Market-Long-Waves: Geithner's "Stressful" Katrina Bank Stress Test
Politics / Credit Crisis Bailouts May 04, 2009 - 02:54 PM GMTBy: Andrew_Butter
The results of the Stress Tests are about to be released. The leaked news is that these won't be a "whitewash", but that's not the point, whatever they say, no one is going to believe them anyway.
So what IS the point?
Might as well have told a Big Fat Lie and got on with things, which is what I assumed was going on, now I’m confused, I can't understand the protestations of "transparency" when the whole process appears to be so manifestly un-transparent.
The whole point of a valuation is not that it's "right", it is that everyone needs to agree that the valuation is probably in the right ball-park and is reasonable. At that point transactions can start, and investors and counter-parties can start to believe in banks audited accounts, which right now they can't.
On 2nd May WSJ told a tale about how Citi were in a "discussion" about whether they needed another $10 billion of capital or not (http://seekingalpha.com/article/134769-citi-needs-up-to-10-billion-in-new-capital). Think about it, with the threshold TCE of 3% that means a difference of opinion about how much Citi's assets are worth of $330 billion, and that's from two parties that presumably have all of the facts; I wonder if BOA is arguing about the $50 billion or so they are supposed to need, that's a $1.5 trillion or so "difference of opinion". What a rational outside party is supposed to make out of that, I fail to understand.
Why NOT just tell a big fat lie?
The way Secretary Geithner originally explained it, the tests were going to be an exercise in "forebearance", at least that's how it looked to me.
The logic looked sound, simply work out how much money the banks would need to ride through the storm and go easy on the ratios and boxes that have to be ticked under prevailing capital adequacy norms; just have the government stand-by to inject cash as and when required to keep the boats afloat (and cut the ones that can't be saved adrift although no one was talking about that then, and they still aren't, although the simple straightforward analysis done by Martin Hutchinson (http://www.marketoracle.co.uk/Article10358.html) and by Victor Cook (http://seekingalpha.com/article..) would have done the job to figure out which, much better than the stress tests).
It was messy, but in emergencies sometimes you have to improvise, and wait for the storm to blow over; then when it does, start repairing the damage and building better defenses for next time.
The way it evolved (combined with the other mind-blowing and expensive programs) appears to have turned into an attempt to drive the hurricane backwards by huffing-and-puffing-and-blowing hard counter clockwise against the wind.
But there are some natural forces that just can’t easily be tamed; perfect storm hurricanes and markets re-adjusting themselves are two of them.
Hurricane Katrina
There are similarities between the current crisis and Hurricane Katrina; the cause of that disaster was arrogance and indifference to real dangers facing ordinary Americans, the disaster was compounded by slow reactions followed by denial followed by an outbreak of bureaucratic box-ticking, i.e. more arrogance. This time it's the old same-old-same-old.
Secretary Geither is at heart a bureaucratic box-ticker, of that there is no doubt, as was chronicled so adroitly by Felix Salamon (http://seekingalpha.com/article/132336-a-telling-tim-geithner-anecdote). That box-ticking is not where the solution lies was illustrated by Warren Buffet when he said "you can't put a value on these banks by ticking boxes".
If you could then Warren Buffet, who appears to know how to do a valuation (or two), and who understands that markets often miss-price assets and that ticking boxes does not bring you any closer to reality; would not be one of the richest men in the world.
And Secretary Geither and Chairman Bernanke would not be floundering around trying to understand the basic principles of valuation; and USA would not be mired in a sea of debt.
What's wrong with the Stress tests?
For a start they are "sold" as an exercise in "transparency". That's the last thing you need in a hurricane, when the wind blows the clothes off your next-door neighbor, what do you do (a) take a photograph and post it on the Internet (b) grab a sack or an old blanket and help her cover herself up?
Naming and shaming is not helpful right now, what "forebearance" is about, and that's what's needed, is a responsible (and trustworthy) government that simply says, "we have the information we need, and we will do what it takes to see these banks through the storm"...."and we will sort out the details (and punish the criminals), once the storm has passed. And no we WON'T forget to sort out the details or to punish the criminals".
In a hurricane sometimes all you can do, is do what's necessary to keep existing structures intact, because you know that when one structure fails the debris will endanger the integrity of all the other structures.
But the Stress Tests don't even get to First-Base; they will not even generate useful information.
The issue is not TCE, which is how much money equity shareholders will be left with if the banks were liquidated today, or next year or the year after. And sure a 3% threshold is a disgrace (and many are a long way from there), but that is just testimony to the mistakes of the past, and sure in the future TCE could prudently be set higher (and a lot of other things could be changed too), but right now, in case no one noticed, there is a battle for survival.
The issue is whether there will be "cover" (i.e. will TCE be positive) whenever the markets for some of the assets held by banks re-starts. That's the number that is key, anything else is just hot air.
Why no useful information?
The parameters for the Stress Test ("Real" GDP, House Prices, and Unemployment) risk repeating exactly the same mistakes the mistakes of the past. Then the "case for house prices going up forever" used spurious arguments and tracked the wrong data, this time...same-old-same-old.
That's because there is no clear evidence that any of these three parameters will be any better. At least none that I have seen, and if "transparency" and "calming down the market" is an objective, then someone should have explained how it is that those three parameters can be used to predict how much extra capital adequacy banks will need.
