Thursday, August 13, 2009

$700 Billion is a lot of Guacamole!


An article in today's Forbes online entitled Trouble with TARP, reports a growing concern by the Congressional Oversight Panel (COP) about the effectiveness of the $700 billion program. The COP reports that the effectiveness of the program is difficult to determine due to lack of transparency of how funds were spent. The COP report also states that the absence of any reporting guidelines for TARP participants impedes effective oversight.

The 145 page report starts with a retelling of the extreme conditions confronting the banking sector as the credit crisis exploded last autumn. It also outlines the choices confronting regulators, legislators and industry executives as the crisis deepened. We were led to believe by Treasury and Federal Reserve officials that the global banking system was in imminent danger of collapse. Nothing less then immediate and drastic measures taken by sovereign government officials and industry executives would prevent the catastrophic consequences of global economic carnage. The report makes it clear that these market conditions were so extreme that regulators were navigating through uncharted waters. Any remediation measures taken had little historical precedence to guide actions. Hence Paulson was given carte blanche to handle the crisis with unprecedented latitude and executive facility.

As this blog reported earlier this week, the TARP was originally designed to acquire troubled assets from banking institutions. TARP funds were earmarked to purchase mortgage backed securities and other derivatives whose distressed valuations severely eroded capital ratios and stressed banks balance sheets. Hank Paulson later shifted the strategy and decided to inject TARP funds into the banks equity base. This has done wonders for the shareholders of the banks but troubled assets remain on the banks balance sheet. As the recession continues, unemployment, home foreclosures, SME bankruptcies and the looming problem with commercial mortgage backed securities (CMBS) are placing a new round of added strain on the banking system.

The TALF program is designed to draw private money into partnership with the government to acquire troubled assets from banks. So far the program has received a tepid response. I suspect that the principal factors inhibiting the expansion of the TALF program are numerous. Chief among them is the inability of FASB to decide upon valuation guidelines of Level III Assets. Banks holding distressed securities may also be reluctant to part with these assets because they have tremendous upside potential as the economy improves.

The COP also questioned the effectiveness of TARP because stress tests were only conducted on 19 banks. The report states that additional stress tests may be required because the previous tests failed to account for the length and depth and length of the recession. Community banks are also of concern. They face a perfect storm in challenging macroeconomic conditions. Of particular concern is commercial real estate loans. Many economists are concerned that high rate of loan defaults in commercial loan portfolios pose great threats to the community banking sector.

Though interest rates remain low due to the actions of the Federal Reserve, lending by banks still remains weak. SME's are capital starved and bankruptcy rates are quickly rising. SME's are critical to any economic recovery scenario. A strong SME sector is also crucial for a vibrant and profitable banking system. Perhaps a second round of TARP funding may be required to get more credit flowing to SME's. If banks start failing again it would be devastating. The Treasury and the Federal Reserve don't have many bullets left to fire because of all the previous expenditures and a waning political will of the people to continue to fund a systemically damaged banking system.

Risk: banks, SME, economy, credit, market

You Tube Video Music: Billie Holiday with Lester Young, Pennies from Heaven

Tuesday, August 11, 2009

Waiting for the Other Shoe to Drop


According to a recently published report by a Congressional Oversight Panel reviewing the effectiveness of the Troubled Asset Relief Program (TARP), many banks remain vulnerable due to questionable commercial loans still held on their balance sheets. This is a looming problem for community and smaller banking institutions. Smaller banks are being adversely effected by the the rise of commercial loan defaults. Many community banks have large loan exposures to shopping malls and other small businesses hard hit by the recession.

The report states, "Owners of shopping malls, hotels and offices have been defaulting on their loans at an alarming rate, and the commercial real estate market isn't expected to hit bottom for three more years, industry experts have warned. Delinquency rates on commercial loans have doubled in the past year to 7 percent as more companies downsize and retailers close their doors, according to the Federal Reserve.

The commercial real estate market's fortunes are tied closely to the economy, especially unemployment, which registered 9.4 percent last month. As people lose their jobs, or have their hours reduced, they cut back on spending, which hurts retailers, and take fewer trips, affecting hotels."

Defaults in sub prime and other residential mortgages precipitated last years banking and credit crisis. The TARP program succeeded in stabilizing a banking system that was teetering on collapse. The $700bn infusion into the banking system appears to have buttressed depleted capital ratios and severely stressed balance sheets of large banking institutions. But many banks are still carrying troubled assets on their balance sheets. Commercial Mortgage Backed Securities (CMBS) values are tied to the cash flows generated by renters and lessors of the underlying mortgaged properties. As occupancy rates of commercial properties fall cash flows dissipate. The market value of these securities plummets creating a distressed condition. This places additional strain on the banks balance sheet driving capital ratios lower and places a banks liquidity and ability to lend at risk.

