April 22 2009 2: Not If But When

Ben Shahn 6 gals for $1.00 Summer 1938
Tourist signs along Route 40 in Central Ohio

Ilargi: Today was one sad day among many to come. General Motors finally gave up on survival today, a development which is deeply tragic for its employees and pensioners, more than most of them realize right now. And perhaps someday we'll know why Freddie Mac's acting CFO David Kellerman was found hanging in his basement. The upcoming revelations of large scale defaults on the firm slash federal agency slash toxic dumpster's mortgages may well be the main reason. Fannie Mae and Freddie Mac, with $5-6 trillion in their combined portfolio's (not counting their deep dabbling in securities), are powderkegs waiting to blow up. The old “not if, but when” question, just like at GM.

Fannie and Freddie should never have existed in the first place, but they should certainly have been wound down long ago. As it is, what's slushed through to Wall Street via AIG is but a pittance compared to what's being parked at Fannie and Freddie. And there's a limit even to that game. After all, California defaults just rose to new highs again.

Thinking about the trillions that have been spent "rescuing" Detroit and the mortgage industry, you have to wonder what parallel universe Washington is located in. And what happened to the money. Let's ask Stephen Hawking, he may have the only honest answer. We should also ask him why the money was transferred to the banks, and not to the soon to be even more destitute people in Detroit and beyond. For that remains the major issue here. Nothing has been done to catch their fall, though a few billion, let alone a trillion, here and there would have gone a long way towards cushioning the worst of their predicament.

As nations, societies and communities we should be able to do better than putting our fellow citizens out with the trash on the curb.

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As GM Plans Bond Payment Miss, Last Vestiges Of Hope Fade Away

Any investors with knowledge of General Motors Corp.'s bonds won't be shocked to learn that the company is going to miss a bond payment - the market has been forecasting a bankruptcy for months. The concern is what the words "GM" and "default" together will do to investors who are not intimately aware that the auto giant's bonds are trading at less than 10 cents on the dollar. "People don't understand where these bonds are trading; this is not new information," said Doug Forsyth, who manages about $3.75 billion in high yield and convertible bonds at Nicholas-Applegate Capital Management. "From a manager's perspective this is par for the course, but it makes headlines and spooks some people away." To be sure, as Forsyth pointed out, GM is a miniscule part of the high-yield market now.

Most traders have long written the company off, and articles about a prospective bankruptcy have been part of the news flow about the company since at least last year when the company appealed to the federal government for help. Large GM bondholders were already aware that the company was planning on missing a big interest payment, according to a person familiar with the thinking of the ad-hoc committee that holds just under half of the company's bonds. The person said they knew the June 1 government deadline for a restructuring plan wasn't a coincidence; the government didn't want the struggling company to spend $1 billion to keep servicing its debt. Much of the market has long been following that line of thinking. Portfolio manager Greg Hopper of the Artio Global High Income Fund said that at this point most of the holders of auto-related debt are professional distressed investors and know what they're getting into.

Still many of GM's bonds traded down Wednesday afternoon, implying there were still some hopefuls out there. The company's $3 billion 8.375% bond offering due 2033 recently changed hands at 9.1 cents on the dollar, according to online trading platform MarketAxess, down 0.81 cents for the day on 10 trades. As much as 20% of GM's $28 billion in bonds are held by small investors who haven't already read the writing on the wall. Many of them won't have been able to trade out of their bonds and will only take losses if the company defaults. "If it does default I think you're going to see a profound reorientation in Middle America," said Richard Peterson, managing director of hedge fund MarketPsy Capital LLC. "It's going to have ripples throughout the investing public."

GM Chief Financial Officer Ray Young - who told reporters that the auto maker had no plans to meet the June 1 interest payment - may have done investors a favor by reminding everyone of the harsh reality ahead. "People should be getting the sleep out of their eyes and seeing it's over," said Marilyn Cohen, president of retail bond investment manager Envision Capital. "I would imagine they're going to file any minute...Not making a payment - it's going to show them that this time, they mean it." Next week will be the one to watch to see how the projected GM default will play out. GM's Young said the company will launch a debt-for-equity exchange in coming days - it has to do so by May 1 to avoid a filing. Investors will also be watching how Chrysler's restructuring deadline will be handled by the government, which is widely seen as a dry run for GM. "This is all to get GM, which is the real big fish, lined up and primed, hopefully to make a bankruptcy filing as clean and expedient as possible," said Kip Penniman, GM debt analyst at KDP Advisor.

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GM Plans to Idle 15 North American Plants in May-July Period as Sales Drop

General Motors Corp., contending with a 49 percent decline in U.S. sales this year, will idle 15 North American assembly plants for at least a week from mid-May through July, a person familiar with the plans said. The shutdown, similar to its shuttering of factories in December, January and February, is meant to control excess inventory of unsold models on dealer lots and doesn’t reflect permanent closings, said the person, who didn’t want to be identified because the plans weren’t yet public. GM intended to announce the moves at the end of the week, the person said. "We don’t have anything to announce at this point," Tom Wilkinson, a GM spokesman, said today "Any announcements we have to make we will make to our employees first."

