Finance Ind(Readings): Barbarians, Fixes and Outlooks
The prior two posts were our weekly surveys of Market and Economic information. We'll grant that typical blog practice is one/two clip(s) per post but we think something is served by collecting and categorizing them so that the patterns and implications are clearer. At least it works for us. We mention that by way of pro forma apologia for the infodensity, there and now. Because that econ/mkt information is only mildly interesting to us for its' own sake. What we think is even more important is the implications for business performance...industries...companies and you. Which is also by way of suggesting that with those two in mind it's really time to roll it forward and look at the consequences....which are, IOHO, pretty dire. Before rolling on we'd like to suggest a few minutes spent listening to Dave Wessel on CNBC will help set the table:Econ-Recon Mission Perspectives on the economy, with David Wessel, The Wall Street Journal economics editor.
Here we'll focus on the implications for the Finance Industry...at least in part. Consider the graphic at right where we've down our best to capture what we think is going on. Though admittedly I'm not a finance industry expert we've all had to learn more about that arcane and mysterious industry in the last year than we ever wanted (btw do you realize we're over a year on the first small canary the Shanghai Surprise and the big one - the first BSC disasters ? Think about those as warning sigils in light of this arm-waving).
What we've tried to capture is the impact of the credit crisis so-called and how it's rippled thru the system and what's likely to still happen. So what we've seen so far is bad loans (1) moving up the chain of leveraged links to create ripples (2) and breakdowns across many different credit markets. That almost brought the whole house of cards down. Those losses led to massive writedowns and P&L losses (3) which severely damaged almost all the players in the Finance Industry. The catch on that set of loops is that sub-prime problems aren't thru and we have a whole host of other sources, e.g. ARM resets, HELOCs, etc. which are also turning bad; which'll keep that loop going. It's that metastasis of the credit contagion that folks like Whitney are warning about. Consider this the revenge of the "Rocks-in-the-Ponds" model.
The real on-going problem likes in the deteriorating general economic conditions which will lead to to additional credit tightening (4) and asset deteroriorations (5). In fact as we enter a "normal" cyclic downturn all the host of standard consumer and business loans (6) are now qued up to go thru a similar decline. And there impacts on things are not even factored in because everybody knows "the worst is over", right ? So as you skim the readings below please keep in mind that the real reason to make you wade thru the Market and Economy readings was to frame the context of what's going to happen to the Finance Industry as these cycles kick into high-gear.
UPDATES (5/22): Two other major data points on rising delinquencies and on leveraged loans have been added to the readings.
Barbarians at the vault BANKS have endured a brutal nine months since credit markets froze in August. Losses and write-downs already total $335 billion; many of their best businesses have disappeared. In developed economies, almost all banks are facing economic and regulatory headwinds that will cut revenues and jobs. Yet the biggest danger facing Western finance is not a fall in its earning power but a loss of faith in how it works. Two criticisms assail the industry, one based on fairness and the other on efficiency. The first argues that finance is rigged to enrich bankers, rather than their customers, shareholders or the economy at large. Some worry about the way bonuses are calculated; others about moral hazard. Bankers will take wild bets because they know they will be bailed out by the taxpayer. Look at Bear Stearns or Northern Rock. The second, deeper question is whether a market-based approach to finance is efficient. Some Chinese officials claim the Western system has been shown up by the crisis (see article). This week Germany's president demanded that the “monster” of financial markets “be put back in its place”: bankers had caused a “massive destruction of assets”. The critics do not lack ammunition. The lapses in credit-underwriting in the subprime-mortgage market hardly reflect a wise allocation of capital. The opacity of the shadow banking system and the mind-boggling complexity of those toxic asset-backed products have raised doubts about the discipline of the market. Economist Special Report on International Banking…breakdowns, problems, regulation and futures. (***)
Ken Griffin, and Thoughts on Fixing Wall Street Kenneth C. Griffin, who runs one of the biggest and most successful hedge fund firms, has a blunt assessment: “We, as an industry, dropped the ball.” The breakdown happened, Mr. Griffin contends, when big investment banks gambled away money and jobs during the late great credit boom. The bosses let all those young gung-ho traders take far too many risks and now everyone is paying the price. But the answer is simple, in his view. The entire industry needs to overhaul its thinking and, believe it or not, perhaps even accept greater regulation. He is upset that the investment bank Bear Stearns ran aground. He is annoyed at the big-name chief executives who took too much risk and then watched as billions of dollars of value vanished from balance sheets. He is anxious about high-priced finance jobs moving abroad. And he is particularly galled with regulators in Washington who have overseen what he calls “the great depression on Wall Street.” But Mr. Griffin isn’t just a serial complainer. He has thought about solutions. First, “the investment banks should either choose to be regulated as banks or should arrange to conduct their affairs to not require the stop-gap support of the Federal Reserve,” he says.But that’s not all. He also wants new government oversight of the arcane world of credit default swaps, a business with a notional value and risk of $50 trillion. “Everyone is missing the elephant in the room,” he said. It was the interlocking relationships between thousands of investors and banks over credit default swaps that pushed the Fed to help rescue Bear Stearns. In particular, Mr. Griffin wants the government to require the use of exchanges and clearing houses for credit default swaps and derivatives.That way, instead of investment banks playing matchmaker between parties, an exchange will do it with strict rules in place, eliminating billions of dollars in exposure and creating more transparency.
