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“Banking System Still Quietly Insolvent” ; Larry Summers’ Imagination Reaches Escape Velocity

Inquiring minds are reading an excellent post by John Hussman about Stock Market Valuations, Extend and Pretend Banking, Public Policy on Housing Bailouts, and Solvency of the Banking System. Here are a few snips from Extend and Pretend.

Over the past 12 years or so, I’ve been repeatedly astonished at the tendency of investors to do things that they should have known to avoid simply with the use of a calculator and basic arithmetic. We’ve used numerous metrics during this period to show that the estimation of long-term market returns (7-10 years and beyond) doesn’t require calculus or statistics, but fairly direct methods to normalize earnings, plus a bit of arithmetic. Rich valuations are predictably followed by sub-par returns. As a result, investors have earned an average annual total return of just 2.4% in the S&P 500 over the past 12 years, while enduring two separate instances where they have lost about half of their money as part of the ride. Essentially, we have gone nowhere in an interesting way. At present, investors have priced the market at a level that makes a continuation of this experience likely for several years to come.

As of last week, the S&P 500 remained strenuously overvalued on the basis of normalized fundamentals. From that perspective, even if the trough we observed in March 2009 was the ultimate price low of the secular bear market since 2000, it’s not likely to represent the ultimate valuation trough. Given the current state of valuations, and the likelihood of several years of additional credit deleveraging, it seems that economic conditions, valuations, and the typical duration of secular bear markets converge on the likelihood of several more years of interesting but unrewarding market volatility. Secular bull market periods tend to begin with quite low multiples to normalized earnings (historically, on the order of 7), which is what provides the platform for a very long period of subsequent gains.

Extend and Pretend

With regard to credit conditions, the U.S. financial system continues to pursue a strategy of “extend and pretend.” … The impact of “extend and pretend” is to create a gap between the reported value of assets and the value they would have on the basis of the cash flows that those assets can reasonably be expected to generate over their maturity.

Moreover, regulatory changes over the past year have affected what actually gets reported as “troubled.” As the New York Times recently observed, ” A bank owed, say, $4 million on a property now worth $3 million would previously have had to classify the entire loan as troubled. Now it can do that to the $1 million difference only.”

As for policy efforts to reduce delinquencies, I’ve long argued that it is a bad idea for policy makers to announce delinquency prevention plans that have, as their centerpiece, publicly subsidized reductions in mortgage principal. It’s one thing to extend the loan in a way that preserves its present value, by swapping a claim on future appreciation in return for principal reduction, but it’s quite another to offer to cut the principal outright. The reason is that instead of confining the assistance to presently troubled borrowers, you create a whole new set of borrowers who then choose to be troubled in order to get the assistance. According to a University of Chicago study, “strategic defaults” – where people choose to default on their mortgages even though they can afford to pay – accounted for 35% of all residential defaults in December 2009, up from 23% in March 2009. Offering public subsidies for this behavior, when too many homeowners are already legitimately struggling, does not smack of a bright idea.

The real concern from my perspective remains the potential for a second wave of delinquencies beginning in data as of the first quarter of 2010 and extending well into 2011. …

In short, my impression is that investors are deluding themselves about the solvency of the banking system. People learned in the 1930′s that when you don’t require the reported value of assets to have a clear and tangible link to the value that the assets would have in liquidation, bad things happen. Yet this is what regulatory and accounting rules are allowing for the banking system at present. While I do believe that bank depositors are safe to the extent of FDIC guarantees, my impression is that the banking system is still quietly insolvent.

There is much more in the article including a series of charts on bank loans, real estate loans, and credit card loans.

Global Banking System Extend and Pretend Insolvency

I happen to agree with John Hussman on all points mentioned. Moreover, it is not just the U.S. banking system that is insolvent, the global banking system is nothing but a giant extend and pretend operation including the PIIGS (Portugal, Ireland, Italy, Greece, Spain), China, the UK, and even Canada as soon Canada’s gigantic housing bubble crashes.

Just as U.S. housing policy encourages more walk-aways, the EU’s subsidized loans to Greece (See Grecian Formula 16 Now On Sale) practically guarantees the EU will need to offer the same deal to Spain and Portugal at a minimum.

Note too, that European banks have their own extend and pretend game going in regards to loans based in Euros to the Baltic states. Those loans cannot possibly be paid back.

George Soros is talking about a pound devaluation for the U.K. Please see Former Fed Gov. Poole Blasts Fed’s Favoritism; Soros Bought More Gold, Says Pound Devaluation is Option for details.

