Look. You can play hot potato with the toxic assets all day long, and only outcome will be that the public will suffer the losses that would otherwise have been properly taken by the banks' own bondholders. You can tinker with the accounting rules all you want, and it won't make the banks solvent. It may improve “reported” earnings for a spell, but as investors who care about the stream of future cash flows that will actually be delivered to us over time, it is clear that modifying the accounting rules doesn't create value. It simply increases the likelihood that financial institutions will quietly go insolvent. I recognize that the accounting changes may reduce the immediate need for regulatory action, since banks will be able to pad their Tier 1 capital with false hope. But we have done nothing to abate foreclosures, and we are just about to begin a huge reset cycle for Alt-A's and option-ARMs. As the underlying mortgages go into foreclosure, it will ultimately become impossible to argue that the toxic assets would be worth much even in an “orderly transaction.”
Meanwhile, in a bizarre convolution of reality reminiscent of Alice in Wonderland, the Financial Times reported last week: “US banks that have received government aid, including Citigroup, Goldman Sachs, Morgan Stanley and JPMorgan Chase, are considering buying toxic assets to be sold by rivals under the Treasury's $1,000bn plan to revive the financial system.” And why not? They can put up a few percent of their own money, and swap each other's toxic assets financed by a bewildered public suddenly bearing more than 90% of the downside risk. The “investors” in this happy “public-private partnership” keep half the upside while ordinary Americans take the downside off of their hands. Some partnership.
With regard to the economy, there is quite a bit of optimism that the recent market advance represents a forward-looking call that the economy will recover in the second half of the year. Indeed, some analysts have noted that year-over-year consumer spending has only declined very slightly, hailing this as evidence that economic concerns are overblown. The difficulty is that consumer spending has never declined on a year-over-year basis, except in this downturn, so that slight decline is actually the worst showing for consumer spending in the available data. Likewise, capacity utilization has plunged to levels seen only in 1974 and 1982, both which were accompanied by far deeper valuation extremes than at present.
Tuesday, April 7, 2009
"Fighting Recklessness with Recklessness"
That's the title of John Hussman's latest market commentary. Excerpt: