Thursday, December 10, 2009

Ken Rogoff (Videos): "Banking System Far from Healthy", Sovereign Debt Defaults Likely in Next Few Years

Now that we let banks mark their books to their own devices, due to political pressure on the national accounting board, all it took was that one accounting change and a "negotiated" stress test [May 9, 2009: WSJ - Banks Won Concessions on Tests]  and the US banks have gone from systematic default to "all clear".  Who knew it would be that easy?  I'll admit, I completely underestimated how beneficial lying about what is on your balance sheet, with government backstop would be to the US financial system.  But now that we live in an Alice in Wonderland system - unicorns and singing mermaids are just around the corner.  As Japan showed us the past 2 decades...

Both Bank of America (BAC) and now Citigroup (C) are in a race to pay back their TARP funds (yes, Citi and Bank of America - they of $300B bailouts just a few quarters ago)... because they are healthy want to pay excessive compensation so they don't lose "talent"... to say the United Kingdom.  Since mark to market was killed in March 2009 and we are going to pretend banks asset values are realistic (last time we left the banks to their own discretion, how did that work out?), I am not sure if we're going to have another banking crisis in the years to come.  As long as we all believe in fiction there is nothing to panic about after all.  But I'd love to see another just for the drama of Geithner having to go to Congress and ask for a new bailout.  It truly is amazing what changing 1 accounting rule did for the entire American banking system ... make believe is a wonderful thing; worked for Enron for many years.

[Feb 20, 2009: Nationalization of Bank of America and Citigroup Beckons]
[Dec 1, 2008: Hello, I'm Bank of America and I need your Tax Dollars]
[Nov 26, 2008: After Citigroup is Bank of America Next?]
[Nov 24, 2008: Details on Citigroup Bailout]

Harvard professor Ken Rogoff, one of those souls who has detached from the Matrix, weighs in in these 2 videos from Yahoo Tech Ticker.  At the bottom of this piece Minyanville's Todd Harrison talks about the smoke and mirrors financial system and how the financial oligarchy continues to play the US taxpayer for the tool... or fool.   But as Todd says... we'll worry about all these things "some day"... for now, party on Garth.

1) Banking System "A Long Way from Healthy"

The Obama Administration is going to extend the TARP program into 2010, Treasury Secretary Tim Geithner told Congress Wednesday. But the focus is going to be on aiding consumers vs. financial institutions, amid a sense the banking system is back on its feet after its near-death experience in 2008.

"We didn't have a [second] Great Depression, we could have. You have to give them a lot of points for averting that," says Harvard professor Kenneth Rogoff, co-author of This Time Is Different.
But that doesn't mean the danger is over.

The system is "a long way from healthy," Rogoff says, noting the banks have only profited this year thanks to various and sundry government programs and the Fed's easy money policies. "If I told you, you could borrow almost 30 times what your house is worth at almost zero percent and lend around to anyone you wanted, I'd bet you'd make money too," he says. (but Mr. Rogoff, that takes talent...the type of talent that should get hundreds of times the wages of the typical peon in America, no?)

The big reason banks aren't lending aggressively is they're bracing for a lot more write-downs in the years ahead, as defaults in consumer loans and commercial real estate mount, Rogoff says. In that regard the banks are acting rationally.

But Rogoff fears onerous regulations will be the ultimate payment for the massive taxpayer subsidized bailouts the banks received in 2008 - and the moral hazard they engendered.

"If bondholders think they can lend to financial institutions at no risk we're going to get into trouble in another 10 years or less if we don't do something," he says.

Unfortunately, that "something" probably means tighter regulations, which could contribute to slower growth going forward, he says. (not to worry, the lobbyists will be hard at work shooting holes in both the initial regulation and then fraying it over the coming years... our next 'black swan' will still be awaiting us - I trust in my oligarchs to make sure it happens)

2) Sovereign Debt Default Likely Over the Next Several Years

Global markets tumbled overnight amid fresh concerns about the global economy, and more specifically, the prospect of sovereign debt defaults.

