US Treasury Calls TARP Repayments A “Milestone” While Ignoring The Elephants In The Room

June 17, 2010 by admin Leave a Comment

Treasury’s Victory Call On Financial Bailout Premature

The Treasury Department’s latest public relations effort to highlight the success of the financial system bailout focuses on the amount of TARP repayments versus total debt outstanding. In addition, the Treasury, which had previously estimated the cost of the TARP program at $341 billion, has now lowered that estimate to only $105 billion.

Wall Street Journal – The U.S. Treasury Department said Friday the total amount repaid to taxpayers for government funds used to bail out U.S. companies has surpassed, for the first time, the amount of outstanding debt.

The Treasury, in its May report to Congress on the Troubled Asset Relief Program, reported TARP repayments reached $194 billion, which has exceeded by $4 billion the total amount of outstanding debt—$190 billion.

Treasury’s assistant secretary for financial stability, Herb Allison, in a statement described the totals as a “milestone” and said this is “further evidence that TARP is achieving its intended objectives: stabilizing our financial system and laying the groundwork for economic recovery.”

Does the general public accept the Treasury’s view that the bailout was a resounding success at a relatively modest cost? Recent Pew Research data, which reveals overwhelming negative public opinion for both the government and the banks, suggests that the Treasury’s spin on the bailout will be given little credence by the public.

Large majorities of Americans say that Congress (65%) and the federal government (65%) are having a negative effect on the way things are going in this country; somewhat fewer, but still a majority (54%), say the same about the agencies and departments of the federal government.

But opinions about the impact of large corporations and banks and other financial institutions are as negative as are views of government. Fully 69% say that banks and financial institutions have a negative effect on the country while 64% see large corporations as having a negative impact.

In March, during the final debate over health care reform, just 26% of Americans offered a favorable assessment of Congress – by far the lowest in a quarter-century of Pew Research Center polling.

Large majorities across partisan lines see elected officials as not careful with the government’s money, influenced by special interest money, overly concerned about their own careers, unwilling to compromise and out of touch with regular Americans.

The skepticism regarding the ability of government to operate honestly in the public’s best interest is well founded and the latest Treasury report on progress of the TARP program bears this out. While the Treasury reports on the “success” of repayments under the $700 billion Troubled Asset Relief Program, other government bailouts and guarantees that are far exceed the cost of the TARP program are conveniently ignored. If the Treasury really wants to provide a comprehensive accounting of what the financial system bailout will cost the American taxpayers, here’s my short list of additional items to address in their next report.

1. The amount currently owed under the TARP program does not include amounts committed by the US Treasury but not paid out. According to the WSJ, “the outstanding debt amount does not include $106.36 billion that has been committed to institutions but has yet to be paid out by the Treasury. Factoring in that amount, the outstanding debt would be roughly $296 billion.”

2. Two of the biggest ongoing bailouts in history go unmentioned. The Housing and Economic Recovery Act of 2008 provided for a $400 billion bailout of Fannie Mae and Freddie Mac. The Government subsequently granted Fannie and Freddie an unlimited line of credit with the Treasury. Fannie and Freddie have already drawn $145 billion and according to Bloomberg, the final cost to bailout out the two agencies could approach $1 trillion.

3. Future banking failures constitute another sizable risk for increasing the cost of bailing out the US financial system. The FDIC has been able to resolve banking failures to date using premiums collected from the banking industry, including a special assessment of $46 billion at the end of 2009. While the FDIC has not yet had to tap its $500 billion line of credit with the US Treasury, future banking failures may require it to do so.

In its latest quarterly report, the FDIC reported an increase in the number of problem banks to 775, out of a total of 7,932 FDIC insured banks. Assets at the problem banks total $431 billion. Total deposits insured by the FDIC now total $5.5 trillion. The amount of reserves in the FDIC Deposit Insurance Fund total negative $20.7 billion. Liquid reserves of the FDIC total a mere $63 billion. If the US economy weakens and more banks fail, the FDIC’s only option will be a costly bailout by the US Treasury.

