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Thursday, 9 April 2009
Have banks hit bottom yet? The numbers say no
Have we reached the bottom yet? That’s a question that people ask me from time to time. I haven’t got an answer yet, but today I have some numbers that may give us an idea. And the preliminary verdict is: No!
Have we reached the bottom yet? That’s a question that people ask me from time to time. I haven’t got an answer yet, but today I have some numbers that may give us an idea. And the preliminary verdict is: No!
Why? Because the commercial banking industry in the U.S. is likely to be bankrupt – by which I mean its liabilities could exceed its assets – as we approach the bottom. Just how bad will it get? It could see 41 percent of its core capital wiped out by loan losses alone. And when you take into account all the toxic waste and derivatives on the banks’ books, its capital looks mighty thin.
To understand how I reached this conclusion, consider that the banking industry has $6.7 trillion worth of loans and $1.2 trillion in equity capital. During the Great Depression, loan losses peaked in 1934 at 3.4 percent of loans. Banking analyst Mike Mayo believes that this figure could be far worse this time around – hitting 5.5 percent in 2010.
So? If banks need to write off 5.5 percent of their $6.7 trillion in loans, it would require them to wipe out $369 billion worth of their capital.
That doesn’t sound so bad until you consider that banks have a mere $880 billion in so-called Tier I, or core capital. In that context, a $369 billion write-off represents 41 percent. And regrettably there is a huge amount of potential for additional write-offs totalling in the trillions because the banks have $1.7 trillion in debt securities and $201 trillion in derivatives.
The IMF estimates that the U.S. has $3.1 trillion in toxic waste – which if written off would likely turn that $1.2 trillion in equity capital negative -- depending on how much of that toxic waste is held by commercial banks.
If we assume that U.S. banks have $1 trillion of toxic waste and they take $369 billion in loan losses, that would leave the industry with a negative net worth of about $169 billion ($1.2 trillion in equity capital less $1.369 trillion in toxic waste and loan losses).
I hope it’s not worse.
Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College. His eighth book is You Can’t Order Change: Lessons from Jim McNerney’s Turnaround at Boeing.
Rosenberg Says Don’t Mistake Slower Economic Slide for Rebound
By Matthew Benjamin
April 8 (Bloomberg) -- Investors shouldn’t mistake an economy that’s sliding less rapidly downhill for one that’s poised to start climbing, say Bank of America Corp.’s David Rosenberg and Deutsche Bank AG’s Joseph LaVorgna.
Improvements in consumer spending and home sales have been taken by some investors as signs that the recession, now in its 17th month, may be near a turning point. Partly as a result, the Dow Jones industrial average climbed as much as 22 percent from the recession low it set on March 9.
The data, however, are at best a signal that the worst of the contraction is over, said Rosenberg, chief North American economist at Banc of America Securities-Merrill Lynch in New York.
“Investors seem to have confused an actual recovery with the fact that the economy isn’t detonating anymore,” Rosenberg said in an interview yesterday. “Markets right now are dangerously extrapolating an improvement in the rate of change to an improvement in the actual level of economic activity. These are two very different events.”
The Dow Jones industrials lost 186.29 points, or 2.3 percent, to close at 7789.56 in yesterday’s trading. The index still stands 19 percent above its March 9 level.
The economy shrank at a 6.3 percent annual pace in the fourth quarter, the worst performance since 1982. Economists surveyed by Bloomberg estimate that the rate of contraction slowed in the first three months of this year to 5.2 percent. The Commerce Department will report its initial estimate of first-quarter growth on April 29.
Rate of Decline
“In most cases, what we’re seeing is the rate of decline in activity is diminishing, not that the level of economic activity is rising,” David Hensley, director of global economic coordination at JPMorgan Chase & Co. in New York, said in an interview yesterday.
He points to business surveys such as the Institute for Supply Management’s factory index as evidence of a slowing rate of decline. The ISM index has climbed for three months in a row, while still remaining below 50, the dividing line between contraction and expansion.
“There is a pronounced improvement in key aspects of the surveys, but they remain at levels consistent with steep contraction,” said Hensley.
Similarly, an index of consumer confidence, as measured by the Conference Board, increased to 26 in March from a record low of 25.3 set in February.
‘Not Here Yet’
Even when the economy does hit bottom, it may take a while before robust growth resumes, LaVorgna, chief U.S. economist at Deutsche Bank Securities in New York, said in an April 6 interview. “A bottoming out is no longer consistent with an imminent recovery, as it has been in the past. Investors are making the assumption history will repeat itself, yet recovery is not here yet.”
That hasn’t kept investors from viewing better-than- forecast economic indicators as an opportunity to buy. A March 12 Commerce Department report that retail sales decreased 0.1 in February, less than the 0.5 percent drop economists had forecast. The data helped spark a 4.1 percent rally in the Standard & Poor’s 500 Index that day.
