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Unwinding The Spin

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We are caught in a steady “spin cycle” of contradictory reports about our most fundamental concerns:  the environment and the economy.  Will China financially intervene to resolve the sovereign debt crisis in Europe and save us all from the economic consequences that loom ahead?  Will the “China syndrome” finally become a reality at Fukushima?  When confronted with a propaganda assault from the “rose-colored glasses” crowd, I become very skeptical.

Widespread concern that Greece would default on its debt inflamed lingering fear about debt contagion throughout the Eurozone.  Economist John Hussman, one of the few pundits who has been keeping a sober eye on the situation, made this remark:

Simply put, the Greek debt market is screaming “Certain default. Amésos.”

Meanwhile, the Financial Times reported that China Investment Corporation has been involved in discussions with the government of Italy concerning Italian bond purchases as well as business investments.  Bloomberg BusinessWeek quoted Zhang Xiaoqiang, vice chairman of China’s top economic planning agency, who affirmed that nation’s willingness to buy euro bonds from countries involved in the sovereign debt crisis “within its capacity”.

Stefan Schultz of Der Speigel explained that China expects something in return for its rescue efforts:

The supposed “yellow peril” has positioned itself as a “white knight” which promises not to leave its trading partners in Europe and America in the lurch.

In return, however, Beijing is demanding a high price — the Chinese government wants more political prestige and more political power  .  .  .

Specifically, China wants:  more access to American markets, abolition of restrictions on the export of high-technology products to China as well as world-wide recognition of China’s economy as a market economy.

Even if such a deal could be made with China, would that nation’s bailout efforts really save the world economy from another recession?

As usual, those notorious cheerleaders for stock market bullishness at CNBC are emphasizing that now is the time to buy.  At MSN Money, Anthony Mirhaydari wrote a piece entitled, “The bulls are taking charge”.

Last week, Robert Powell of MarketWatch directed our attention to an analysis just published by Sam Stovall, the chief investment strategist of Standard & Poor’s Equity Research.  Powell provided us with this summary:

Consider, at a place and time such as this, with the economy teetering on the verge of another recession, none of the 1,485 stocks that make up the S&P 1,500 has a consensus “Sell” rating. And just five, or 0.3%, are ranked as being a “Weak Hold.”

*   *   *

From his vantage point, Stovall says it “appears as if most analysts are not expecting the U.S. to fall back into recession, and that now is the time to scoop up undervalued cyclical issues at bargain-basement prices.”

However, in S&P’s opinion, it might be high time to “buck the trend and embrace the traditionally defensive sectors (including utilities), as the risk of recession — and downward earnings per share revisions – appear to us to be on the rise.”

On September 14, investing guru Mark Hulbert picked up from where Robert Powell left off by reminding us that – ten years ago – stock analysts continued to rate Enron stock as a “hold” during the weeks leading up to its bankruptcy, despite the fact that the company was obviously in deep trouble.  Hulbert’s theme was best summed-up with this statement:

If you want objectivity from an analyst, you might want to start by demanding that he issue as many “sell” recommendations as “buys.”

It sounds to me as though Wall Street is looking for suckers to be holding all of those high-beta, Russell 2000 stocks when the next crash comes along.  I’m more inclined to follow Jeremy Grantham’s assessment that “fair value” for the S&P 500 is 950, rather than its current near-1,200 level.

While the “rose colored glasses” crowd is dreaming about China’s rescue of the world economy, the “China syndrome” is becoming a reality at Japan’s Fukushima nuclear power facility.  Immediately after the tragic earthquake and tsunami, I expressed my suspicion that the true extent of the nuclear disaster was the subject of a massive cover-up.  Since that time, Washington’s Blog has been providing regular updates on the status of the ongoing, uncontrolled nuclear disaster at Fukushima.  The September 14 posting at Washington’s Blog included an interview with a candid scientist:

And nuclear expert Paul Gunter says that we face a “China Syndrome”, where the fuel from the reactor cores at Fukushima have melted through the container vessels, into the ground, and are hitting groundwater and creating highly-radioactive steam . . .

On the other hand, this article from New Scientist reeks of nuclear industry spin:

ALARMIST predictions that the long-term health effects of the Fukushima nuclear accident will be worse than those following Chernobyl in 1986 are likely to aggravate harmful psychological effects of the incident.

As long as experts such as Paul Gunter and Arnie Gundersen continue to provide reliable data contradicting the “move along – nothing to see here” meme being sold to us by the usual suspects, I will continue to follow the updates on Washington’s Blog.


 

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The “Bad Bank” Debate

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January 29, 2009

The $700 billion Troubled Assets Relief Program (TARP) doesn’t seem to have accomplished much in the way of relieving banks from the ownership of “troubled assets”.  In fact, nobody seems to know exactly what was done with the first $350 billion in TARP funds, and those who do know are not talking.  Meanwhile, the nation’s banks have continued to flounder.  As David Cho reported in The Washington Post on Wednesday, January 28:

The health of many banks is getting worse, not better, as the downturn makes it difficult for all kinds of consumers and businesses to pay back money they borrowed from these financial firms.  Conservative estimates put bank losses yet to be declared at $1 trillion.