The TALF (Term Asset Backed Loan Facility) was instituted in March to extend $200bn in credit to buy side financial institutions to purchase troubled assets and remove them from banks balance sheets. So far only $30bn has been allocated through the program. Clearly banks balance sheets remain at risk due to their continued high exposure to this asset class.

A strong economic recovery will address this problem. A prolonged recession will resurrect the banking and credit crisis we experienced last autumn. It would appear that TARP II may be a necessity if more private sector investors don't step up to the plate and participate in TALF.

Risk: CMBS, commercial real estate, banks, credit risk

Monday, August 10, 2009

Drivers Wanted!

fuel efficient

The cash for clunkers rebate program looks like it is a great success. The first $2. bn allotted to the program was used up within two weeks. The recently approved additional allocation of $1. bn for the program will no doubt be taken advantage of by consumers. American's always keen to do a deal and can't wait to drive away in a brand new ride unwritten in part by our most favorite relative, Uncle Sam.

The government's goals of the cash for clunkers program are being achieved. The program will have a positive environmental impact as more fuel efficient vehicles replace the old gas guzzling clunkers. The program has also allowed car manufacturers to liquidate 2009 inventories that were piled high due to tepid demand borne from the recession and credit crisis. The program may also help cure consumers recession psychology and their new found aversion to purchasing new stuff.

It is hoped that this boost to car manufacturers may kick start the economy. Ford Motor Company's recent positive earnings announcement and GMs and Chrysler's arrest of declining quarterly sales are one of the "green shoots" of recovery pointed to by politicians and economists. However a huge question remains concerning how to incubate long term sustainable drivers that will end the recession? The $600 tax rebate checks sent out by Paulson last year provided a temporary boost to the economy. Its effects did little more the forestalling the more deleterious effects of the growing recession. See The Charge of the Light Brigade. Hopefully cash for clunkers will help to kick start some recovery momentum to an economy aching for relief from systemic malaise.

The US economy has grown overly dependent on a few industry sectors that include services, real estate, banking and construction. The SME service sectors have been devastated by the contraction of credit, unemployment and the curtailment of consumer demand brought on by the recession. During the good times, these sectors were driving economic growth and expansion. Unfortunately these sectors remain conspicuously absent as leading drivers in the new emerging economy. Macroeconomic factors unpinning recovery continue to be negative for these sectors. Hi tech and manufacturing seen as critical to a lasting recovery have also been a bit lethargic. These industries are capital intensive and with the capital markets still seeking a firm recovery footing these sectors will remain weak. Health care and pharmaceuticals are key sectors in the US economy, but political uncertainty around reforming industry practices and much needed restructuring hampers the sectors ability to assume a leading position in recovery scenarios.

Last year Sum2 published The Hamilton Plan, a Ten Point Program to incubate small midsized enterprise (SME) manufacturers. At its core, the plan seeks to encourage capital formation initiatives from public and private sources. Manufacturing is key to any sustainable economic recovery. Our ability and desire to link manufacturing to the entrepreneurial capabilities and business skills of SME's to address targeted needs could well be the drivers that finally steer us out of the recession.

Risk: recession, SME, manufacturing

Wednesday, August 5, 2009

Job Loss Decelerating?

ADP has released its National Employment Report for July reporting a 371,000 decrease in non-farm private sector jobs. ADP has also revised its numbers for May from a decline of 473,000 to a decline of 463,000.

The ADP report states, July’s employment decline was the smallest since October of 2008. As a trailing economic indicator, unemployment is expected to continue to rise for the next few months. As the recession recedes and the economic recovery takes hold employment is likely to decline for at least several more months, albeit at a diminishing rate.

Highlights of the report include:

The report estimates non-farm private employment in the service-providing sector fell by 202,000.

Employment in the goods-producing sector declined 169,000, with employment in the manufacturing sector dropping 99,000, its smallest monthly decline since September of 2008.

Large businesses, defined as those with 500 or more workers, saw employment decline by 74,000, while medium-size businesses with between 50 and 499 workers declined 159,000.

Employment among small-size businesses, defined as those with fewer than 50 workers, declined 138,000. Since reaching peak employment in January 2008, small-size businesses have shed nearly 2.4 million jobs.

In June, construction employment dropped 64,000. This was its thirtieth consecutive monthly decline, and brings the total decline in construction jobs since the peak in January 2007 to 1,483,000.

Employment in the financial services sector dropped 26,000, the twentieth consecutive monthly decline.

The full report can be accessed here: ADP National Employment Report

Risk: unemployment, recession