The government seems to believe they can fool all of the people all of the time. Whatever happened to “change you can believe in”?

Filed Under: Bailout, Banking Industry, Confidence, Corruption, Government spending, Problem banks Tagged With: treasury's report on TARP paybacks omits the biggest bailouts, ultimate cost of financial system bailout?, US Treasury's report on TARP falls short on full disclosure

Mr Obama, Please Don’t Read This

June 10, 2010 by admin Leave a Comment

US Companies Build Massive Cash Reserves Based on Economic Worries

Wall Street Journal – U.S. companies are holding more cash in the bank than at any point on record, underscoring persistent worries about financial markets and about the sustainability of the economic recovery.

The Federal Reserve reported Thursday that nonfinancial companies had socked away $1.84 trillion in cash and other liquid assets as of the end of March, up 26% from a year earlier and the largest-ever increase in records going back to 1952.

Idle cash of almost $2 trillion is a massive amount, but let’s put that into perspective by comparing that to the spending habits of the U.S. Government. If the U.S. Government expropriated every dollar of cash held by U.S. companies, it would barely cover 16 months of U.S. deficits. The entire $1.84 trillion of cash held by U.S. companies would pay for a mere 6 months of U.S government spending.

In the government’s last fiscal year, receipts were $2.1 trillion and spending totaled $3.5 trillion for a deficit on $1.415 trillion. Latest figures from the U.S. Treasury indicate that the current fiscal year’s deficit will exceed last year’s deficit – here are the numbers month by month.

FISCAL 2010 RECEIPTS OUTLAYS DEFICIT

$MILLIONS

OCTOBER……………..135,294 311,657 176,363

NOVEMBER…………..133,564 253,851 120,287

DECEMBER…………….218,918 310,628 91,410

JANUARY………………205,240 247,874 42,634

FEBRUARY…………….107,520 328,429 220,909

MARCH……………………153,358 218,745 65,387

APRIL………………………245,260 327,950 82,689

MAY…………………………146,795 282,722 135,927

YEAR TO DATE 1,345,950 2,281,566 935,606

Graphical Representation of Looming Disaster

Government spending is now almost twice total receipts. How long can any entity continue at this pace before hitting an economic brick wall?

Source: Department of the Treasury

Fed Chairman Bernanke recently warned that unless deficits are reduced, the U.S. could become the next Greece, but the economy is currently too fragile to initiate deficit reductions. Translation – we are facing social and economic disaster from out of control deficit spending, but we can’t do anything about it right now. Conclusion – the government will need trillions every year for the foreseeable future to cover the gap between receipts and spending.

Let’s hope the President doesn’t connect the dots here – $trillions needed by the government while companies are sitting on $trillions that they are not investing, spending or paying to shareholders – not very patriotic! After having already proposed a plethora of tax increases on everything possible, “idle corporate cash” could easily become a very tempting target. Let’s hope Mr. Obama does not read this post.

Filed Under: Government Deficits, Government spending, Sovereign Default Tagged With: us companies hold $2 trillion in cash, US spending 169% of receipts

Geithner Lectures Europe On Fiscal Discipline – This Is Like BP Giving A Seminar On Oil Well Safety

June 8, 2010 by admin Leave a Comment

With Europe Facing Meltdown Geithner Offers Advice

After recently “saving” the US from economic Armageddon, Treasury Secretary Geithner must feel uniquely qualified to advise European governments on their looming sovereign debt crisis. Geithner’s solution to Europe’s out of control deficits is additional stimulus (via increased deficit spending), bailouts and stress tests on Europe’s tottering banks to rebuild public confidence in the banking system.

Wall Street Journal – LONDON—U.S. Treasury Secretary Timothy Geithner landed in Europe and reasserted a traditional American role of dispenser of financial advice to the world, telling European governments to get their fiscal houses in order.

After two years in which an historic financial crisis seemed to deprive the U.S. of its self-confident global economic leadership, Mr. Geithner signaled a new-found willingness to reassert American authority on the future of the world economy.

