Words Of Caution From Market Experts

Roubini continues to label this a bear market rally, saying we can’t subsidize the banks forever:

The results of the government’s stress tests on banks, to be released in a few days, will not mark the beginning of the end of the financial crisis. If we are to believe the leaks, the results will show that there might be a few problems at some of the regional banks and Citigroup (C) and Bank of America (BAC) may need some more capital if things get worse. But the overall message is that the sector is in pretty good shape.

This would be good news if it were credible. But the International Monetary Fund has just released a study of estimated losses on U.S. loans and securities. It was very bleak - $2.7 trillion, double the estimated losses of six months ago. Our estimates at RGE Monitor are even higher, at $3.6 trillion, implying that the financial system is currently near insolvency in the aggregate. With the U.S. banks and broker-dealers accounting for more than half these losses there is a huge disconnect between these estimated losses and the regulators’ conclusions.

The hope was that the stress tests would be the start of a process that would lead to a cleansing of the financial system. But using a market-based scenario in the stress tests would have given worse results than the adverse scenario chosen by the regulators. For example, the first quarter’s unemployment rate of 8.1% is higher than the regulators’ “worst case” scenario of 7.9% for this same period. At the rate of job losses in the U.S. today, we will surpass a 10.3% unemployment rate this year - the stress test’s worst possible scenario for 2010.

- Barry Ritholtz reports 33% of CA homeowners with mortgages are underwater.

- Henry Blodgett discusses the Geithner recapitalization plan of converting preferred shares to common, including some balance sheet analysis.

- Karl Denninger is feeling pessimistic:

The continued refusal by our government to put these financial institutions where they belong - in front of a bankruptcy judge where priority is honored, the capital structure is crammed down and the assets sold off for whatever the market will bear - is leading us inexorably toward economic Depression. Both President Bush and now Obama are proceeding under the (false) hope that if they can hold things together for a little while the economy will turn and it will all be ok.

The “green shoot” people are all predicting positive GDP in the 3rd and 4th quarter. What they’re not talking about is what the real number was for the 1st Quarter - there was a trade balance shift credit in there worth nearly 3%; take that back out and we weren’t -6% annualized, we were -9%!

The bad news is that the trade balance shift is actually bad for the economy and signifies extreme weakness yet it shows up as a positive contributor to GDP due to how the math works. Nice eh?

But that was likely a one-time change, which means the second quarter could get real interesting.

Here is the reality folks:

Until continuing claims start to come back into a reasonable range and the U-6 “frustrated” employees find work, the consumer credit picture cannot materially improve in terms of default rates on all sorts of credit. The consumer is 70% of the economy.

When that happens we will still be left with an economy that is missing the “pulled forward” demand represented by home equity extraction and rabid, unsustainable granting of all forms of credit. This is likely in the 3-4% of GDP range, and that adjustment will be permanent!

The excess debt in the system not only hasn’t been flushed it has to a large degree been hidden and/or shifted to The Federal Government! Defaulting it there doesn’t do anyone a damn bit of good - in fact, it spreads the damage to everyone instead of keeping with the people who made the bad bets on both sides (borrower and lender.) This is pure insanity, but it is what our government has done because we “the sheeple” keep believing we can have something for nothing.

There is no way to “fix” the bank balance sheets without massive dilution. Either you convert preferred to common, you issue new common, or you sell performing (cash-flowing) assets. The first two dramatically dilute everyone holding the common stock and the latter takes a pole-axe to the earnings side of the balance sheet, having the same effect on shareholders as the first two. The recent runup in bank stock prices, doubles in many cases or more, is not only unsustainable it is something right out of The Three Stooges.

Subscribe by RSS Subscribe by Email