And profit (earnings) is almost irrelevant now; profit is the change of assets net of liabilities over a period of time, and well if there is no clear consensus (between the banks, the regulators, FASB, investors, counter-parties) on how to value a significant portion of the assets - how on earth can you work out profit?
What people want to know is whether the bank they are investing in, or lending to, will be in business in three years or so time, or not. By that time, profits will be able to look after themselves.
Take GDP for example
First there is a clear dependent relationship between nominal GDP and house prices (http://www.marketoracle.co.uk/Article9658.html), and well presumably… unemployment, so you only need ONE number (look at the graphic).
So if you think you need three variables to work out how much you can reasonably expect to be able to sell an asset for in three years time, there is something wrong with your model, of an order of magnitude of the model that said house prices are going to go on going up forever (or $330 billion in the case of Citi).
Perhaps there is a model, if there is why isn't it part of the plan and open for everyone to see, so that everyone can agree it's proper and reasonable? That's transparency, and that's what's mandated under International Valuation Standards, if you rely on data, any data for your model, (hopefully market derived-data), then you need to explain it in Plain English and investors who rely on your valuations should get that explanation, and if you don't want chaos (like now) you mandate that by Law.
Otherwise you might as well save everyone the bother and just say "we are not going to tell you what our assets are worth, but the government has had a look and they have said they will support us" - which is back to the original argument.
Don't come up with a spurious half-cocked-valuation and treat investors and counter-parties like imbeciles, that takes you nowhere.
Second: As far as I have ever known "Real" GDP is (a) a figment of the imagination (anyone who believes the "official" CPI figures believes in fairies – (http://www.marketoracle.co.uk/Article10119.html)), and (b) my model of house prices says there is a 99.5% probability that GDP is the ultimate driver and I haven't seen any others that work as good, and the reality is the market-long wave explains what value is (http://www.marketoracle.co.uk/Article9658.html).
Why use a number that no one with half a brain believes in when there is a perfectly good number lying around which everyone believes in?
Third: the effect of GDP depends on where the toxic assets that a bank owns have their collateral, which (a) isn't hard to find out and (b) makes a huge difference.
This Chart shows the % foreclosure in 2007 compared to "Real" GDP growth for every State in USA. Notice, there is a rather strong correlation, that's not an accident, and it's not a coincidence either.
Sure, (a) perhaps the rate of GDP growth is dependant on foreclosures, sure (b) it is unscientific to project outside that most extreme point of data, and most likely if nominal GOP were used instead of the concoction of "Real" (and who can say if inflation is more or less in one State than another), then it is highly likely that a better correlation would be found. I don't have the data, but I'm sure Secretary Geithner does, what's worrying is that he is apparently not looking at it.
A properly constructed Stress Test would have as its "base case", the second order polynomial (the middle line), the low case as the exponential (top line) and the best case the linear solution (bottom line).
And make no mistake, all the stress tests are, are valuations, i.e. estimates of what will be the price you will be able to get for assets in the future. Just the Stress Tests are not very good valuations done by people who apparently don't know much about doing valuations, perhaps they are the same people who worked out that house prices would go on going up forever - Black Swans permitting?
Why they don’t use International Valuation Standards, a standard recognized by every valuation institute of any consequence in the world (including USA an France – imagine that), and instead concoct an idiotic “make it up as you go along” standard that no one believes, is beyond me. Perhaps it’s time for some adult supervision in the Greatest Nation on Earth?
The numbers that should have been used:
1: Nominal GDP (by State).
2: Long Term Interest Rates
Those are independent variables, and both are to a greater and lesser extent under the direct control of the government, and both can be proved to have a direct causal effect on foreclosures, and house prices, which is what you need to know if you are going to come up with a credible estimate of the likely value of a big portion of the assets owned by banks, in one, two and three years time.
Which affects the decision about whether they should be allowed to stay in business or not, which affects decisions made by investors and counter-parties.
What next?
The key issue now is how many people who bought into the rally that started on 9th March 2009 believe (believed) in fairy stories.
My guess (and no I don't "trade" and I don't gamble (except for fun - going to a Casino and losing how much I planned to lose is my idea of a good time)); my guess is that the people who bought realized that the only thing that matters is that incompetent and incoherent or not, the US Government will continue to support the banks regardless of what the stress tests say or what they don't say.
It's like that Quentin Tarantino film "Jackie Brown" (the one where Robert De Niro shoots Bridget Fonda in the car park for teasing him about forgetting where he put his car). Earlier he'd talked to Samuel Jackson and asked him if he "trusted" Melanie (Bridget Fonda) and Jackson said:
"Darn, of course I don't trust Melanie, but I know I can always trust Melanie to be Melanie".
At least the Stress Tests won't do any harm, and perhaps what's needed is for one or two boats to be cut loose in the storm, not that the tests are likely to reveal which ones.
It's a bit like when the neighborhood lunatic stands on the beach huffing and puffing to try and blow the hurricane round in the other direction. You might question his strategy, but at least you can't criticize his motives. Although at the rate he's burning the taxpayer's money, if I was a US taxpayer, I might question the logic.
Let's see, was that's a dead cat, a sucker rally, a bear rally...or what...or did it get "downgraded" to a bimbo rally...like a lot of hurricanes do?
Time is a telling!
By Andrew Butter
Andrew Butter is managing partner of ABMC, an investment advisory firm, based in Dubai ( hbutter@eim.ae ), that he setup in 1999, and is has been involved advising on large scale real estate investments, mainly in Dubai.
© 2009 Copyright Andrew Butter- All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.
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