Inside No. 11 Downing Street, the home of his British counterpart, Mr. Geithner pushed continental Europe to speed up the rescue of debt-laden economies, and to not stint on fiscal stimulus.

The U.S. is also advising European countries that can afford it—the U.K., Germany, France—to keep pumping stimulus into their economies.

“This crisis is multifaceted, but I believe bank stress tests can be helpful as a critical component of any comprehensive plan to restore confidence in the European financial system,” said Lee Sachs, who was, until a month ago, a top adviser to Treasury Secretary Timothy Geithner.

Mr Geithner’s advice that over indebted nations should borrow more money to solve their debt crisis was met with scorn by European officials. The recommended stress tests for banks was viewed as a mere public relations exercise.

WSJ – For Geithner critics, the new U.S. assertiveness is misplaced. Desmond Lachman, a former senior IMF European official who is now a researcher at the American Enterprise Institute, said the repeated bailouts engineered by Mr. Geithner have made the overall problem worse, and that the U.S. advice of providing even more financing for heavily indebted countries like Greece is bound to fail.

Mr. Lachman said Greece’s debt needs to be restructured and that weaker euro-zone countries should consider dropping the euro and reverting to their national currencies. “Geithner is part of the problem,” he said. “It’s obvious this can’t work.”

“You don’t need a stress test to tell you what would happen if Spain became bankrupt; it would be horrible,” one German official said. German officials argue the U.S. tests were little more than public-relations stunts, designed so that banks would pass.

European governments realize that the American solution of borrowing trillions for bailouts and fiscal stimulus has only compounded the original problem of too much debt. US Government debt now exceeds $13 trillion and the debt to GDP ratio of the US equals or exceeds that of many European nations that are now tottering on the fiscal abyss. Based on continued unprecedented expansion of the national debt, the IMF is forecasting that total US debt will exceed GDP by 2012. Debt to GDP ratios over 100% raise serious questions about a country’s ability to service their debt, especially if interest rates rise.

Tragically, Europe has bought into the “Geithner solution”. Despite their doubts and with no other easy options, Europe will lend up to $1 trillion to bailout hopelessly over indebted sovereign borrowers. Does anyone really believe that this latest bailout is a solution?

Filed Under: Bailout, Geithner, Government spending Tagged With: Geithner tells europe to cure debt problem with more debt

Time Tested Indicator Predicts Huge Gains For Gold Stocks

June 8, 2010 by admin 2 Comments

K-Ratio Flashing Major Buy Signal

The increase in gold prices over the last five years has outperformed virtually every other asset class. From the low $400 range in 2005, gold has soared almost 300% to over $1200 per ounce.

5 Year Gold - Courtesy Kitco.com

Although many gold stocks have seen substantial gains since 2005, the overall price gains of gold stocks has underperformed the price appreciation of the metal as can be seen by viewing the PHLX Gold&Silver Index, comprised of 16 major gold and silver producers. While the price of gold has appreciated almost 200%, the XAU has lagged considerably with a gain of 96%.

XAU GOLD&SILVER INDEX -COURTESY YAHOO.COM

While the reasons for the price disconnect between gold and individual gold stocks are in many cases company specific, the question on most investors minds is where do we go from here? Will the large increase in gold prices eventually translate into major gains for the gold producing stocks? The emphatic prediction, according to the K-Ratio, a time tested method for timing the purchase of gold stocks, is telling us to stay long and accumulate gold stocks.

The K-Ratio is computed by dividing the value of Barron’s Gold Mining Index (GMI) by the Handy and Harmon price of gold. The index reflects the relative value of the price of gold stocks to the price of the underlying metal. When the ratio of the price of gold stocks to the price of gold is low, it is a bullish signal. Conversely, if the price ratio of the gold stocks relative to the metal is excessive, it is usually a good signal to sell the gold stocks.