“It’s good to see anything in the economic front that beat expectations,” David Heupel, who helps manage $60 billion at Thrivent Financial for Lutherans in Minneapolis, said that day. “Any news that is not bad right now is good for the market.”
Not every investor buys that view.
‘Very Low Levels’
While the market’s rally shows a sense of some economic stabilization, “we’re talking about stabilization admittedly at very low levels,” Leo Grohowski, chief investment officer at Bank of New York Mellon Wealth Management, which oversees $140 billion, said in an interview on Bloomberg Television yesterday. “Investors should continue to position their portfolios for a prolonged period of subdued economic growth.”
The Dow added 178 points, or 2.5 percent, on March 17 after a government report that housing starts unexpectedly jumped 22 percent in February from the previous month, snapping the longest streak of declines in 18 years.
“There’s a feeling that maybe the economy has hit the bottom,” Chip Hodge, a managing director at MFC Global Investment Management in Boston, who oversees a $9 billion natural-resource-company bond portfolio, said that day. “For the first time in a while we aren’t looking at mostly negative headlines.”
Even so, economists warn that the negative will continue to dominate the news for months.
Warsh’s View
“Though the pace of decline is likely to abate, I am decidedly uncomfortable forecasting a sharp and determined resumption of growth in the coming quarters,” said Federal Reserve Governor Kevin Warsh in an April 6 speech in Washington.
Rosenberg agrees. “I really don’t believe the contours of this recession will achieve clarity until we’re in the opening months of 2010 at the earliest,” said Rosenberg. That leads him to predict a stock market bottom sometime in the fall.
Since 1949, the average time between the stock market cycle low, as measured by the S&P 500 Index, and the end of a recession is 5.3 months, according to Westport, Connecticut- based Birinyi Associates Inc. In 2001 the economy turned up just 2.3 months after the stock market did.
Between the crash of October 1929 and the market’s bottom in July 1932 there were five rallies of 20 percent or more, with one of them a 48 percent jump.
“There were peaks where that market got started again only to get knocked back down,” said Charles Geisst, a professor of finance and economics at Manhattan College in New York and author of “Wall Street: A History.” He said this stock market reminds him of the early years of the Great Depression.
“There’s a false optimism out there,” Geisst said in an interview yesterday. “It’s a sign that we don’t understand much about what’s happening in the economy.”
2 comments:
Have banks hit bottom yet? The numbers say no
Peter Cohan
7 April 2009
Have we reached the bottom yet? That’s a question that people ask me from time to time. I haven’t got an answer yet, but today I have some numbers that may give us an idea. And the preliminary verdict is: No!
Why? Because the commercial banking industry in the U.S. is likely to be bankrupt – by which I mean its liabilities could exceed its assets – as we approach the bottom. Just how bad will it get? It could see 41 percent of its core capital wiped out by loan losses alone. And when you take into account all the toxic waste and derivatives on the banks’ books, its capital looks mighty thin.
To understand how I reached this conclusion, consider that the banking industry has $6.7 trillion worth of loans and $1.2 trillion in equity capital. During the Great Depression, loan losses peaked in 1934 at 3.4 percent of loans. Banking analyst Mike Mayo believes that this figure could be far worse this time around – hitting 5.5 percent in 2010.
So? If banks need to write off 5.5 percent of their $6.7 trillion in loans, it would require them to wipe out $369 billion worth of their capital.
That doesn’t sound so bad until you consider that banks have a mere $880 billion in so-called Tier I, or core capital. In that context, a $369 billion write-off represents 41 percent. And regrettably there is a huge amount of potential for additional write-offs totalling in the trillions because the banks have $1.7 trillion in debt securities and $201 trillion in derivatives.
The IMF estimates that the U.S. has $3.1 trillion in toxic waste – which if written off would likely turn that $1.2 trillion in equity capital negative -- depending on how much of that toxic waste is held by commercial banks.
If we assume that U.S. banks have $1 trillion of toxic waste and they take $369 billion in loan losses, that would leave the industry with a negative net worth of about $169 billion ($1.2 trillion in equity capital less $1.369 trillion in toxic waste and loan losses).
I hope it’s not worse.
Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College. His eighth book is You Can’t Order Change: Lessons from Jim McNerney’s Turnaround at Boeing.
Rosenberg Says Don’t Mistake Slower Economic Slide for Rebound
By Matthew Benjamin
April 8 (Bloomberg) -- Investors shouldn’t mistake an economy that’s sliding less rapidly downhill for one that’s poised to start climbing, say Bank of America Corp.’s David Rosenberg and Deutsche Bank AG’s Joseph LaVorgna.