The shutdown heightens the pressure on Detroit-based GM as it tries to avoid a June 1 government-ordered bankruptcy and keep $13.4 billion in U.S. loans. GM has enough inventory on dealer lots for five months of sales of pickup trucks and three months for sport-utility vehicles such as the GMC Acadia, JPMorgan Chase & Co. estimated in a report today. GM’s first-quarter U.S. sales decline was steeper than the industry’s 38 percent drop, which extended a 17-month slump. In February, the industry’s annual sales rate was the lowest since 1981. GM, Ford Motor Co. and Chrysler LLC shuttered about 59 factories starting in December, with some remaining closed into February, to trim the number of unsold models at dealerships after sales slowed in 2008’s last quarter.

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U.S. Weighs Revealing Each Bank's Capital Needs After Stress-Test Resultss

The Obama administration may direct banks that are judged to be short of capital after stress tests to disclose how they are going to get additional funds when the government reveals the results on May 4, according to a person familiar with the matter. The government would release a bank-by-bank assessment, while the lenders would say how they plan to shore up their finances, said the person, who spoke on condition of anonymity because a decision hasn’t been made. By pushing for details to become public, the administration is seeking to bolster confidence in the reviews, as well as the health of the 19 companies under review. The move would also address the concerns of some investors that banks needing extra money will be punished without a detailed strategy already in place to get the capital.

"Transparency is critical," said Bill Brown, a visiting professor at Duke Law School and a former managing director at Morgan Stanley. "While banks have pushed to keep the kimono closed, the stress tests have forced it open." Treasury Secretary Timothy Geithner yesterday outlined several choices for lenders to add to their capital, including converting previous government investments from preferred to common stock, getting money from private sources or tapping the $700 billion financial rescue program. Financial regulators remain concerned about investors’ reaction to a bank that wants to seek private money but doesn’t have a firm commitment, one official said. The Treasury’s capital assistance program gives companies six months to obtain the funding.

In one scenario under discussion, firms that fall between those strong enough to forgo new capital and those that need injections, the Treasury would provide the money immediately and the banks will announce that the investment is provisional. "Where there is a need for additional capital," Geithner told a congressional oversight panel in Washington yesterday, "then those banks will have a series of options for how they meet that need, and they’ll work out with their primary supervisors what’s the best mix of those options." The Treasury and banking regulators are still working out the final details of how to reveal the test results and plans could change, said the person. Generally, the regulators favor less disclosure because bank exam data is confidential, while the Treasury advocates releasing more details.
Banks will begin to get preliminary results from the reviews on April 24, the same day the Federal Reserve is scheduled to release the methodology for the exams.

The Fed is leading the assessments, which are designed to ensure that firms have enough capital to weather a deeper economic downturn over the coming two years. Regulators conducting the stress tests are increasingly focusing on the quality of loans banks made after finding wide variations in underwriting standards, a regulatory official said on April 20. They concluded that banks’ lending practices need to be given as much weight as macroeconomic scenarios in determining the health of each bank, the person said. In his prepared statement for yesterday’s oversight hearing, Geithner said "the vast majority of banks have more capital than they need to be considered well capitalized by their regulators."

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Banks: How Stressed Are They?

Wells Fargo and Morgan Stanley on Wednesday confirmed the trend seen in the last week: Profits mask growing concerns about whether banks have adequate reserves and capital to weather the downturn. Strong first-quarter profits at all but Morgan Stanley (which had a wider than expected loss) were driven by trading and other one-time gains. They come as the government prepares to deliver its stress test results to 19 of the largest U.S. banks. Analysts say the government may be basing the tests on assumptions that are too optimistic. The Treasury Department's end game is to ferret out banks that need more capital. That would separate the weak from the strong and put the latter group of banks in the position to repay money they got under the Troubled Asset Relief Program. The consensus has been that banks for the most part won't need more capital, with a few exceptions.

But Paul Miller, an analyst at Friedman Billings Ramsey, says the government might make an example of more than a few. "In order for the test to have any credibility, we expect that a material number of the 19 tested institutions will have to raise additional capital," he said Wednesday. "But the Treasury's goal is not to 'fail' any of the tested institutions." Instead, the government's hurdle is tangible common equity of at least 3% of risk weighted assets, Miller says. Tangible common equity simply divides common share value by tangible assets and is a measure of financial strength. One way to boost the ratio is to convert outstanding preferred shares to common shares, significantly diluting shareholders. Citigroup is doing just this, and in doing so the government will wind up with a 36% stake.