The K-Ratio works best at extremes. The rule of thumb based on past history tells us that a K-Ratio at 1.20 or lower indicates that gold is cheap compared to the price of bullion. A K-Ratio reading of 1.90 or higher is extremely bearish and indicates extreme overvaluation of the gold stocks.

The latest weekly reading on the K-Ratio shows a very bullish reading of .96 (Barron’s Gold Mining Index of 1158.99 divided by the Handy and Harmon Gold Price of $1203.50). Since 1975, readings at or below 1.15 on the K-Ratio have resulted in gold stock gains 90% of the time over the next 12 months with an average gain of 40%. Lending anecdotal support to a large rally in the gold stocks is the overwhelming number of bearish articles on gold by the mainstream press. From a fundamental perspective, of course, it does not hurt that logical minds are beginning to question the value of paper currencies of numerous sovereign nations.

Accumulation of high quality gold stocks such as NEM, GOLD, GG, KGC and AUY seems warranted, especially on price pullbacks. Based on the technical and fundamental factors, the bull market in gold stocks has a long way to run.

Courtesy yahoo.com

Courtesy: yahoo.com

Disclosures: Long NEM, GOLD, GG, KGC, AUY

Filed Under: Gold, Gold Stocks, K-Ratio Tagged With: 40% GAINS FOR GOLD STOCKS?, Gold - the path to wealth, TIME TESTED INDICATOR SAYS BUY GOLD STOCKS, WHY GOLD STOCKS WILL SOAR

Why The Biggest Risk To The Economy Is A Strong Recovery

January 12, 2010 by admin 2 Comments

Concerns about the current economic mess turning into another Great Depression seem to have faded. The consensus view of government officials and private economists seems to be that the economy, although still fragile, is well on its way to a robust recovery. According to Bloomberg,

Companies in the U.S. expanded in December at the fastest pace in almost four years, signaling the economic recovery is gaining speed heading into 2010.

The Institute for Supply Management-Chicago Inc. said today its barometer rose to 60, exceeding the most optimistic estimate of economists surveyed byBloomberg News and the highest level since January 2006. The gauge, in which readings greater than 50 signal expansion, showed companies boosted production and employment as orders climbed.

Stimulus programs and discounting have propelled a rebound in global sales that is reducing stockpiles, which may spur manufacturers to further increase production in coming months.

The world’s largest economy expanded at a 2.2 percent pace from July through September after a yearlong contraction that was the worst since the 1930s, figures from the Commerce Department showed last week. Economists surveyed byBloomberg forecast growth to pick up to a 3 percent pace in the fourth quarter and average 2.6 percent for all of 2010.

Predictions for a strong economic recovery seem to grow by the hour. Recent articles in the press lead one to believe that – unemployment has bottomed, the growth of foreign economies will result in greater demand for U.S. goods and services, inflation will remain subdued, the dollar has stabilized, a recovery in the housing market has started, mortgage rates will remain low, the bailed out banks are in full recovery mode, the Fed will gradually remove excess liquidity from the system, the politicians will get the deficit under control and the stock market will continue to post impressive gains.

Is the bullish consensus getting out of hand or will there be a few surprises on the path to a booming economy? One scenario that could shatter the dreams of the bulls is if private individuals and businesses are crowded out of the debt markets by a U.S. government that needs to borrow seemingly endless trillions of dollars. The latest data on private and governmental borrowing from the St Louis Federal Reserve show that crowding out could slam the brakes on an economic recovery. Businesses and individuals may be unable to borrow in strained capital markets or face much higher borrowing costs as they compete with the government for capital.

Lending by large commercial banks has plunged, a combination of tougher lending standards and reduced loan demand. Any economic recovery would result in increased loan demand by the private sector which strained capital markets may not be able to supply. Competition for funds could lead to a spike in interest rates.

As lending to the private sector has collapsed, government borrowing has exploded.

With no end in sight to new trillion dollar programs being passed by Congress, the financing needs of the U.S. Government are not likely to be reduced any time soon. The recovery of the U.S. economy that many foresee may come to a grinding halt if private sector borrowers are crowded out of the capital markets.