Improvements in consumer spending and home sales have been taken by some investors as signs that the recession, now in its 17th month, may be near a turning point. Partly as a result, the Dow Jones industrial average climbed as much as 22 percent from the recession low it set on March 9.
The data, however, are at best a signal that the worst of the contraction is over, said Rosenberg, chief North American economist at Banc of America Securities-Merrill Lynch in New York.
“Investors seem to have confused an actual recovery with the fact that the economy isn’t detonating anymore,” Rosenberg said in an interview yesterday. “Markets right now are dangerously extrapolating an improvement in the rate of change to an improvement in the actual level of economic activity. These are two very different events.”
The Dow Jones industrials lost 186.29 points, or 2.3 percent, to close at 7789.56 in yesterday’s trading. The index still stands 19 percent above its March 9 level.
The economy shrank at a 6.3 percent annual pace in the fourth quarter, the worst performance since 1982. Economists surveyed by Bloomberg estimate that the rate of contraction slowed in the first three months of this year to 5.2 percent. The Commerce Department will report its initial estimate of first-quarter growth on April 29.
Rate of Decline
“In most cases, what we’re seeing is the rate of decline in activity is diminishing, not that the level of economic activity is rising,” David Hensley, director of global economic coordination at JPMorgan Chase & Co. in New York, said in an interview yesterday.
He points to business surveys such as the Institute for Supply Management’s factory index as evidence of a slowing rate of decline. The ISM index has climbed for three months in a row, while still remaining below 50, the dividing line between contraction and expansion.
“There is a pronounced improvement in key aspects of the surveys, but they remain at levels consistent with steep contraction,” said Hensley.
Similarly, an index of consumer confidence, as measured by the Conference Board, increased to 26 in March from a record low of 25.3 set in February.
‘Not Here Yet’
Even when the economy does hit bottom, it may take a while before robust growth resumes, LaVorgna, chief U.S. economist at Deutsche Bank Securities in New York, said in an April 6 interview. “A bottoming out is no longer consistent with an imminent recovery, as it has been in the past. Investors are making the assumption history will repeat itself, yet recovery is not here yet.”
That hasn’t kept investors from viewing better-than- forecast economic indicators as an opportunity to buy. A March 12 Commerce Department report that retail sales decreased 0.1 in February, less than the 0.5 percent drop economists had forecast. The data helped spark a 4.1 percent rally in the Standard & Poor’s 500 Index that day.
“It’s good to see anything in the economic front that beat expectations,” David Heupel, who helps manage $60 billion at Thrivent Financial for Lutherans in Minneapolis, said that day. “Any news that is not bad right now is good for the market.”
Not every investor buys that view.
‘Very Low Levels’
While the market’s rally shows a sense of some economic stabilization, “we’re talking about stabilization admittedly at very low levels,” Leo Grohowski, chief investment officer at Bank of New York Mellon Wealth Management, which oversees $140 billion, said in an interview on Bloomberg Television yesterday. “Investors should continue to position their portfolios for a prolonged period of subdued economic growth.”
The Dow added 178 points, or 2.5 percent, on March 17 after a government report that housing starts unexpectedly jumped 22 percent in February from the previous month, snapping the longest streak of declines in 18 years.
“There’s a feeling that maybe the economy has hit the bottom,” Chip Hodge, a managing director at MFC Global Investment Management in Boston, who oversees a $9 billion natural-resource-company bond portfolio, said that day. “For the first time in a while we aren’t looking at mostly negative headlines.”
Even so, economists warn that the negative will continue to dominate the news for months.
Warsh’s View
“Though the pace of decline is likely to abate, I am decidedly uncomfortable forecasting a sharp and determined resumption of growth in the coming quarters,” said Federal Reserve Governor Kevin Warsh in an April 6 speech in Washington.
Rosenberg agrees. “I really don’t believe the contours of this recession will achieve clarity until we’re in the opening months of 2010 at the earliest,” said Rosenberg. That leads him to predict a stock market bottom sometime in the fall.
Since 1949, the average time between the stock market cycle low, as measured by the S&P 500 Index, and the end of a recession is 5.3 months, according to Westport, Connecticut- based Birinyi Associates Inc. In 2001 the economy turned up just 2.3 months after the stock market did.
Between the crash of October 1929 and the market’s bottom in July 1932 there were five rallies of 20 percent or more, with one of them a 48 percent jump.
“There were peaks where that market got started again only to get knocked back down,” said Charles Geisst, a professor of finance and economics at Manhattan College in New York and author of “Wall Street: A History.” He said this stock market reminds him of the early years of the Great Depression.
“There’s a false optimism out there,” Geisst said in an interview yesterday. “It’s a sign that we don’t understand much about what’s happening in the economy.”
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