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Moody's Discusses Liquidity Withdrawal and Bank Balance Sheet Risk
The world is officially upside down when presumably objective financial analysts can't wait to issue round after round of upgrades on financial stocks they think are the new dot coms (very much like what they did last summer, which did not work out too well, especially for CNBC's new darling Dick Bove), while traditional cheerleaders of the system such as Moody's are the ones providing analysis that at least attempts to scratch below the surface and not feed on hyperbolic market euphoria.
In its weekly report, Moody's provides a piece called: "Treasury’s Exit from Financial Sector Support Programs Will Test Banks and Investors" which is a surprisingly accurate summary of the key liquidity withdrawal and bank balance sheet risks.
Last Monday, the U.S. Department of Treasury released a document entitled “The Next Phase of Government Financial Stabilization and Rehabilitation Policies” in which it officially announced its exit strategy from financial sector support programs. This next phase consists in moving away from the “rescue” of financial institutions to a period of “stabilization, rehabilitation and rebuilding” by winding down those programs that are no longer necessary to prevent systemic failures. But with the expiration of these programs, and in absence of any new program to support the issuance of long-term debt, banks will be challenged to reconstruct their funding profiles in a cost effective way.
The announcement was largely symbolic, as the expiration dates of the programs mentioned by Treasury had already been released in previous weeks. But Treasury’s document is also a reminder that we have not returned to a normal operating environment and that the system remains sensitive to unanticipated market events. We agree with Treasury that “it is unclear whether the improvements achieved to date will persist without a period of continued government support.” Short-term debt markets appear to have healed, but we continue to believe that there are important weaknesses remaining in the financial fundamentals of banks, particularly with respect to their asset quality and funding profiles. Credit losses continue to put banks’ earnings and profitability under pressure, and the fact that banks’ debt profile is skewed towards short-term maturities makes them vulnerable to market volatility and swings in investor confidence.
Treasury confirmed that it is removing from the President’s budget a contingent allocation of $250 billion it had earmarked for stabilization efforts and it is letting some programs expire at their expected termination date; namely, the Money Market Mutual Fund Guarantee Program, on September 18, and the FDIC Temporary Liquidity Guarantee Program (TLGP) on October 31, 2009. It did not confirm when other programs will be withdrawn, but it emphasized the decline in utilization of the Term Auction Facility, the Term Securities Lending Facility and the Commercial Paper Funding Facility. These are all programs designed to support access to relatively short-term funding.
In our view, a more challenging test will be the withdrawal of assistance provided via the Federal Reserve’s purchase of mortgage-backed securities from Freddie Mac and Fannie Mae and via TALF. The Fed has acquired about $1 trillion of securities from the Government-Sponsored Enterprises (GSE) and is scheduled to stop its purchases when it reaches $1.25 trillion by the end of this year. The question is whether this will cause the borrowing cost of GSEs to increase, which would in turn make it more expensive and difficult for banks to finance mortgages via these government agencies. TALF, which is scheduled to expire at the end of March 2010 for new ABS and at the end of June for new CMBS, has supported the bulk of the approximately $80 billion in new ABS issued in 2009. Its effect has only recently begun to be felt in the CMBS market.
When even Moody's tells you that the "recovery" is based on simply near-term stabilization courtesy of trillions of taxpayer dollars flooding capital markets in an attempt to what effectively comes down to kill the dollar (by making it the carry currency of choice now that US rates are below Japan), people should be worried. And the main reason is, as has been pointed out numerous times, that the liquidity injection has to stop at some point. Granted it could continue in perpetuity, however a rational person thinks that even China will say enough once it buys up a few extra trillion in USTs. On the other hands, the probability of the Fed voluntarily ending its monetization activities is now what crops up as a key risk factor. So look elsewhere for exogenous events that will dictate the actions of the Obama-Bernanke dollar destroying complex.
One big threat is that the free liquidity is setting up the banking system with structural imbalances, that many have highlighted as "duration mismatch", which simply means taking on disporportionately outsized interest rate risk. Throw in a few hundred trillion in interest rate swaps, and this could quickly escalate out of control. Even Moody's seems aware of this:
As we mentioned before, banks have not provisioned for the full amounts of loan and securities losses that they will incur over the coming year, which we expect to reach $470 billion in write-downs by the end of 2010. Approximately only half of this has been recognized to date and we expect earnings to be insufficient to offset these losses during that period, resulting in many banks being unprofitable. The risk premium on bank debt is unlikely to fall in such a context. If anything, it may actually increase, especially for long-term debt which already commands a significantly higher premium. This may, in fact, be the most vulnerable feature of the U.S. banking sector right now.
We believe that for risk management and regulatory purposes, banks will need to rebalance their debt portfolios by replacing maturing debt with new long-term debt. As illustrated below, spreads on long-term corporate debt (includes financial institutions) are already relatively steep despite the quasi zero interest rate on the 3-month Treasury benchmark. Replacing a short-term debt instrument by a long-term one could increase a bank’s cost by 100 to 200 basis points currently.