Filed Under: Crowding Out, Economy, Government spending, Interest Rates, Risky lending Tagged With: Crowding out may kill recovery, Economic Boom without lending?, Strong economy - not so fast!

Federal Reserve Super Low Rate Policy Crushes Savers And The Elderly

November 24, 2009 by admin 5 Comments

Fed Sees Solution In Zero Rates

The Federal Reserve recently vowed to keep interest rates “exceptionally low” for the foreseeable future in an attempt to revive the economy. Since mid 2006 the Fed has brought the Fed Funds Rate down from 5% to virtually zero in an attempt to reduce the debt service burden on over leveraged borrowers.

A world of ultra low interest rates may continue for much longer than many expect.

Fed To Keep Rates Low (WSJ) – Fed officials voted unanimously to maintain their target for the key federal-funds interest rate — at which banks lend to each other overnight — near zero and said they expect to keep it there for an “extended period,” which suggested increases are at least several months off.

While consumers are spending, the Fed noted they were “constrained by ongoing job losses, sluggish income growth, lower housing wealth and tight credit.” Meanwhile, “businesses are still cutting back on fixed investment and staffing, though at a slower pace.”

A low interest rate policy has worked in the past to stimulate the economy and the Fed is applying the same prescription to the current economic downturn. At this point, it is too early to tell if the same policies of super low rates and easy money will work as it has in the past. Japan stands out as the premier example of a post bubble economy still failing to recover despite twenty years of super easy fiscal and monetary policies. The Fed prescription of attempting to revive an overly indebted economy with more lending may very well produce the same results as in Japan – slow economic growth, lower incomes and crushing public debt burdens.

Individuals who were prudent enough to save and avoid debt are now left to wonder if they will ever see a return on their savings. Short term CD’s are below 1%, money market funds pay a ridiculously low rate barely above zero and short term treasuries have a negative yield. Those who are retired and depend on interest income for living expenses must now deplete their savings or take on more risk by investing in higher yielding bond funds subject to substantial market fluctuations.

The Fed’s low interest rate policy effectively represents a massive wealth transfer from savers to debtors. FDIC insured deposits of bank savings and CDs currently total $4.8 trillion and there is approximately $5 trillion in money market funds for a total of $10 trillion that is earning at best 1% compared to 5% in 2006. The drop in interest rates from 5% to 1% represents an annual income loss to savers of $400 billion dollars per year.

Congress and the Fed have attempted to bailout out every imprudent debtor with super low interest rates – homeowners who borrowed too much, bankers who lent foolishly, and hundreds of poorly run, over indebted companies from GM to AIG. Someone always pays in the end and in this case, the victims are the savers.

More On This Topic

Near-Zero Rates Are Hurting The Economy

Filed Under: Bailout, Banking Industry, Congress, Deleveraging, Federal Reserve, Interest Rates Tagged With: elderly savers subsidize reckless borrowers, savers pay for Fed's low rate policy

Depression In Commercial Real Estate Results In Bargains For Some

October 14, 2009 by admin 4 Comments

Depression Pricing As Empty Hotels Slash Rates

The recent era of easy lending was not confined to residential real estate. Commercial real estate lending is the next big worry for a banking industry already beset by an avalanche of non performing loans. The banking industry has $1.8 trillion dollars of commercial real estate loans and many analysts believe that banks have reserved for only a small fraction of current and future losses. Recent examples of losses on commercial hotel loans in major travel destinations such as Hawaii and Las Vegas indicate the severity of the problem.

Hawaii Hotel Industry Downturn Worse Than Great Depression

Hawaii Hotels Face Fewer Visitors – For the hotel industry in the continental U.S., this downturn is the worst since the Great Depression. But the Hawaiian resort industry is taking a beating that’s even more severe.

Meanwhile, revenue per available room has fallen nearly 25% in the past two years and now averages $150.75.