Canada did not avoid a crisis because their banks were better or smarter or used less leverage. Canada avoided a crisis because for whatever reason, their housing bubble did not yet blow sky high. However it will, and Canada’s banking crisis is yet to come.

To understand why, please see California USA vs. Ontario Canada – Which State (Province) Is In Worse Shape? Canadian Banks vs. US Banks Comparison.

There are so many reports on bubbles in China that I hardly know where to begin. Here are a couple of them. GMO has a white paper on 10 Signs of Speculative Mania in China. In response to that paper, please consider an Email from a Chinese on China’s Real Estate Bubble.

Finally, in the US, please consider an interactive map of the $3+ trillion public pension plan deficit, state by state: Interactive Map of Public Pension Plans; How Badly Underfunded are the Plans in Your State?

In short, consumer and bank debt simply cannot be paid back in a global wage arbitrage economy, with massive consumer and corporate debt and no source of jobs.

Escape Velocity

Amazingly, Larry Summers says that problems with healthcare, education, and even long term fiscal deficits are being addressed. That is proof economists are starting to believe their own nonsense on extend and pretend.

“I think the economy appears to be moving towards escape velocity.” said Summers.

One thing that has reached escape velocity is Larry Summers’ imagination.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

From The Daily Capitalist.

Dear Santa:

Since you give away stuff for free, I hope you aren’t a socialist and ignore my wish list during the annual potlach. By the way, it seems that the Obama Administration is way ahead of you in giving out free stuff to everyone. I hope you can catch up.

I think I’ve been a pretty good boy this year. I have regularly bitten my tongue in my commentary so as not to be accused of being a flamer. I don’t think I’ve defamed anyone. And I try to write as much original material as possible to avoid being labeled a “scraper” (lifting stuff off the Net and publishing it under my own name). And, I haven’t sold out my opinions for mere money. For a blogger, that’s a pretty good record.

Here’s my wish list. I couldn’t find where to post it on Amazon, so here goes:

1. Kill The Bill

No, not the Uma Thurman thing. I’m talking about the health care “reform” bill going through Congress right now. If your magical powers extend that far, please put economic sense into our politicians’ collective heads that government control over the system is not a way to “save money” or create “efficiency.”

2. Put in the Fix

Instead of eliminating market forces in health care, please convince Congress to fix it by peeling back the convoluted rules and regulations that have screwed it up in the first place. Suggest these four little things we could try first that actually would work, save billions, and cover more people:

Give Medicare enrollees a voucher and the freedom to choose any health plan on the market;

Give workers control over their health care dollars with “large” health savings accounts which would allow them to purchase secure health coverage from any source;

Break up state monopolies on insurance and allow insurance companies to compete across state lines; and

Block-grant Medicaid and the State Children’s Health Insurance Program to prevent massive waste and encourage states to target resources to the truly needy.

3. Turn the Sausage Makers into Sausage

I understand it’s Christmas and it would be kind of negative to wish political ill fortune on someone, but, there’s this especially despicable sentator, Ben Nelson, that I would like for you to arrange to catch him with a hooker or taking a bribe. Whatever you think would work, Santa. Make sure there are tapes. I have lots more names, but I’d be happy with Ben.

4. Firing Suggestions

Please arrange for Obama to fire Ben Bernanke, Larry Summers, Timmy Geithner, and Christina Romer.

5. Hiring Suggestions

To replace the above, how about Ron Paul at the Fed, and the following economic advisers: Walter Block, Russ Roberts, and Joseph Salerno. They are all fine economic scholars and would steer our President in the right direction.

6. Freeze Congress

Don’t let Congress pass any more bills until they’ve all read, and discussed with the No. 5 guys, Economics in One Lesson by Henry Hazlitt, the best little book on economics, ever. Televise it.

7. Bring Back the Real Constitution

Please have Obama appoint strict constructionists to the Supreme Court. Nominees who understand natural law, and that the Ninth and Tenth Amendments actually mean something. Maybe we’d get our individual sovereignty back.

8. Make Work is No Work

Let Mrs. Pelosi and Mr. Reid see the folly of the American American Recovery and Reinvestment Act of 2009, a useless $787 billion bill that is nothing other than intergenerational theft. Someone has to pay for it and I’m afraid it will be my children, grandchildren, and ten generations of my great-grandchildren.

9. Beautiful Sunsets

Require Congress to sunset every spending law they pass. You know how they promise that a program will be very effective and that it will only cost so much? Make them prove it, say every two years. If the bill fails to cure the perceived ill, get rid of it. If the program exceeds its budget, get rid of it. It will also provide us with a handy voting guide at election time.

10. Let a Thousand Flowers Bloom

Sprinkle some free market magic dust on the economics departments of our major universities. Maybe that will help the sheep break from Keynesian orthodoxy and actually begin to think.