In addition, we have observed an important transformation of banks’ funding profiles in recent years; most of them having increasingly relied on short-term debt. This phenomenon makes banks more vulnerable to markets’ volatility. Should there be changes in inflationary expectations, or if investor confidence proves to be fickle, banks’ cost of funds could quickly increase and add further pressure on earnings and profitability.
So now you know why near maturity Treasuries are at record tights. The big question mark is how will banks become affected as they start moving further back on the curve. Alas, at this point nobody seems to care or know. All that matters is that Bernanke will be eager to keep providing bail out options to each and every firm when they need it. And as the Chairman is accountable to no one, which in some ways brings back the whole client-attorney privilege scam from the BofA-Merrill fiasco, there is no indication that once the crisis moves into its next mode, in that world far from now where the Fed is actually sucking up liquidity, that anything will change. After all, the Fed has blessed moral hazard as the de facto modus operandi of the new world economy. And while Wall Street gets ever richer (together with corprate insiders, selling their stock by the boaloads) the rest of America gets to sit back and watch the DXY chart which measures the destruction of America's already meager savings tick by tick.
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As I've maintained from the start, this is a land-grab. The Fed won't rest until it is collecting rent from all US citizens while inflating all wealth away from the few people who manage to save.
US citizens are being robbed then turned into slaves. The poor peons don't realize by whom.
C'mon people, pitchforks and torches already, what's taking so long?
It has a name you know:
OPERATION ENDURING BUBBLE
If we're expecting our emotionally immature and self deluded pampered population to actually grow a pair and rise up against our masters, we're just as deluded.
We are a nation of cowards. We don't want to know the truth. Just leave us alone with our flat screen TVs and our high speed Internet connections so we can surf the net looking for information that confirms what we already know, that things are getting better and everything will be just fine without me getting involved.
Now shut up and pass me the corn chips. American Idol's coming on in 10 minutes. BTW, did you see the 2 hour premier of Heroes last night? Awesome dude! How about those Jets? Did you see Favre chuck the pigskin? ................................
1.7 M people marched in DC and more may come on Oct 1st, while Pharaoh 0 pretends not to notice...
18 When that year was over, they came to him the following year and said, "We cannot hide from our lord the fact that since our money is gone and our livestock belongs to you, there is nothing left for our lord except our bodies and our land. 19 Why should we perish before your eyes—we and our land as well? Buy us and our land in exchange for food, and we with our land will be in bondage to Pharaoh. Give us seed so that we may live and not die, and that the land may not become desolate." Genesis 47
http://stockcharts.com/def/servlet/Favorites.CServlet?obj=ID3251493
$470 billion (with a B) to unwind minimum peak-to-trough. And we're only half the way there. And from the half-way point, things look as bleak as they do.
Good god. This becomes alarming. I don't know how we can survive the rest of the journey intact. Either they start handing out the strong drugs, or this is going to blow itself to pieces in very interesting ways.
cougar
Interesting it took WEB slinger dumping MCO for them to grow a pair...
Hard to believe anyone can find value in equities now. Stock
prices are being held up to allow CEOs and other insiders to bail before stocks are destroyed.
First of all, the Treasury has no credibility. BAU will go on as before with a few carefully placed fig leaves.
BAU being the continuing bailout business.
All and sundry in the smart set are banging fists on tables denouncing the failure of administrators to actually fix some of the banking industry's problems. Borrowing short and lending long - or not lending at all - is a primo ongoing structural problem. BANG BANG BANG! When the next time ...
... of course there will be a next time, this is guaranteed. It's the ongoing 'Moral Hazard experiment' to see where and how far down the rat hole the finance system can descend.
I think the us dollar - euro carry trade takes months to full power. Spain is an economically bankrupt country as a whole. Only a fool would invest in spanish shares.
The Spanish market has outperform the (crazy) US market by 35% since March.
Spanish market - US market (both in dollars)
http://stockcharts.com/h-sc/ui?s=EWP:SPY&p=D&b=4&g=0&id=p65328333547
The Italian market and other junk euro asset markets present similar images.
Banks continuing to borrow short and lend long.
Poetic karma justice for all the teaser ARMs and
62% credit cards they issued...
Let's see what happens to the dollar carry trade tomorrow afternoon....
Shadowstats documentd an M-3 reduction from 18% growth at the beginning of 2008 to 4% recently.
BB has been draining the punchbowl to prevent hyperinflation and the collapse of the Fed.
This may end badly, with inflation hedges collapsing as=nd deflation hedges benefiting, exactly the opposite of what the crowded market mob expects...
As we mentioned before, banks have not provisioned for the full amounts of loan and securities losses that they will incur over the coming year, which we expect to reach $470 billion in write-downs by the end of 2010. Approximately only half of this has been recognized to date and we expect earnings to be insufficient to offset these losses during that period, resulting in many banks being unprofitable. The risk premium on bank debt is unlikely to fall in such a context. If anything, it may actually increase, especially for long-term debt which already commands a significantly higher premium. This may, in fact, be the most vulnerable feature of the U.S. banking sector right now.
someone should show this to bianco @ bac/ml as his call is overweight financials and (contrary to history) the domestic financials will be a leader out of this recession. I saved his last report, should be good for laughs in the not so distant future.