Major renovations of existing hotels are common in Hawaii because construction of new resorts has been limited since the 1980s because of steep land prices and local governments’ opposition to expansion. “So the name of the game is to buy, renovate and reposition,” says Joseph Toy, president and CEO of the hotel-consulting company Hospitality Advisors, based in Honolulu. Many of the resorts that changed hands in recent years were built by Japanese owners in the 1980s.

But practitioners of that pricey repositioning strategy now find themselves in a bind due to the recession, the capital crisis and Hawaii’s tourism downturn. “The operating numbers have cratered, the underlying fundamentals aren’t very good, and you have a whole bunch of problem loans,” says David Carey, president and chief executive of Outrigger Enterprises Group, which owns 30 Hawaiian hotels, none in foreclosure.

Las Vegas Hotel Worth 41% Of Construction Cost – Cheaper to Tear Down Than Finish

Doubts Are Cast On Value of Las Vegas’s Fontainebleau – LAS VEGAS—The Fontainebleau the luxury hotel and casino development at the northern end of the Las Vegas Strip, sits more than half-finished after falling into bankruptcy in June.

But as potential suitors consider rescuing the project, they are facing a grim reality: It may not be worth the money it would cost to complete it. More than $2 billion has already been poured into construction.

“It is going to take $1.2 billion to $2 billion to finish Fontainebleau, and it’s not worth that much,” Penn National Gaming Chief Operating Officer Tim Wilmott said. Penn is currently negotiating to take it over from the project’s creditors.

When the 4,000-room Fontainebleau project was first mapped out four years ago, gambling revenues were soaring and Las Vegas barely had enough hotel rooms to accommodate a flood of visitors.

Now, Las Vegas has a surfeit of luxury rooms. Occupancy rates in August fell to 83% from 94.9% two years earlier, and room rates have fallen sharply.

An outside analysis contracted by some of the Fontainebleau lenders last spring found that Fontainebleau would be worth $1.76 billion if it were completed in May 2010, according to a court filing, far less than its $3 billion total cost.

Depression Pricing For Hotels

Overwhelming supply and weak demand have resulted in hotels slashing room rates to keep the cash flow going. In many cases, the cost of lodging at major hotels and resorts has dropped as much as 50% from two years ago and vacancy rates still remain high. For newer resorts that were built during the boom years, the picture is even bleaker, resulting in bargain rates that were previously unimaginable. On a recent trip to Mexico in September, I had the occasion to visit the newly completed and mostly vacant multi billion dollar resort, La Amada Hotel, Playa Mujeres, Cancun. The La Amada website describes the property, which opened in May 2009, as follows:

La Amada Hotel is a 5-star luxury hotel. Here you’ll have a comfortable home base of contemporary luxury. Stylish hotel architecture and decor, generous suites, spotless service, deluxe facilities, and of course, our secluded beachfront setting, all enable you to let your days here happen naturally. Situated just 25 minutes from Cancun International Airport, Playa Mujeres is the newest luxury resort destination in greater Cancun.

This 922-acre (373 hectare) luxury development includes a boutique hotel, upscale residences, a golf, yacht, and beach club, and Cancun’s first marina situated on tranquil Playa Mujeres in the Mexican Caribbean. Envisioned as an exquisitely and carefully developed sustainable community, La Amada is a destination where culture, ecology, history and art are integrated in a stimulating style.

La Amada, located in the Marina section of the Playa Mujeres “master planned’ community, is a 552-unit project of one, two and three bedroom residences, a 110-room five star boutique hotel, and a top of the line spa. In addition, the developers have created a “marina village” with 150,000 square feet of commercial space for restaurants, bars, cafes and shops, creating an ambiance akin to top European resorts such as Puerto Banus and St Tropez. No expense was spared on this spectacular creation; residences can even fly in and land on the properties private helicopter pad.