Using the government's stress test assumption that unemployment will peak at 10%, most of the big banks would meet the 3% standard, Miller says. On Wednesday, Wells Fargo said its tangible common equity to risk weighted assets was 3.83%. Morgan Stanley said its ratio was 9.3%. But Friedman Billings and other analysts think unemployment could peak above 10%, possibly reaching 12%, and the peak would not come until the middle to end of 2010. At 12% unemployment, Miller says, many large banks would fall below that 3% tangible common equity ratio hurdle, including Bank of America, Wells Fargo, BB&T, PNC Financial, SunTrust Banks, Regions Financial, Capital One and U.S. Bancorp. Concerns about banks seemed to vanish last week when Goldman Sachs and JPMorgan Chase surprised investors with better than expected profits. Likewise, on Wednesday, Wells Fargo beat expectations by bringing in a record $3 billion, or 56 cents a share.

It got a boost from adding Wachovia to its balance sheet. Out of total revenues of $21 billion, $12 billion came from the old Wells, the bank said Wednesday. That contrasted sharply with Morgan Stanley's worse than expected $578 million loss in the quarter. Despite strong fixed-income trading, the bank was weighed down by a $1.5 billion accounting-related loss. Morgan Stanley lost ground across its businesses. Net revenues from investment banking and trading fell 66% from the first quarter of 2008, global wealth management fell 44% and asset management fell 87%. It lost $319 million on principal investments in real estate and private equity. There are signs of more trouble ahead. "Credit is bad, and we believe credit is going to get worse before it will eventually stabilize and improve," Bank of America Chief Executive Kenneth Lewis said on Monday.

At Wells, non-performing assets rose to $12.6 billion from $9 billion at the end of the fourth quarter. Its allowance for loan losses in the coming year was $22.8 billion, or 2.7% of loans--flat with where the bank was in the fourth quarter. Banks are hoping to take advantage of widening spreads between short- and long-term interest rates to earn their way past the credit quality problems. Wells Fargo said much of its gains came from a surge in mortgage revenue. It originated $100 billion of mortgages, the biggest quarter in six years. And it has another $100 billion of unclosed applications awaiting finalization. Morgan Stanley paradoxically got dinged by wider credit spreads. Banks typically benefit from a bigger difference between short- and long-term interest rates, not only because it leads to lending profits, but also because it leads to write-ups on their own debt. At Citigroup, for example, the gain was $2.7 billion in the quarter. For Morgan Stanley, however, the widening spreads forced it to book a $1.5 billion accounting loss on its debt.

To preserve capital, Morgan Stanley cut its dividend to 5 cents from 27 cents. The company says it did not take as much risk as its competitors in trading during the quarter, which helped to mute its trading revenues to $1.4 billion. Goldman, in contrast, had a record $6 billion from fixed-income trading alone. John Mack, Morgan Stanley's chief executive, seems eager to prove to someone that he's being responsible, seeing as his company is a TARP recipient. "In this volatile environment, we have focused on prudent stewardship of our balance sheet, capital and risk profiles," he said.

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Banks Get Stress Tests, Investors Get Stressed

The idea wasn’t to create angst among investors. Rather, the stress tests were designed to assess the capital adequacy of the 19 biggest banks under a variety of economic scenarios during the next two years. Somehow, in the two months since the tests were announced by Treasury Secretary Timothy Geithner, the exercise has morphed from an internal process to ensure banks can withstand additional loan defaults to a financial market fixation with a moveable end date and changing terms. With a white paper on the stress-test methodology due for release Friday, followed by the results of the examinations on May 4, the bar has been set very high for the Federal Reserve, which is coordinating the exams. Unless investors lower their expectations, there’s bound to be disappointment over a lack of detail on the May 4 report card.

Ignore for the moment the fact that it’s against the law for any regulator to release information from a supervisory examination. (The law provides for a process whereby the heads of the various regulatory agencies can breach that confidentiality and release specific information.) If the government opts to keep the nuts and bolts secret -- "They all passed" -- or releases select, generic and no doubt upbeat information, it risks a loss of confidence among investors. President Barack Obama and his Treasury secretary remember the thumbs-down response when Geithner unveiled the new Financial Stability Plan on Feb. 10. The veil went up, stocks went down -- 4.6 percent for the Dow Jones Industrial Average. Earlier this week, the Treasury had to deny a blog posting claiming most of the banks were insolvent in an attempt to quell a sell-off in bank stocks.

While the Fed has been working to increase transparency, greater openness applies to the central bank’s objectives, forecasts and implementation of policy, not to its proprietary information on the bank-holding companies it regulates. That’s worth bearing in mind in advance of the May 4 report card. The public at large already thinks the government is in bed with the banks, which it is to the tune of $200 billion via its capital purchase program. Americans will probably assume the bad news is being swept under the rug or the numbers are being fudged until the government can come up with another plan to keep the banks afloat. Yesterday, Bloomberg News reported that regulators are broadening the scope of their stress tests to include the quality of the bank loans in addition to their expected performance under different macroeconomic scenarios, such as a 10 percent unemployment rate or continued decline in GDP growth.

