Ten Notes For the Current Crises

1) General Growth Properties — another case of too much leverage, illiquid assets, and liquid liabilities.  I live near Columbia and Baltimore, so I know of a lot of property owned by General Growth that was bought when they acquired the Rouse Corp.  I can hear the Rouses in the distance congratulating themselves on a good sale.

For those that haven’t read me much, the deadly trio of too much leverage, illiquid assets, and liquid liabilities is what causes most corporate defaults of financial companies, not lesser issues like mark-to-market accounting.

2) The government thinks it is doing something good, and then it realizes that it is in over its head.  Consider AIG and Fannie Mae.  Where does the bailout end?  The government does not have a team of financial analysts competent to dig into murky balance sheets, and they have the mistaken notion that they must act fast.  Having worked on several takeovers of large financial firms, I can tell you that work done quickly destroys value.  Either there is an underestimate that leads to losing the bid, or an overestimate that leads to overpaying, and an eventual writeoff of part of the investment.

With Fannie Mae and AIG, (and probably Freddie also) the government clearly did not know what it was doing.  What were the main drivers of the loss, and how much worse could they get?  Is this scenario self-reinforcing?  The cursory work led to a bad result that is getting worse.

3) Amazing that we are almost to the end of the first $350 billion of bailout capital.  The government is behaving like a person that just won the lottery, and is profligate with spending, because they’ve never had that much money to throw around with complete discretion until now. As it says in Proverbs 13:11, “Wealth gained by dishonesty will be diminished, but he who gathers by labor will increase. [NKJV]”  Easy come, easy go.  I am not surprised in the slightest that the US Government has mis-estimated the loss exposures.  They don’t have anyone with a concentrated interest (a profit motive) in the result.

4) Here’s another angle in the Fed refusing to disclose what assets they are financing.  If we knew who they were buying from, and what they were buying, the markets would ask the question, “How much more firepower are they willing to expend?”  If the judgment is “little”, market players would sell what the Treasury/Fed was buying, and if the judgment is “a lot”, market players would buy what the Treasury/Fed was buying.

That leads me to believe that the Treasury/Fed doesn’t want to commit a lot more resources to this fight.  If they felt they had a lot more firepower, they would happily disclose their actions, because the private markets would aid their actions.

5) I’ve been talking about it for over a decade, so pardon me if I point at the great pensions disaster.  We have had a lost decade where DB pension money needed to earn 8-9%/yr, and earned around 1%/year.  That gap of 7-8%/yr over 10 years is enough to destroy most well-funded plans at the beginning of the period.  The problem exists for DC plans as well, because as people age, they lose time to compound their money.  Hey, think of this — the dumb guys that put all their money in the stable value fund did much better than those that put their money at risk.  So much for the equity premium in hindsight, but now it’s time to begin committing funds to riskier assets.  (Don’t do it all at once.)

6) At least Mr. Obama can make one market go up — muni bonds.  Wait, that’s not good?!  At least healthy municipalitiestheir borrowing rates improve as higher taxes lead the wealthy to shelter income from taxation.

7) Maybe Obama’s tax poicy could have more bite.  Close down tax havens.  This is something I can get behind.  I like low tax rates, but I don’t like the ability for some to lower their tax rates, and not others.  Let there be a level playing field in the tax code, such that there is no advantage to moving profits offshore.

Now, could Obama enact real tax reform that would be fair, and cause Buffett (and others) to pay taxes on his unrealized capital gains?  He could, but he won’t, because he is a slave of Democratic special interests.

8 ) I understand why the Treasury did it.  They wanted an opaque way of encouraging the purchase of weak banks by stronger banks.  So, they let them absorb tax losses of the acquired bank.  Too bad it is not legal, but legality doesn’t affect our government much these days.

9) Give Spain a hand — they managed to increase capital requirements on their banks during the good times.  Things aren’t perfect now, but Spanish  banks are in decent shape given all of the credit stress.

10) Why is the Fed funds rate so low?  The 75 basis fee point forces the effective Fed funds rate from 1.00% to 0.25%.  Though some see the Fed hemmed in here, I think that as they reduce the Fed funds rate, they will also reduce the 75 bp fee.