La Amada is a spectacular luxury resort hotel. Equally spectacular are the discounts – luxury suites are being offered at $280 per night, marked down from $700. Apparently, even at these discounted prices, income stressed consumers are saying no. During three visits to the property, I saw only one couple on an otherwise deserted beach. Finished units remain empty with no guests to be seen. The planned bars, cafes and shops have not opened. Virtually all of the 176 slips in the Marina remain empty. La Amada was built during an era of easy money when it was assumed that prosperity, based on eternal asset appreciation, would never end. There is little doubt that the investors in La Amada have created a truly fabulous resort – far less certain is whether or not they will ever see a return on their investment.

La Amada sign points to empty hotel

Deserted La Amada beach

Beachfront La Amada

Empty boat slips at marina

La Amada - where are the guests?

Discount prices fail to lure guests

Filed Under: Deleveraging, Economy, Housing, Mortgage Defaults, Risky lending Tagged With: depression is time for savers to celebrate, depression pricing for hotel rooms, huge hotel discounts fail to lure customers

The Correlation Between Incomes And Default Rates

October 12, 2009 by admin Leave a Comment

The Marginalization Of Risk

The massive number of loan defaults that has put the entire banking industry on the brink on insolvency did not happen by accident. Banks recklessly extended credit, even to low income borrowers who obviously had the least ability to service their debts. What may have seemed like a virtuous circle of increased consumer consumption and higher banking profits has turned into a debt disaster for both borrower and lender – consider the Democratization of Credit.

WSJ -The recession has forced a financial reckoning for Americans across the income spectrum. The pressure is especially acute for the low-income Americans who relied on borrowing for daily expenses or to gain the trappings of middle-class life. Shifting credit practices over several decades had enabled them to live beyond their means by borrowing nearly as readily as the more affluent.

But the financial crisis and recession have reversed what some economists dubbed the “democratization of credit,” forcing a tough adjustment on both low-income families and the businesses that serve them.

“We saw an extension of credit to a much deeper socioeconomic level, and they got access to the same credit instruments as middle-class and mainstream Americans,”…

The financial crisis has forced lenders to be especially cautious with the riskiest borrowers, a category that low-income families often fall into because their debt tends to be higher relative to income and assets.

Some are turning to wherever they can for credit. A publicly traded pawnshop chain, EZCorp., reported a 37% rise in revenue in the second quarter. “With credit limited and other options disappearing, there are people looking for somewhere they can get emergency cash,” said David Crume, president of the National Pawnbrokers Association.

Cash-strapped workers have long obtained advances through “payday loans,” available at storefront lenders for fees that equate to high annual interest rates. Even that move is not so easy now.

“More customers are walking in the door, but turndowns are up,” said Steven Schlein, a spokesman for the payday-loan industry’s trade group, the Community Financial Services Association of America.

The Journal article also includes a chart showing that the combined delinquency and default rate for lower income groups dramatically exceeds that of higher income groups. Are lower income groups inherently a poorer credit risk or did lenders create the conditions for default by recklessly granting credit in excess of a borrower’s ability to repay?

The Journal article perhaps should have more appropriately been titled “the marginalization of risk”. Banks failed miserably in executing their basic mission – lending prudently based on a borrower’s ability to service the debt. Regulators failed miserably by allowing banks to make inherently unsound loans. Did the bankers really believe the income numbers supplied by borrowers who “stated” their income? What were the regulators thinking when they allowed banks to lend money without considering a borrower’s income, such as with “no doc” loans?

The long term adverse economic consequences of reckless lending are now obvious – the bigger tragedy is that it was allowed to happen in the first place.

Filed Under: Banking Industry, Liar Loans, Risky lending Tagged With: bankers blind to risk, lower income groups have huge default rates, unsound lending

Japan’ Solution To Debt Crisis – Expand Zombie Banking

October 6, 2009 by admin 1 Comment

Japan’s Zombie Banking Taken To New Levels Of Lunacy

Japan’s real estate and stock market bubbles burst in the early 1990’s. Since then, twenty years of non stop Government stimulus programs have failed and left Japan with the highest debt to GDP ratio in the world and two decades of lost economic growth. The costly attempt to have failed banks prop up failed companies has lead to a massive misallocation of capital and resulted in Zombie Firms and Zombie Banks.