Standard & Poor’s lowered its outlook for Spain's debt grade as the country's finances worsened. A day earlier, Fitch cut Greece's long-term debt to BBB+ from A minus, marking the first time in a decade the country has seen its rating pushed below an A grade.

The news doesn't come as a surprise to our guest Ken Rogoff, professor of economics and public policy at Harvard University. As Dubai's recent debt crisis shows, more sovereign debt defaults will be likely over the next several years, he says.

The International Monetary Fund will try to prevent any global economic crisis in the near term says Rogoff, a former IMF chief economist. But, longer-term, difficult decisions remain about how to tackle mounting debt among G8 nations. "We can barely have the political will to raise taxes to pay our own debts," which means less money to pay for bailouts of other creditors, he predicts.

"In a couple of years as U.S. debt explodes, as German debt explodes, and they're all going to be pushing difficult levels, they're really going to start thinking. 'Hmm. Do we really want to cast this safety net?' We've got to scale back," says Rogoff, also co-author of a new book, "This Time Is Different: Eight Centuries of Financial Folly." The book outlines how periods of boom and bust are marked by bouts of overspending and mounting debt, whether by consumers, banks or governments -- just like the current crisis.

Should American taxpayers be worried? Financial crises in Asia during the late 1990s and in Latin America during the '80s largely were regional affairs but higher U.S. inflation is almost a certainty.

Rogoff, however, is more certain about the future of California, a state strapped by rising expenses and falling tax revenues. They'll be on the brink of default repeatedly, Rogoff says.

3) "A Proxy for all the Smoke and Mirrors"  Citi Seeks to Follow Bank of America Out of TARP

In the past 48 hours, Bank of America has finished repaying its TARP debts and, according to CNBC, Citigroup is making plans to do the same.  Bank of America raised over $19 billion last week and Citigroup is seeking to raise a similar amount, according to published reports.

Citi shares were up Thursday in part on anticipation the bank will be able to raise the funds and reach an agreement with Treasury to escape the "harsh" restrictions of its government overlords.

As with Bank of America, the widespread view is that Citigroup wants to exit TARP so it can avoid any onerous restrictions on compensation.

"Obviously they're doing this to be able to retain their talent," says Todd Harrison, CEO of
Set aside, for a moment, the questions of what constitutes "excessive" pay and whether it makes sense to pay anything to the same group of people who put the industry, and the global economy, on the precipice of disaster a little more than a year ago. (it's so laughable as to be surreal at this point)

Instead, consider the state of mind on Wall Street (and in Washington) that very little consideration is seemingly being given to whether the banks are healthy enough and the system stable enough that exiting TARP makes practical sense.

From Harvard's Ken Rogoff to bank industry veteran (and Minyanville contributor) Peter Atwater and Mike "Mish" Shedlock, a series of recent guests have argued the banking system isn't as healthy as the rebound in their share prices would indicate.

On this point, Harrison agrees:
Banks are "the proxy for all the smoke and mirrors that are going on" with government policies, Harrison says. "That doesn't mean they can't rally but the conditional elements for trouble are still there," most notably "the DNA in the global financial machinations of $500 trillion of derivatives and counterparty risk."

So what happens if the banks exit TARP and then find themselves in trouble in another year, or two? Where there be the political will for another bailout, or will populist resentment really boil over and trigger the "socio-economic unrest" Harrison often talks about?

Considering that's probably a 2011 or 12 (or beyond) story, few in the speculative community seem too terribly concerned at the moment. But there is the immediate-term issue of the serious dilution to existing shareholders another capital raise by Citi will trigger. The company may also be hit with a special charge of as much as $10.8 billion to wind down the government's stake, The WSJ reports.

For these and other reasons, Harrison currently has no positions in the banks. "I won't touch the financials right now," he says. "There are easier fish to fry."  Less rotten ones, too.

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