"It took 10 years to come up with Basel II, and the models failed," says Josh Rosner, managing director at Graham Fisher & Co., an investment research firm in New York, referring to international standards on capital adequacy. "Is it credible that the Treasury and New York Fed could come up with an alternative stress test in two weeks?" Like many of the decisions throughout the crisis, the tests "were supposed to be confidence inspiring," Rosner says. Instead, the inherent conflict between the government’s desire to appear credible and its aversion to releasing bank exam data demonstrates an inability "to think about unintended consequences." Because it was predetermined that none of the banks would be allowed to fail, the only question is what will be required to award them a passing grade. It’s like the third-grade teacher who, under pressure from parents, provides special tutoring to the slow students or shows leniency in grading to avoid awarding anyone an "F."

Testifying to a congressional oversight panel yesterday, Geithner said the "vast majority" of U.S. banks have more than enough capital. Those among the Big 19 that don’t will have six months to raise private capital or accept funding from the Troubled Asset Relief Program. TARP currently has about $110 billion of the $700 billion appropriated by Congress last year. Treasury expects $25 billion in repayments this year, bringing available funds to $135 billion. The stress tests are being conducted by an array of bank regulators, including the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the Federal Deposit Insurance Corp. in addition to the Fed. In other words, the regulators are doing what they were supposedly doing all along. Why regulators decided at this late date that underwriting standards were an important metric for capital adequacy determination is hard to understand -- and therefore subject to alternative interpretations.

"The second stage of the tests, of the bank-specific follow-up, is allowing banks to justify exposure to examiners once again," Rosner says. He suspects the initial results weren’t great, that the broadened scope of the tests will "allow banks to give their input, to appeal" their case. So, if the 19 banks are too big to fail, and the Fed hasn’t made a determination yet on what it will disclose to the public, what should investors look for? The grade-A banks will find a way to let the public in on their performance. The grade-C banks will be less eager to do so. Their rating could be inferred. A tip-off might be a CEO who suddenly retires to spend more time with his family.

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Wells Fargo Made Billions On Mark-To-Market Change

Wells Fargo helped spur the latest bank rally when it pre-announced a big, profitable quarter. This morning it reported the official numbers, even exceeding revised analyst expectations. But it wasn't the cleanest number imaginable. In fact, while most banks said they saw little effect from FASB's mark-to-market rule change, Wells took advantage of it in a big way. This note was in the release:

The net unrealized loss on securities available for sale declined to $4.7 billion at March 31, 2009, from $9.9 billion at December 31, 2008. Approximately $850 million of the improvement was due to declining interest rates and narrower credit spreads. The remainder was due to the early adoption of FAS FSP 157-4, which clarified the use of trading prices in determining fair value for distressed securities in illiquid markets, thus moderating the need to use excessively distressed prices in valuing these securities in illiquid markets as we had done in prior periods.

So that's about a $4.4 billion benefit form the rule change. Given that the bank only made a net profit of $3.05 billion, that more than explains the whole thing.

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We are not even half-way through the banking crisis - IMF

A month ago the International Monetary Fund was charged by the G20 finance ministers with finding out precisely how the balance sheets of the world's major banks would look if they were to get back to lending again at more or less the rate they were in the pre-crisis days. Today the Fund delivered its verdict and it is both clear and terrifying. The simple truth is laid out in page 33 of the Global Financial Stability Report, published today in Washington: "if banks were to bring forward to today loss provisions for the next two years, before expected earnings, US and European banks in aggregate would have tangible equity close to zero."

In other words, the entire global banking system would be bankrupt - kaput - if its institutions immediately wrote off all the toxic assets still sitting in their vaults without any government assistance. And bear in mind this already takes into account the money we have already thrown at the banks. So even after all this has been spent the financial system remains, effectively, insolvent, bearing in mind the amount of cash the banks have lost as a result of the bubble of the 2000s. But, you might well respond, what about all the cash that has been thrown at the banks - almost $800bn across the world, including $110bn in the UK (just over £70bn)? Well, the problem is that according to the IMF this hasn't been enough to get the banks back to health again.

In fact, it calculates that a further $125bn will need to be poured into Britain's banks if they are to start lending again at anything like a normal rate. If they are to bring their balance sheets back to a state as healthy as in the mid 1990s, it will take a further $125bn on top of this again. In other words, if you thought the immense amounts of taxpayer cash funnelled into the system over the past couple of years was enough to bring us back to good health, think again. It is an extremely worrying verdict, particularly coming at a time when many had been assuming that green shoots were starting to sprout and the recession was coming to an end. But it underlines one simple but undeniable truth: that this recession is different. It is the consequence not of a simple one-nation housing crash or a consumer slowdown but a catastrophic collapse of the financial system.