The continuing need for banks to unload their toxic assets has brought attention to the idea of creating a “bad bank” to buy mortgage-backed securities and other toxic assets, thus freeing-up banks to get back into the lending business.  Bloomberg News and other sources reported on Wednesday that FDIC chair, Sheila Bair, is pushing for her agency to run such a “bad bank”.  Our new Treasury Secretary, Tim Geithner, has also discussed the idea of such a bank (often referred to as an “aggregator bank”) as reported on Wednesday by Reuters:

Geithner said last week the administration was reviewing the option of setting up a bad bank, but that it is “enormously complicated to get right.”

The idea of creating such a bank has drawn quite a bit of criticism.  Back on January 18, Paul Krugman (recipient of the Nobel Prize in Economics) characterized this approach, without first “nationalizing” the banks on a temporary basis, as “Wall Street Voodoo”:

A better approach would be to do what the government did with zombie savings and loans at the end of the 1980s:  it seized the defunct banks, cleaning out the shareholders.  Then it transferred their bad assets to a special institution, the Resolution Trust Corporation; paid off enough of the banks’ debts to make them solvent; and sold the fixed-up banks to new owners.

The current buzz suggests, however, that policy makers aren’t willing to take either of these approaches.  Instead, they’re reportedly gravitating toward a compromise approach:  moving toxic waste from private banks’ balance sheets to a publicly owned “bad bank” or “aggregator bank” that would resemble the Resolution Trust Corporation, but without seizing the banks first.

Krugman scrutinized Sheila Bair’s earlier explanation that the aggregator bank would buy the toxic assets at “fair value”, by questioning how we define what “fair value” really means.  He concluded that this entire endeavor (as it is currently being discussed) is a bad idea for all concerned:

Unfortunately, the price of this retreat into superstition may be high.  I hope I’m wrong, but I suspect that taxpayers are about to get another raw deal — and that we’re about to get another financial rescue plan that fails to do the job.

Krugman is not alone in his skepticism concerning this plan.  As Annelena Lobb and Rob Curran  reported in Wednesday’s Wall Street Journal, this idea is facing some criticism from those in the financial planning business:

“I don’t see how this increases liquidity,” says Paul Sutherland, chief investment officer at FIM Group in Traverse City, Mich.  “This idea that we should burn million-dollar bills from taxpayers to take bad assets isn’t the best path.”

Billionaire financier Geroge Soros told CNBC that he disagrees with the “bad bank” strategy, explaining that the proposal “will help relieve the situation, but it will not be sufficient to turn it around”.  He then took advantage of the opportunity to criticize the execution of the first stage of the TARP bailout:

As to Paulson’s handling of the first half of the $700 billion Wall Street bailout fund known as TARP, Soros said the money was used “capriciously and haphazardly.”  He said half of it has now been wasted, and the rest will need to be used to plug holes.

Former Secretary of Labor, Robert Reich, anticipates that a “big chunk” of the remaining TARP funds will be used to create this aggregator bank.  Accordingly, he has suggested application of the type of standards that were absent during the first TARP phase:

Until the taxpayer-financed Bad Bank has recouped the costs of these purchases through selling the toxic assets in the open market, private-sector banks that benefit from this form of taxpayer relief must (1) refrain from issuing dividends, purchasing other companies, or paying off creditors; (2) compensate their executives, traders, or directors no more than 10 percent of what they received in 2007; (3) be reimbursed by their executives, traders, and directors 50 percent of whatever amounts they were compensated in 2005, 2006, 2007, and 2008 — compensation which was, after all, based on false premises and fraudulent assertions, and on balance sheets that hid the true extent of these banks’ risks and liabilities; and (4) commit at least 90 percent of their remaining capital to new bank loans.

However, Reich’s precondition:  “Until the taxpayer-financed Bad Bank has recouped the costs of these purchases through selling the toxic assets in the open market” is exactly what makes his approach unworkable.  The cost of purchasing the toxic assets from banks will never be recouped by selling them in the open market.  This point was emphasized by none other than “Doctor Doom” himself (Dr. Nouriel Roubini) during an interview with CNBC at the World Economic Forum in Davos, Switzerland.  Dr. Roubini pointed out:

At which price do you buy the assets?  If you buy them at a high price, you are having a huge fiscal cost.  If you buy them at the right market price, the banks are insolvent and you have to take them over.  So I think it’s a bad idea.  It’s another form of moral hazard and putting on the taxpayers, the cost of the bailout of the financial system.

What is Dr. Roubini’s solution?  Face up to the reality that the banks are insolvent and “do what Sweden did”:  take over the banks, clean them up by selling off the bad assets and sell them back to the private sector.

Nevertheless, you can’t always count on the federal government to do the right thing.  In this case, I doubt that they will.  As David Cho pointed out at the end of his Washington Post article:

The bailout program “is a public relations nightmare,” one government official said.  He added that Obama officials are sure to face criticism for whatever course they take.