Thank you, Dear Santa. I’m forever hopeful.

Econophile

I was down in Washington on a business trip. That ended at four and I
headed for a bar. I found a spot between Pennsylvania and Kentucky
Avenues. Nice place. Two barkeeps, me and another guy who looked like
he had been drinking gin for the past few hours. Quiet, just the way I
like it.

Sure enough, at five the place fills up. It’s a young crowd. Good
looking. Well dressed. This looked like an Ivy League group. I was
thinking that they could be DOJ, possibly IRS (they looked too happy,
but who knows). They could have been Treasury folks; the headquarters
is not far off. Anyway, they had two drinks gossiped for and hour and
left. I stayed.

At one point I happened to look under the now empty stool next to me.
Some folded up papers. Being the nosey S.O.B. that I am, I picked them
up and took a look. Bingo!

I am just guessing, but these initials could stand for Geithner,
Volker, Summers, Goolsbee and Romer. Of course they could stand for
anything. I will leave it to you to draw any conclusions that might be
appropriate after a look at this. Judging from the notes that were
taken, this must have been an interesting meeting. I am using the
Scribd format so you can enlarge this. Enjoy!

Found Memo

If you haven’t as yet, take a look at the ‘labels for this post’. Life is a comedy. We’re all a part of it. Happy Holiday.
bk

The Consequences Of “The Big Lie”

In what is the start of the biggest uphill battle in D.C., arguably even bigger than deposing the printing press leprechaun, five democrats are proposing an amendment to reinstate Glass-Steagal, whose repeal, through the Larry Summers orchestrated Gramm-Leach-Bliley Act, in 1999 set the economy on the collision course that culminated with the implosion of every single Goldman Sachs FICC competitor in 2008. The five Democrats who have undertaken the sisyphean task of taking on both Wall Street and their direct boss, are Maurice Hinchey of New York, John
Conyers of Michigan, Peter DeFazio of Oregon, Jay Inslee of Washington,
and John Tierney of Massachusetts.

If adopted, the measure would give banks one year to choose between
being commercial banks or investment banks. The nation’s biggest –
those now commonly referred to as “too big to fail” — would be broken
up. The Obama administration opposes the measure.

Obama, presumably a Democrat, continues to persist in endorsing each and every Republican legacy when it comes to Wall Street’s landed interests (and risk “management” practices). Of course, the last thing the administration needs is for the populace to comprehend the chameleonic nature of the administration’s action.

More from HuffPo:

The act was repealed in 1999 at the urging of, among others, Larry
Summers, now President Barack Obama’s chief economic adviser.

The five congressman all voted against the repeal then — and now they want it back.

Former Federal Reserve Chairman Paul Volcker is one of a number of
financial luminaries calling for at least a partial return to
Glass-Steagall. The Wall Street Journal’s
editorial page also endorsed the concept in a recent editorial as a way
to “reduce moral hazard” and “limit certain kinds of risk-taking by
institutions that hold taxpayer-insured deposits.”

The law’s repeal ushered in an era marked by big banks getting even
bigger. The country’s four largest — Bank of America, JPMorgan Chase,
Citigroup and Wells Fargo – now control more than half of the nation’s
mortgages, two-thirds of credit cards and two-fifths of all bank
deposits.

And because their deposits are taxpayer-insured, there’s a growing
concern that they will feel overly confident about making risky bets
through their investment arms because they know that should they suffer
huge losses, taxpayers will ultimately be there to bail them out.

The five Democrats face big obstacles, including their own leadership and the Obama administration.

At this point the whole systemic regulation debate is getting glaringly amusing. At the core of every conflict are proposed reforms that are so obvious from a risk mitigation debate: audited Fed, split up banks which are now bigger than ever before, propping a bankrupt FDIC, which in turn is backing up bankrupt institutions, and a bankrupt country which is trying to fool the world into a game of M.A.D. knowing full well if the US taxpayer goes down directly or indirectly, the world, and the proverbial flood, follow after. And the only sensible reforms are those getting the biggest push back from Obama, and of course, Wall Street. How these two seemingly traditional opponents have ended up on the same side of the page is testament enough to the cataclysmic legacy of Bernanke and Summers. Of course, nothing will be done about anything, in tried and true American fashion, until it is too late, and Main Street is left sorting through the rubble of Goldman’s new glass-plated headquarters, even as all inhabitants have long-ago departed the country and left the U.S. with a few quadrillion in I.O.U.’s. At this juncture the best option before politicians is to simply delay for one year until mid-term elections provoke some vestige of sensibility in the ruling class.