And with that system still in a wreck normal service will simply not be resumed without more costly bail-outs - or else we must accept the consequence that money will be far more expensive to borrow in the future, and that economic growth will be far less in the future. To anyone with a keen sense of history this should hardly come as a surprise. The 1930s were marked by periods of optimism before reality set in again. The IMF's verdict may also take a while to sink in, but here it is, laid out in table 1.4 of the report: we aren't even halfway through the bank bail-out. Gulp...

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How the IMF withdrew its shock-horror number on UK toxic debt

The IMF Global Financial Stability Report, issued yesterday, was always going to have a top-line horror story on toxic debt. Instead of a $2 trillion write off the world is facing a $4 trillion write off. Fingers hovering above the keyboard and fighting off jet lag I was preparing to wade through this to see if they could put a figure on the UK's toxic debt bill. The Treasury was "not steering us away" from the FT's proposed price tag of £60bn - although indicating that this was "cautious" ie high and even musing privately that Britain would not lose any money at all on its bank bailout insurance scheme.

The Conservatives, acting fast, found the number and did the sums. 13.4% of Britain's GDP would be needed to cover the fiscal cost of the bailouts. That's £200bn said the Tories and hit the airwaves. There was a slight problem: these were not like for like figures. The IMF's figure included not just losses on insuring toxic debt, but also actions like Northern Rock and even proposed losses on Bank of England operations to shore up the credit markets. However, that did not invalidate the Tories' point. The £200bn figure is a massive hit to the UK taxpayer, much bigger than the coy briefings received by the FT and pretty annoying if you are a taxpayer. That was the story at 5pm as we finished filming our Newsnight pre-budget piece.

At 9pm I finally got the Treasury to respond to the Conservatives' press release and the IMF report. The figure is wrong, they told me. They had raised this with the IMF and the IMF would be withdrawing the figure. It should be in a range between 6-13% of GDP said the Treasury. The word "bonkers" came up in the conversation, I seem to remember. I phoned the IMF. They tried to put me through to an economist dealing with the case but nobody ever returned my voicemail request for clarification. I started hitting the refresh button on the PDF file of the report and, lo, at around 9.45 pm, discovered that it was still there but with the relevant table missing and covered by the words "Under Embargo". Now embargo is a term for holding back information you have not yet released, not withdrawing information you have already released. This latter is called a U-turn not an embargo, or as they say in Private Eye, a reverse-ferret.

The IMF's new version of the report (see p44 in this PDF file), the erroneous original has disappeared into that memory tube Winston Smith uses in Nineteen Eighty Four) states that the cost will be 9.1% of GDP will be needed to cover bailouts, which is apparently £130bn. But weirdly the new list of countries mentioned is shorter than the old one. And Britain's figure is not "in a range" between 6-13% but almost exactly halfway along that range. So maybe there is an interesting explanation of why the original list got made, why it was so much worse for the UK, why Ireland was on it and is now not on it, and why it got pulled. Unfortunately I do not have time to find out because it is Budget Day. There you go.

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Ilargi: Both the Brits and the Yanks have issues with the IMF predictions. But since they -largely- own the "Fund", don't be surprised if there's an ugly game being played here.

The Pessimistic IMF

The International Monetary Fund's global economic outlook went from bad to worse after its economists concluded a recovery for world financial markets is farther off now than the agency thought in January. But take heart -- the IMF is notoriously pessimistic and critics say that the doom and gloom is a bit overdone. The IMF pulled its global gross domestic product forecast down to negative 1.3%, from its previous forecast of 0.5% it offered in January. The financial industry's health is key to the global recovery as it provides the credit necessary for consumers and businesses to increase their current rates of investing and spending.

"By any measure, this downturn represents by far the deepest global recession since the Great Depression," the IMF said in its latest World Economic Outlook. "All corners of the globe are being affected." Max Clark, chief economist at IDEAglobal, noted though the IMF is historically downbeat. He also took exception to the IMF's projection for the U.S. GDP, which he expects to shrink between 1.2% and 1.5% in 2009 while the IMF says it will lose 2.8%. the IMF expects Japan to drop 6.2%. Russia to lose 6.0% percent, a 5.6% loss in Germany and a 4.1% in Britain.

Clark doesn't forecast other countries but believes that if the IMF has the US wrong, it's got the world wrong too. "The U.S. alone counts for 25.0% of global growth," Clark said. Clark's projection that the unemployment rate in the U.S. will reach between 10.0% to 10.5% was consistent with the IMF's own forecast that the U.S. average is will push to 10.1% in 2010. As in 2009, Clark's expectation of a modest rebound from U.S. economy in 2010 differs from that of the IMF, which forecast the U.S. to be flat. Globally the IMF predicts the world economy will grow, but by only 1.9%. It noted that economic recoveries after financial crises are typically significantly slower than ordinary recoveries.

