Market crash: are we there yet ?

[TropicCat]

I'm positively shocked. The NRO should have reported it as I doubt there's a democrat in the bunch of allegations.

Sorry John, I just had to do it. Enough fun for one night, I have to get back to work.

[PBzeer]

Actually, it's also covered in The Nation, so you have what little there is of the story coming from the right and left.

[craigimass]

Originally Posted by TropicCat

Irrelevant

Banks can only lend 10x assets. Assume every loan they made is solid. No defaults.

Correct me if I am wrong, but I think this number is not only way off - BUT, if we held to this number we wouldn't even be talking about this!

It is much more complicated that we can lay out in a board post, but my understanding is that by a combination of deregulation and wrongheaded moves, that the ratio was allowed to be anywhere from double the normal (I think 12x was normal) to as much as 40 to 1.

The crowning glory was in 2004:
Net capital rule - Wikipedia, the free encyclopedia
"Prominent scholars such as Alan Blinder, John Coffee, Niall Ferguson, and Joseph Stiglitz have supported this position by explaining (1) the old net capital rule limited investment bank leverage (defined as the ratio of debt to equity) to 12 to 1 or 15 to 1 and (2) following the 2004 rule change, which relaxed or eliminated this restriction, investment bank leverage increased dramatically to 30 to 1 or more. "

Note - that rule covered only five brokerage houses...the biggies, who brought down the economy.

Of course, then there were the "guarantees", called Credit Default Swaps, which allowed all these companies to feel good about that high leveraging - after all, the risk was passed to someone else (AIG, and in the end, you and I).

Sure, there are lots of nuances. But I can't see any way this can be described as a normal course of events figuring on the 10x (12x according to the articles I saw) of regular banks.

I WISH it was as simple as the last one - the S&L crisis, where it only cost us 200 billion and banks went bust because they went all the way to 14 to 1.....

[wind_magic]

Originally Posted by craigimass

As to the distribution of capital.....well, one could certainly argue that since the Fed Reserve has always printed and distributed money to banks, that we have been in that mode for generations! If so, I'm sure you've been pointing this out for decades.

We actually have very little experience with the Federal Reserve banking system as it exists today. The Fed was not created until 1913, not even 100 years ago, and even then we were on the gold standard so the Fed could not create money in the way it is created today. In the 1930's deflation the government decided the currency needed to be devalued the same way they have decided it today, but back then the Fed couldn't buy Treasury debt to print money as they are doing right now with quantitative easing, so instead of doing that FDR confiscated all the gold in citizen's possession and then doubled the price of gold, effectively halving the value of greenbacks. It was then illegal to own gold for approximately 40 years until we completely left the gold standard and the laws were done away with, and during that time the value of the dollar declined rapidly until we arrived at 10+% interest rates in the 1970's.

Only since the 1970's has the Fed had the power to print money in exactly the same way that they are doing it now, for approximately the past 40 years. Nobody can say for certain what will happen as a result of quantitative easing, but we will certainly all find out together.

It is normal for debtors to demand currency devaluation during deflation, it has happened many times before. During the 1930's the government outlawed private possession of gold as their means to an end, before that during a previous deflation the government and people devalued the currency with silver which at the time was being mined in great quantity. The purpose of that time was to satisfy the cries of farmers who were upside down in farm debt, they wanted the government to end the deflation and inflate away their debts by coining silver. See The "cross of gold speech" for a rousing 19th century argument on the common man's desire to screw lenders in favor of borrowers by devaluing the currency and paying back loans with cheapened money.

Click HERE for the audio version of the cross of gold speech for a populist message that should sound REALLY FAMILIAR. Listen close to the concepts, I know you have heard them before, VERY RECENTLY.

Here is a picture of one of our countries first currencies, the Continental, which of course we destroyed. Paper currencies aren't new, history is littered with them ...

[chris_gee]

The 10% supposed reserves and therefore 10:1 leverage cited here a couple of times is inaccurate.
The 10% applies to demand deposits cheque and non term savings and is a liquidity measure for cash.
Actual leverage is tangible assets/tangible common equity.
This gives a leverage of 66 for Citi at the end of last year - see Option ARMageddon » Blog Archive » Banks’ Tangible Common Equity, 12/31/08
This takes equity as common shares as valued by the market which has its own view of what the assets are worth, and assets as disclosed in the balance sheet.
The difficulty is that the assets may not be correctly valued and that some figures may be hidden in off balance sheet SIVs. If the banks are insolvent the liabilities exceed assets and the market equity would become nil.
By fiddling eg marking liabilities down to market value and taking the difference as a profit although the purchase and profit were never made and not fully writing down assets a false picture is painted.
Leverage is far higher than 10 and hence the potential for losses of equity greater in a downturn. It may not be as high as 66 because assets may be overstated and market capitalisation rated too low. On the other hand it may be rated too high.
The actual figures are hard to determine but the problem is clearly overleverage in a falling market.
They have some difficulty in the face of this in raising private capital and since only a proportion of their loans can be recalled it is more likely that they will not roll over loans particularly to businesses leading to more failures and contraction.

