Global, but it is truly a problem. Internal audit/risk management needs to answer to a separate entity, apart from the CEO and possibly apart from the Board itself if the CEO has had a part in selecting the board. This way there is true independence and the nonsense that you just saw with MF Global has a much less likely chance of happening.

Alas, such is life. For instance, why are you reading this through a subscription blog versus PWC's audit report of MF Global? Hmmmmmm.....


Published in BoomBustBlog

For anybody who didn't catch the hint, another banking crisis the continuation of the banking crisis is inevitable. I've said it before, Is Another Banking Crisis Inevitable? This is the current landscape, undoubtedly fudged over by optimistic marks.

Banks NPAs to total loans

Source: IMF, Boombust research and analytics

Euro banks remain weak as compared to their US counterparts

Health of European banks is weaker when compared to US banks. European banks are highly leveraged compared to their US counterparts (11.1x versus 4.1x) and are undercapitalized with core capital ratio of 6.5x vs. 8.5x. Also, the profitability of European banks is lower with net interest margin of 1.2% compared with 3.3%. However, non-performing loans-to-total loans for European banks are slightly better off when compared to US with NPL/loans at 4.9% vs. 5.6%. Nonetheless, considering the backdrop of high exposure to sovereign debt in Euro peripheral countries, we could see substantial write-downs for Euro banks AFS and HTM portfolio, which would more than offsets the relative strength of loan portfolio.

I really do mean substantial!

Published in BoomBustBlog

With all due respect to that Nassim Taleb dude who popularized the term "Black Swasn", Black Swan events are both overrated and the term is sloppily bandied about by those who may not be putting the requisite thought into just how utilitarian the knowledge of Black Swans actually are. Since you can't accurately predict, nor back test against, nor adequately hedge against such events, exactly what good is a Black Swan discussion. Well, I can answer that question. Black Swan events do maximum damage when the economic cycle is at its weakest. In Reggie Middleton's Economic Circle of Life (think the Lion King) it is the right portion of the circle in which Black Swan events do the most damage.

Actually, it is not the Black Swan events themselves that do the damage but said event do serve as the catalyst that either bust a bubble that was waiting to pop anyway, or break a structure that was hobbling along on one leg as it was  - where we happen to be now in many places of the developed world - sans rampant propaganda, misinformation and disinformation from less than disinterested sources.

I have always been of the contention that the 2008 market crash was cut short by the global machinations of a cadre of central bankers intent on somehow rewriting the rules of economics, investment physics and global finance. They became the buyers of last resort, then consequently the buyers of only resort while at the same time flooding the world with liquidity and guarantees. These central bankers and the countries they allegedly strive to serve took on the debt and nigh worthless assets of the private sector who threw prudence through the window during the "Peak" phase of the circle of economic life, and engaged in rampant speculation. Click to enlarge to print quality...

Published in BoomBustBlog

My condolences truly go out to the people of Japan. A massive earthquake, a horrifyingly destructive tsunami, and then multiple nuclear emergencies and radiation poisoning is more distress than any nation had had to endure in such a short period of time in recent history. I am reticent to discuss the ramifications of such, alas that is the crux of the analysis of BoomBustBlog. I have noticed that many professional investors are detached from the real world causes and consequences of volatility and large swings in the markets. In a way, I can sort of understand. It's like playing a video game. All you are doing is pushing buttons in reactions to changing pixels on a glowing screen. Unfortunately, the reality of the matter is sometimes much more than that. Thus, as we go on to illustrate what I see will probably come out of this situation, let’s keep in mind that real people are getting hurt to very significant extent. Real children, real families, real grandparents...

Published in BoomBustBlog

What could the ruler of Egypt's turmoils possible have to do with the need to takeover even more banks in western Europe and the potential default of several members of the PIIGS group? Read on, my dear friend...

I received an impressive response from my earlier description of the potential for contagion as a result of the Egyptian uprising. It is very engaging to simply fathom the practical melding of the minds of financial analysts, political analysts and global macro-economists. Unfortunately, this is not common practice. As a matter of fact, it is apparently never done in the analysis & research commonly proffered by the brokerage houses and the mainstream media. The practical applications of such has demonstrably superior predictive power over the application of any of the single approaches. For those who have not followed me over the years or somehow feel that an individual or small group cannot outperform the glorious houses for brokerage of "The Street", I urge you to look into who I am and to compare my performance to that of the street's best and brightest over the last few years . I attempted to demonstrate the predictive powers and effectiveness of looking for deeper understanding outside of one's core discipline by illustrating to my readers how our Sovereign Contagion Model predicted a roughly 40% chance of eruption in the Middle East, reference :

Published in BoomBustBlog

Due to popular demand, I will be including some basic sample trades and some directional tools for BoomBustBlog research, starting with the next dollop of fundamental research. The first set will arrive next week, where we will offer an option tool and currency trend analysis app. Soon, possibly tomorrow, I will discuss the placement of options using the Google research that I illustrated here - Navigating BoomBustBlog Subscription Material To Find The Google Valuation Drilldown.

Published in BoomBustBlog

It has come to my attention that several banks have actually blocked rank and file level access to my blog through their intranet. That, my dear friends, is asinine, and does nothing but engender distrust. While I admit I can be rather flamboyant in my writings, I am nonetheless quite fair. In addition, my opinions are analytically driven, by design. Thus, if you have a differing opinion all you really need to do is challenge me with the facts. One of us will be proven to be right, or at the very least it will be shown to all how we came to our conclusions. I have absolutely no problem admitting when I am wrong or have made a mistake. I have been right long enough and often enough that I have plenty of emotional and even egotistical room for error. I know fully that no one is perfect, and while I would much rather catch any error first, before a third party does it (particularly a dissenting third party) I know that things don't always happen that way.

A commenter had a very intelligent dissent against my Goldman Sachs post on Zero Hedge the other day. While cogent, eloquent and very lengthy, it was still wrong but it definitely exemplified what a bank (or any other entity) should do when they feel that I am not in the right. Of course, if you put yourself out there, there is always the risk that you can be proven wrong as well. Believe it or not, and contrary to what you marketing and PR advisers may tell you - it is alright. As a matter of fact, it is actually good sometimes. You see, to many of the people that matter, it is not only acceptable, it is expected that you will not be right all of the time. Anybody who is right all of the time should be held up to a much higher level of scrutiny. Just ask Bernie Madoff. The true test of character and fortitude is to be able to publicly admit when you have made a boo-boo, and be willing to do something about it. That goes a lot farther in my eyes, than abject perfection. This is a lesson that the global and national banking industry in the US has yet to learn.

On that note, let's go over a few emails that I have received recently...

Published in BoomBustBlog