Wednesday's report comes a day after the IMF released its Global Financial Stability Report, where it restated its estimates for writedowns in the U.S. to move to $2.7 trillion, from $2.2 trillion, with global writedowns to potentially exceed $4.0 trillion. Two-thirds of the estimated losses would be taken by banks. "To call the information contained in it dire, as it relates to the current global financial crisis, would be a dramatic understatement," said Dan Cook, chief market analyst at IG Markets, a European-based Forex and foreign exchange derivatives trading outfit that's been trading currencies since 1974. The reports come ahead of Friday's meetings between the United States and other major economic powers, and weekend sessions of the IMF and World Bank.

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Burying Britain's Future

"Building Britain's Future" is the optimistic title of the U.K. government's latest budget. "Burying Britain's Future" would have been more accurate. Faced with public finances spiraling out of control, Chancellor Alistair Darling needed to use this budget to reassure the financial markets that Britain had a credible plan to reduce the national debt. Instead, this was a nakedly political budget entirely designed to gull voters ahead of an election due within the next year. The result is a shambles that will impress no one.

Even on the government's own forecasts, the budget deficit will hit 12.6% of GDP this year and government borrowing will peak at 79% of GDP in 2013, excluding all the vast contingent liabilities such as unfunded public pensions likely to be equivalent to at least another 60% of GDP. This year alone, the Treasury plans to issue 220 billion pounds ($318 billion) of gilts -- about 25% more than the market was anticipating. At no point in the next decade does the Treasury envisage repaying debt -- even when the U.K. does finally balance current spending in 2017/18, it will continue to borrow 1.25% of GDP to fund "investment". Yet even these numbers -- alarming as they are -- should be taken with a pinch of salt. There are at least three major risks.

First, the UK Treasury's borrowing forecasts are based upon an assumption that the cost of the financial bail-out will be limited to just 3.5% of GDP or around 60 billion pounds. This looks wildly optimistic. The International Monetary Fund estimates the cost is likely to be around 9.1% of GDP.

Second, the Treasury's budget projections rest upon a Pollyannaish forecast that the U.K. economy will grow 1.25% in 2010 and an eye-watering 3.5% in 2011. This looks about as credible as the Treasury's previous forecast only last November that the economy would grow by 0.5% in 2009 -- a forecast now revised down to a 3.5% contraction. The Treasury is assuming nominal GDP will grow in line with the amount of new money being pumped into the economy by the Bank of England as a result of quantitative easing -- a dubious assumption given the current deleveraging across the economy.

Third, there must be considerable doubt whether the Treasury's tax hikes on the better paid will ever deliver as much revenue as forecast. Introducing a new 50% tax rate and cutting pension benefits for those earning more than 150,000 pounds a year and abolishing personal allowances for those earning more than 100,000 pounds is just as likely to drive high earners offshore since it will leave the U.K. with some of the highest personal taxes among industrial countries. Any advantages the U.K. might once have had as a low-tax base for international business have now been jettisoned.

Faced with a similar collapse in its public finances and a potential loss of international investor confidence, the Irish government bit the bullet, introducing sharp tax rises, steep cuts to public spending and savage cuts to public sector pay. Yet the British government has chosen to blatantly disregard a clear warning from the Governor of the Bank of England that the UK could not afford any further fiscal stimulus with a further discretionary spending boost equivalent to 0.5% of GDP. The British public is unlikely to be fooled by Mr. Darling's conjuring tricks and will no doubt retrench ahead of the real pain they know must come after the next election. Meanwhile, the financial markets, which will be asked to swallow 365 billion pounds of gilts in just two years alone, more than in the entire previous decade, will rightly ask whether the U.K. has the political will to face up to its financial problems. Mr. Darling is gambling the government still has enough credibility to see it past the election. But the stakes could not be higher.

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FDIC Woefully Underfunded; Problem Institutions Soar

The latest Quarterly Banking Profile shows something most of us inherently knew: The FDIC is ill prepared for more bank failures.

Deposit Insurance Fund (DIF) Ratio Collapses

Inquiring minds are investigating the Deposit Insurance Fund (DIF) Ratio.

■ The DIF Balance Declines by $16 Billion, and Insured Deposits Grow by 4.6 Percent in the Fourth Quarter
■ DIF Reserve Ratio Declines to 0.40 Percent
■ Twenty-Five Insured Institutions Fail During the Year; Another Five Insured Institutions under the Same Holding Company Receive Assistance

The reduction in the DIF during the quarter was primarily due to $17.6 billion in loss provisions for actual and anticipated insured institution failures. For all of 2008, the DIF balance fell by $33.5 billion (64 percent), primarily because of $40.2 billion in loss provisions.