[TropicCat]

Originally Posted by craigimass

Correct me if I am wrong, but I think this number is not only way off - BUT, if we held to this number we wouldn't even be talking about this!

It is much more complicated that we can lay out in a board post, but my understanding is that by a combination of deregulation and wrongheaded moves, that the ratio was allowed to be anywhere from double the normal (I think 12x was normal) to as much as 40 to 1.

The crowning glory was in 2004:
Net capital rule - Wikipedia, the free encyclopedia
"Prominent scholars such as Alan Blinder, John Coffee, Niall Ferguson, and Joseph Stiglitz have supported this position by explaining (1) the old net capital rule limited investment bank leverage (defined as the ratio of debt to equity) to 12 to 1 or 15 to 1 and (2) following the 2004 rule change, which relaxed or eliminated this restriction, investment bank leverage increased dramatically to 30 to 1 or more. "

I just love it when civilians get involved in this stuff. I'll apologize in advance if you work for a bank, but.. you didn't mention one.

The article you cited should be pulled or clarified. This was the weird ratios sub prime lenders maintained from 2001 through July 2005. All banks wandered north of 10% until they were reined in August 2005 when they got caught and were forced to belly up to the bar. The ratios declined steadily until the market imploded in the summer of 2007. It was unsustainable then and limited to the sub prime segment. No one is over 10% now.

So, the article is wrong. Or at the very least misleading. How do I know? Well, I was 'there'. I'm tired and want to go to bed but didn't want your post to just sit there.

Let's use 2007 numbers. Before the crash... I got these from Bloomberg just now.

Citigroup, had stock, retained earnings and preferred shares in 2007 equal to 10.7 percent of its risk- weighted assets. That was down from 12.02 percent in 2005. Wells Fargo, based in San Francisco, was at 10.68 percent, down from 11.76 percent, and Charlotte, North Carolina-based Bank of America, 11.02 percent, down from 11.08. These are the big boys but even us little guys got the "call" that summer and had to scramble big time.

Try Bloomberg or the Wall St journal for banking research.

[TropicCat]

Originally Posted by chris_gee

The difficulty is that the assets may not be correctly valued and that some figures may be hidden in off balance sheet SIVs. If the banks are insolvent the liabilities exceed assets and the market equity would become nil..

Come on Chris, it's too late to get into this. The devil is in the details and sweeping statements are disingenuous. As for SIVs. No one knows the truth, that's why they're called SIV's and are hidden from regulators.

How the hell do you think we keep the ratio at 10%. Don't pay any attention to the man behind the curtain...

Sheesh...

[chris_gee]

Once again the dismissive Rick has spoken in effect saying I have already spoken so nothing more needs to be said.
By the way did you ever answer my noting your plagiary?
10% applies only to demand deposits except corporate according to the FED.
The details of assets to some extent are obscured, however the market has its own view and values equity giving one part. Tangible assets can be derived from balance sheets at least to some degree. Since the details are unknown the market estimate is way over 10 x leverage.

[TropicCat]

Dismissive? Possibly, but then again I was there. Plagiarism? I remember missing one quote on Roubini last year.

So hang me.

[craigimass]

Originally Posted by TropicCat

I just love it when civilians get involved in this stuff. I'll apologize in advance if you work for a bank, but.. you didn't mention one.
So, the article is wrong. Or at the very least misleading. How do I know? Well, I was 'there'. I'm tired and want to go to bed but didn't want your post to just sit there..

Well, I certainly don't work for a bank - however I have a family member who was President of one - and who lost everything and went bankrupt back in the S&L crisis. Still, that does not educate me.....

When I do the math - in terms of the money and value lost, it comes out to being vastly more than the amount that Real Estate has fallen in value. That would seem to point to excess leverage.....more than just a few points off....in other words, bad bets at the Casino - all lost against money which someone (in the end) didn't have.

Again, for us average joes to understand this stuff, we need the one paragraph version. I only know what I hear from folks like the head of the Mortgage Industry trade group, the folks who sat on the committees in the government who regulated this stuff, etc. (though podcasts, etc.).

My understand is that when the time came, as you say, to belly up to the bar and pay for the drinks, their pockets were empty. Worse yet, their credit was gone because they had made bad bets - often to vastly higher ratios. And then there is Frank.

Frank? Well, this is overly simplistic, but one way of understanding CDS is that almost anyone can take out a million dollar life insurance policy on Frank. Of course, in the real world, only his family can. But, if everyone could (and that is the CDS market), and if everyone (counter parties) made bets on Frank living....and then Frank died, well.......a lot of people would owe a lot of money to the beneficiaries.

Yeah, probably not a good analogy. But I think this thing was caused by something a LOT worse than banks exceeding their ratio by a couple points.