Wednesday, April 22, 2009


The deteriorating global economy means financial institutions now face total losses globally of $4,100bn on loans and other assets, the IMF said yesterday, urging governments to take “bolder steps” to shore up institutions – including nationalising them. The IMF says many loans sitting on institutions’ balance sheets are eroding in value, no longer just the toxic sub-prime securities which first triggered the crisis. But, this is expected and not news. But that does not stop the media exaggerating this as if it is shockingly new.
Banks would bear about two-thirds of the losses, with insurance companies, pension funds, hedge funds and others the rest. Efforts to cleanse these bad assets from balance sheets and replenish viable institutions with capital had so far been “piecemeal and reactive”, the IMF said, calling for more decisive government action. I beg to disagree. In my view the IMF is being irresponsibly alarmist and under-estimates the money-market operations of the world's central banks and the effects to be expected from fiscal and monetary measures. The IMF states, “The current inability to attract private money suggests the crisis has deepened to the point where governments need to take bolder steps and not shrink from capital injections in the form of common shares even if it means taking majority, or even complete, control of institutions.” Complete share ownership and the renewed threat of it will of course totally undermine shareholder confidence and this plus bank shares becoming untradable both further damages the banks' capital reserve and takes away the share gains that should eventually emerge to greatly help restore bank capital. The IMF is not thinking the matter through properly over the medium term. Even though the IMF's writedown estimates are lower than those of some private economists, its global stability will further unnerve investors and governments. On Monday traders were so alarmed by news of rising delinquencies on consumer and business loans at Bank of America that they triggered a stock market sell-off despite its doubling of quarterly profit. US banks have so far taken about half of the writedowns they face, which I agree with, while European banks have only taken one-fifth, which I think is an under-estimate. But if banks took all the writedowns they face immediately, the IMF calculates it would wipe out all their common equity. But this has been eminently predictable for a long time and government measures are cognizent of that. Therefore, the IMF is overstepping a line here for the sake of sensationalism and it also under-estimates internal capital generation, asset swaps with central banks, funding gap financing, and the element of loan-loss provisions that can return to capital reserves once losses are finally crystallised.
To restore their balance sheets to the state they were in before the crisis – defined by the IMF as a tangible common equity ('own capital') to tangible asset ratio of 4% (ratio to gross assets, not risk-weaighted assets) when regulators are insisting now on 6%. The IMF say that US banks need $275bn in capital injections, and Euro Area banks need $375bn, and UK banks $125bn.
The IMF expressed concern that taxpayers are weary of supporting the financial sector. This neglects to see that the banks have only in very small amounts been supported if at all by taxpayers' money; the support is almost all off-budget via T-bills for heavily discounted and profitable fee-based asset swaps, taking banks' assets as collateral, but leaving the central banks with a generous risk ceiling. The IMF says, “there is a real risk that governments will be reluctant to allocate enough resources to solve the problem.” This is a silly statement and flies in the face of the exact opposite being stated by governments in words and deeds.
One possible step would be for governments to convert their preferred shares in banks into common equity, the IMF suggests assomething that the US government, Fed and Treasury are considering, as a senior IMF official told the FT. The logic for this conversion is completely missing when the banks are generating capital and the cycle upturn is expected within a year and further large asset swaps to clean out the balance sheets are in train.
Even if governments do take bold action to shore up the system, according to the IMF, the credit crisis will be “deep and long-lasting”, another 'surpise', another piece of sensationalising that falls flat. All this does not add credence to the IMF's expected role in the G20 New Financial Order! The IMF says said that deleveraging and economic contraction can cause credit growth in the US, the UK and the eurozone to contract and even turn negative in the near future, and only recover after a number of years. By stating this the IMF are effectively stating that all measures to shore up the banks including ordering them to maintain loan levels are useless because even when GDP recovery comes, the banks will continue to drag GDP down, as if there is no gain, no systemic multiplier, in them doing otherwise?
The IMF was also most gloomy about the prospects for emerging markets as foreign investors and banks withdraw FDI and other funds. It estimated the refinancing needs of emerging markets are around $1.8tn.
Reshaping global financial regulation is the G20 topic in the IMF report. It suggests two tiers of regulatory oversight: one to gather information, and a smaller one for (globally) systemically important institutions with “intensified” regulation. It also mooted the idea of levying an extra capital surcharge as a way to deter companies from becoming “too-connected-to-fail” in the first place. This assumes that it knows how to calculate the systemic or network risk of financial instiutions measured globally - now that model would be interesting, does it exist, has it been conceived, designed, is there the theoretical and empirical data basis for building it, the ultimate global stress-test model... er, no, of course not. The next global financial crisis will probably be upon us before then.
The IMF pall of gloom coincided with that of Bank of America. After its shares fell 10% on positive results, BofA shares fell 24.3 per cent, contributing to a 4.3 per cent decline in the S&P 500. This was a response to its economic analysis that was also further insight into the bleeding obvious, led by BoA CEO saying, “We understand that we continue to face extremely difficult challenges primarily from deteriorating credit quality driven by weakness in the economy and growing unemployment.” But, this is just a 'pro-forma' statement that is required to go along with any results publication and is really meaningless. Yet, Asian shares followed Wall Street’s cue, with shares in financial companies sinking across the maiden. Monday’s US stock market falls were the steepest one-day setback since... oh, March 9th (when the S&P closed to a 1996 index level) since when US equities rallied 30% to last Friday.
“The guidance from BofA was not great,” said one head of trading, “Credit costs and foreclosures are still rising.” My view is "of course, so what! It would be a huge unexpected even worrying shock if this was not so!"
Some BofA shareholders are agitating for Lewis to be ousted at next week’s shareholder meeting and over at FDIC the board are considering who to send in as replacemen for the head of Citigroup. Part of the cleaning out and restructuring all banks balance sheets is that all senior bank officers from before the credit crunch and recession crisis must go and be replaced with clean hands and new brighter faces.

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