Banks were not forced to recognize the condition of their balance sheets and were encouraged to continue lending to firms that were themselves unprofitable. Anil Kashyap labels these “zombie firms.”

Zombie banks continued to direct capital to zombie firms. This charade continued for more than a decade, with the result that the once-powerful Japanese economy was completely stagnant for that period. The government’s main response was to dramatically increase spending on infrastructure and frantically try to get Japanese households to save less and consume more. The resulting “lost decade” of economic growth cost Japan more than 20% of GDP.

Japan has now decided to exponentially expand policies that have not worked for two decades by forcing banks to agree to debt moratoriums.

Oct. 6 (Bloomberg) — Japanese banks’ bad loans won’t be driven higher by a proposed moratorium on debt payments by struggling small companies, said Financial Services Minister Shizuka Kamei.

Lenders won’t have to classify loans encompassed by the plan as non-performing, Kamei, 72, said in an interview yesterday at his office in Tokyo. That means they won’t be forced to boost provisions when borrowers postpone repayments of interest or principal, he said. At the same time, Kamei vowed to push banks to extend more credit to small businesses after bankruptcies hit a six-year high in Japan.

“We’re going to get financial institutions to provide these firms with more loans,” said Kamei. “Banks won’t have to treat debt on which they provide a moratorium as bad.”

Japan’s three largest banks, including Mitsubishi UFJ Financial Group Inc., posted combined losses of almost $14 billion last fiscal year as bad-debt charges surged.

“There is a potential for any proposal along the lines Kamei has made of debt moratoriums to backfire horribly,” said David Threadgold, a Tokyo-based analyst at Fox-Pitt Kelton. The plan could make banks more reluctant to lend to small firms, Threadgold said.

The moratorium, postponing repayment of principal and interest, will be extended to individuals as well as firms Kamei said. It will aim at giving relief to companies with about 100 million yen ($1.1 million) or less in capital.

“As long as I’m financial services minister, I’m not going to leave small companies in the lurch unable to get loans,” Kamei said. “If a bank takes that approach, I’ll hit them with a business improvement order.”

Japanese “salarymen” struggling to pay mortgages after bonus cuts may be eligible, he said. “We’re going to make it extremely easy for very small companies to get money,” Kamei said.

Let summarize the lunacy of this new plan: debtors pretend they will pay later; the banks pretend that the defaulted loans will be repaid; banks will be forced by the government to lend more money to debtors who cannot repay what they already owe and the banks will not have to set aside loan loss reserves on the defaulted debt. Japan’s debt moratorium is a final desperate attempt to “save the system” by preventing deeply indebted, income poor borrowers from defaulting on debts that can no longer be serviced. It will move private bad debt onto the already over leveraged public balance sheet and will encourage debt repudiation on a massive scale.

When Debt Becomes Inconvenient

Debt that cannot be repaid won’t be repaid and the consequences of default are in many cases relatively minor compared to the burden of continued payments. Japan now joins the U.S. in actively encouraging the repudiation of debt as discussed in How The Government Encourages Ruthless Defaulters and Loan Mods – Just A Warm Up For The Real Thing – A Mortgage Holiday.

Ironically, the biggest impediment to future bank lending is the growing trend of debt repudiation directly sponsored and encouraged by a government concurrently seeking to encourage more lending.

Consumers having trouble paying their debts can now chose from a long list of government programs for debt forgiveness, loan modifications, rate reductions, 125% loan to value mortgages and more programs on the way. Their is no longer any shame or embarrassment associated with defaults and bankruptcy. Defaulting on debt has become a rational choice for many with little repercussions.

If the long shot odds of economic recovery and job growth do not materialize, expect to see defaults worldwide increase exponentially as even those who can pay will chose not to. Zombie banking is alive and well.

Filed Under: Bailout, Debt Repudiation, Japan Tagged With: debt repudiation the next crisis, Japan takes Zombie banking to new level, Japan's final desperate attempt to inflate, Zombie banking taken to new heights

Mortgaged Future