The DIF’s reserve ratio equaled 0.40 percent on December 31, 2008, which was 36 basis points lower than the previous quarter. During 2008, the reserve ratio decreased by 82 basis points, from 1.22 percent at year-end 2007. The December figure is the lowest reserve ratio for a combined bank and thrift insurance fund since June 30, 1993, when the reserve ratio was 0.28 percent.


Problem Institutions and Failed/Assisted Institutions


click to enlarge

* For 2008, preliminary unaudited fund data, which are subject to change.

** The Emergency Economic Stabilization Act of 2008 directs the FDIC not to consider the temporary coverage increase to $250,000 in setting assessments. Therefore, we do not include the additional insured deposits in calculating the fund reserve ratio, which guides our assessment planning. If Congress were to decide to leave the $250,000 coverage level in place indefinitely, however, it would be necessary to account for the increase in insured deposits to determine the appropriate level of the fund.

*** Prior to 2006, amounts represent sum of separate BIF and SAIF amounts.

**** Five institutions under the same holding company received assistance under a systemic risk determination.

Note the effects of the The Emergency Economic Stabilization Act. The FDIC "temporarily" ups the limit and ignores the effect on DIF. This is ass backwards as the risk of bank failure is high and growing. Ignoring the increased limits is a blatant attempt to hide the fact that DIF is even more underfunded than it looks, and it looks woefully underfunded.

Reserves have plunged, no doubt on their way to negative territory as the number of problem institutions soars. Expect to see requests for more taxpayer bailouts as the FDIC well runs dry.

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California Mortgage Defaults Jump to Record High

Lenders filed a record number of mortgage default notices against California homeowners during the first three months of this year, the result of the recession and of lenders playing catch-up after a temporary lull in foreclosure activity, a real estate information service reported. A total of 135,431 default notices were sent out during the January- to-March period. That was up 80.0 percent from 75,230 for the prior quarter and up 19.0 percent from 113,809 in first quarter 2008, according to MDA DataQuick. Last quarter's total was an all-time high for any quarter in DataQuick's statistics, which for defaults go back to 1992. There were 121,673 default notices filed in second quarter 2008 and 94,240 in third quarter 2008, during which a new state law took effect requiring lenders to take added steps aimed at keeping troubled borrowers in their homes.

"The nastiest batch of California home loans appears to have been made in mid to late 2006 and the foreclosure process is working its way through those. Back then different risk factors were getting piled on top of each other. Adjustable-rate mortgages can be good loans. So can low- down-payment loans, interest-only loans, stated-income loans, etcetera. But if you combine these elements into one loan, it's toxic," said John Walsh, DataQuick president. The median origination month for last quarter's defaulted loans was July 2006. That's only four months later than the median origination month for defaulted loans a year ago, in first quarter 2008. That suggests a period where underwriting criteria were particularly lax. Of the 3.7 million home loans made in 2004, less than 1 percent have since resulted in a lender filing a default notice.

Of the 3.7 million loans originated in 2005, 4.9 percent have triggered a default notice so far. Of the 3 million in 2006, 8.5 percent have so far resulted in default. A particularly toxic period appears to have been August through November 2006 which had more than a 9 percent default rate. Of the 2.1 million loans made in 2007, it's 4.6 percent - a percentage that's likely to rise significantly during the rest of this year. The lending institutions with the highest default rates for loans originated in August to November 2006 include ResMAE Mortgage (69.9 percent of loans resulting in a default notice), Master Financial (64.6 percent) and Ownit Mortgage Solutions (63.6 percent). Of the major lenders, IndyMac has a default rate on those loans of 18.9 percent, World Savings 8.0 percent, Countrywide 7.7 percent, Washington Mutual 6.3 percent and Wells Fargo 3.4 percent. Less than 1 percent of the home loans originated in late 2006 by Citibank and Bank of America have since gone into default.

Many, if not most, of the loans made in 2006 are owned and/or serviced by lending institutions other than those that made the loans (mortgages are often sold off after the initial lender originates the loan, and are often serviced by a different entity). Many of the originating lending institutions no longer exist. While most first quarter 2009 foreclosure activity was still concentrated in affordable inland communities, there are signs that the problem is slowly migrating into other areas. The affordable sub-markets, which represent 25 percent of the state's housing stock, accounted for more than 52.0 percent of all default activity in 2008. Last quarter it fell to 47.5 percent.

On primary mortgages, California homeowners were a median five months behind on their payments when the lender filed the notice of default. The borrowers owed a median $12,926 on a median $346,400 mortgage.
On home equity loans and lines of credit, borrowers owed a median $4,229 on a median $63,600 credit line. However the amount of the credit line that was actually in use cannot be determined from public records.
MDA DataQuick is a division of MDA Lending Solutions, a subsidiary of Vancouver-based MacDonald Dettwiler and Associates. MDA DataQuick monitors real estate activity nationwide and provides information to consumers, educational institutions, public agencies, lending institutions, title companies and industry analysts. Notices of Default are recorded at county recorders offices and mark the first step of the formal foreclosure process. Although 135,431 default notices were filed last quarter, they involved 130,718 homes because some borrowers were in default on multiple loans (e.g. a primary mortgage and a line of credit). Multiple default recordings on the same home are trending down, DataQuick reported.