- Hedge Fund Headwinds Hedge funds are hurt by the credit crunch and under pressure in Washington, with Richard Baker, Managed Funds Association president/CEO and CNBCs Carl Quintanilla
Rubenstein Says `Enormous' Bank Losses Unrecognized U.S. and European banks and financial institutions have ``enormous losses'' from bad loans they haven't yet recognized and may have a harder time wooing sovereign-fund rescuers, Carlyle Group Chairman David Rubenstein said. ``Based on information I see,'' it will take at least a year before all losses are realized, and some financial institutions may fail, Rubenstein said at a breakfast meeting of the Institute for Education Public Policy Roundtable in Washington. He didn't name any companies. Rubenstein said sovereign wealth funds are becoming wary after losing $25 billion on their investments in struggling banks and securities firms worldwide. Financial institutions worldwide have recorded $329.2 billion in credit losses and writedowns and raised $246.6 billion in capital since the beginning of 2007. Rubenstein said about $60 billion of that capital was provided by sovereign funds last fall, and their investments today are worth about $35 billion. On April 28 at a conference in Baltimore, Rubenstein said financial institutions and financial assets are ``the single greatest investment opportunities'' in the U.S. and ``a lot of private-equity firms like ours are going to try to make investments in these firms.'' Sovereign wealth funds and private-equity firms typically have different investment goals. Sovereign funds usually buy a minority stake in a quest for share-price appreciation, while private-equity firms often assume an ownership role and try to rebuild distressed companies. Rubenstein said today that the industry and broader economy aren't likely to turn around until early next year. The economy's troubles, compounded with tighter lending standards, have brought the leveraged-buyout industry to a standstill, he said. There are fewer buying opportunities because many owners of companies have an inflated and irrational sense of their property's value, he said.
CalculatedRisk on Delinquency Contagion:
S&P: Subprime and Alt-A Delinquencies Rising
S&P Cuts Ratings of Prime-Jumbo Mortgage Bonds
Comptroller Dugan on "Unprecedented Home Equity Loan Losses"
Allianz's Dwane Says Some Banks `In Denial' on Debt Risk May 9 (Bloomberg vidclip) -- Neil Dwane, who oversees $65 billion of equities as chief investment officer at Allianz Global Investors, talks with Bloomberg's Jeremy Naylor in London about corporate earnings, the outlook for commodity and financial stocks and his investment strategy. Analysts predict earnings for companies in the S&P 500 will shrink in the first and second quarters, based on data compiled by Bloomberg.
AIG to Raise $12.5 Billion of Capital After Reporting Second Straight Loss American International Group Inc., the world's largest insurer by assets, said it will raise $12.5 billion after posting its second straight quarterly loss, sending the shares down 7 percent. AIG had a record first-quarter net loss of $7.81 billion, or $3.09 a share, compared with earnings of $4.13 billion, or $1.58, a year earlier, the New York-based company said today in a statement. The insurer wrote down the value of contracts to protect fixed-income investors by $9.11 billion. Chief Executive Officer Martin Sullivan's job may be on the line unless he stems losses from the subprime mortgage collapse and reverses a 12-month stock decline of 38 percent. Financial products head Joseph Cassano stepped down after AIG reported a then-record $5.29 billion loss in the fourth quarter. AIG's Need to Raise $12.5 Billion After Loss Renews Doubts About Sullivan
- Bad Investments and a $7.8 Billion Loss at A.I.G. In the worst three months of the company’s 89-year history, American International Group lost $7.81 billion, primarily from bad investments in complex financial instruments.
Insight: A new wave of grime lurks Is something nasty lurking in the leveraged loan woodshed? That is a question a lot of investors are asking these days. But now some investors are starting to wonder if the banks could soon be hit by a new wave of problems – this time from the leveraged loan world. After all, this sector has also seen a dramatic surge of lending in recent years, with a commensurate fall in lending standards. Thus, as the economy slows, the risk is that private equity players could soon start defaulting, creating more bad debt. So is this a real risk in the second half of this year? Unfortunately, the most honest answer is nobody knows, due to the fact that the leveraged world is currently beset with a problem that I like to call the “jingle mail” effect. The essence of this lies in the models that banks, rating agencies, policy makers, and investors, use to predict defaults. In recent years, these have typically operated by looking back at past periods of corporate distress, crunching the numbers into complex formulae - and then projecting the past into the future. Now, however, there is a real risk that something comparable could happen in leveraged finance too. In the last decade this sector has also experienced micro-level change: loan covenants have been radically loosened; new investors, such as hedge funds, have come in; and capital structures been radically altered, in the name of innovation. These microlevel changes already appear to have wrong-footed the analysts – but thus far in a good way. Most notably, default rates in the leveraged world have hitherto been far lower than most observers expected to see. (This appears to reflect the fact that covenants are so weak that it is hard to declare a default; at the same time, hedge funds have become proactive about stepping in to refinance stressed companies, before they default.) Now it is possible that this pattern will continue to surprise on the upside. However, it is also possible to imagine a much bleaker scenario, where lots of so-called “zombie” companies (or those only alive because lenders have no way of pulling the plug) suddenly collapse altogether – meaning that the default rate could surge dramatically with no warning.