Mortgages were least likely to go into default in Marin, San Francisco, and San Mateo counties - the historical norm. The probability was highest in Riverside, Merced and San Joaquin counties. Trustees Deeds recorded, or the actual loss of a home to foreclosure, totaled 43,620 during the first quarter. That's down 5.5 percent from 46,183 for the prior quarter, and down 7.6 percent from 47,221 for first-quarter 2008. They reached 79,511 during last year's third quarter before dropping because of lenders' temporary policy changes (e.g. a temporary foreclosure moratorium). In the last real estate cycle, Trustees Deeds peaked at 15,418 in third-quarter 1996. The state's all-time low was 637 in the second quarter of 2005, MDA DataQuick reported. There are 8.5 million houses and condos in the state. Foreclosure resales have emerged as a significant market factor, accounting for 58.1 percent of all California resale activity last quarter. A year ago it was 33.1 percent. Foreclosure resales varied significantly by area, from 13.0 percent in San Francisco County to 80.8 percent in Merced County.

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IMF: Ukraine economy to lose 8 percent in 2009

Ukraine's economy will contract by 8 percent this year, the International Monetary Fund said Wednesday, in the latest in a string of gloomy outlooks for the country hit hard by the global financial crisis. The IMF revised its earlier forecast of a 6-percent contraction, as the global economy continues to deteriorate, but predicted 1 percent growth next year. The IMF expects inflation to hit 16.8 percent this year and slow to 10 percent next year. The World Bank said earlier this month it believes the Ukrainian economy will shrink by 9 percent this year, after nearly a decade of average annual 7-percent growth, and forecast inflation at 16.4 percent.

Ukraine's economic crisis is one of the worst in Europe. Industrial output slumped by 32 percent in January and February compared with a year ago, and output in the construction industry dropped by 57 percent during that period, according to the World Bank. The national currency, the hryvna, has lost about 40 percent of its value to the dollar since the crisis hit last fall. Furthermore, constant political turmoil has worsened the effect of the global crisis on Ukraine by stalling the implementation of key anti-crisis policies. The IMF gave initial approval last week to granting Ukraine a $2.8 billion second installment of a $16.4 billion loan to recapitalize top banks, prop up the national currency and fund the state budget. The decision came after the country finally adopted a package of stabilization reforms it had failed to launch for months. A final decision on transferring the money should be made by mid-May.

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New Guinea Tribe Sues The 'New Yorker' For $10 Million

In an April 21, 2008, New Yorker story, "Vengeance Is Ours," Pulitzer Prize-winning geography scholar Jared Diamond describes blood feuds that rage for decades among tribes in the Highlands of New Guinea. Diamond tells the story using a central protagonist: Daniel Wemp, member of the Handa clan, a blood-thirsty warrior bent on avenging his uncle's death. That quest, writes Diamond, touched off six years of warfare leading to the slaughter of 47 people and the theft of 300 pigs. Now Diamond's protagonist is fighting Diamond. A two-page complaint filed in New York State Supreme Court on April 20 seeks $10 million from the New Yorker's publisher, Advance Publications, claiming Diamond's story falsely accused Wemp and fellow tribesman Isum Mandigo of "serious criminal activity" and "murder."

Diamond is a best-selling author and winner of a National Science Medal and the MacArthur Foundation's "genius award." But Wemp has some academic backing of his own. Rhonda Roland Shearer, director of the New York City-based Art Science Research Lab, whose media ethics project, stinkyjournalism.org, will soon release a 40,000-word study on Diamond's story. Shearer dispatched researchers to New Guinea and interviewed 40 anthropologists to fact-check Diamond's story with a fine-tooth comb. The result, as summed up by the report's working title: "Jared Diamond's Factual Collapse: The New Yorker's Papua New Guinea Revenge Tale Untrue."

New Yorker spokeswoman Alexa Cassanos said she could not comment on Wemp's suit or Shearer's study because she has seen neither, saying only, "We stand by the story." Diamond did not immediately return calls to Forbes. Complicating Wemp's case, perhaps, is an interview he gave to Shearer's researchers, in which he stated that the stories he told Diamond were in fact true. But a Wemp friend and legal adviser, Mako John Kuwimb, explains: "When foreigners come to our culture, we tell stories as entertainment. Daniel's stories were not serious narrative, and Daniel had no idea he was being interviewed for publication. He has never killed anyone or raped a woman. He certainly has never stolen a pig."

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