The banking system’s cancer

The 4th Quarter Report on Bank Trading and Derivative Activities released last friday by the Office of the Comptroller of the Currency (OCC) is absolutely frightening.

Not only does it show the mounting losses that the US largest commercial banks are facing in most aspects of their activity (especially interest rate, credit and equity trading), but it also shows that their overall risk exposure has been increasing in almost geometric proportions over the last few years. Basically, banks are currently going in a downward spiral where mounting risks cause credit standing declines, which leads to rising counterparty credit spreads, in turn increasing the risk of receivables (especially derivatives).

Even more frightening is the massive concentration of risk with America’s top 5 banks controling 96% of the industry’s total derivatives.

…And the fact that the notional value of derivatives held by U.S. commercial banks increased by $24.5 trillion in the 4th quarter of 2009, to $200.4 trillion.

…And the fact that 96.6% of all derivatives are traded Over the Counter(OTC), ie outside any clearinghouse and therefore escaping regulatory controls.

…And the fact that the percentage of total credit exposure, as calculated by OCC, to risk based capital represents between 179% and 1056% for the top 5 commercial banks, the most exposed being Goldman Sachs.

You thought that Credit Default Swaps (CDS), which lied at the core of AIG’s demise, were like dynamite? Well, they only represent 98.29 % of a trading activity (credit derivatives) that itself only amounts to 9.2% of the total notional value of derivatives traded by commercial banks (78% of total notionals are interest rate contracts).     

It is obvious that the whole commercial banking system needs reform and stringent regulations. But that is for the long term. In the near term though,is there any way out of this mess?

Filed under: Economy, U.S. Banking System , Credit Markets, Derivatives, U.S. Banking System

The Real Estate industry’s take on Geithner’s plan

The Costar group  has released this interesting survey this morning, very much in tune with our most recent post on this page. The survey also provides a telling link to an illustration showing what a trillion dollar represents, to put things in perspective.

Everybody seems to agree that the plan has its own merits but doubts about the results. The expected outcome for most Real Estate professionals is inflation and currency devaluation.

Some seem to believe that it is probably not a bad thing, after all, as it could help reducing some of the pressure coming from the debt.

We believe, however, that this will have an adverse effect on the US ability to borrow, and that it will lead to an interest rates race among leading economies -each trying to attract the capital it needs to finance bailouts and stimulus packages-, which could cripple the world economy for a long time.

This could also very well lead to a shift in the balance of power, worldwide, with cash-rich and lesser indebted economies like China reaping most of the benefits.

Filed under: Economy, Real Estate, U.S. , Credit Markets, Economy, Public-Private Investment Program, Treasury

Details on the Public-Private Partnership Investment Program

Here are the details of Geithner’s plan.

If the intentions of the plan are laudable – restore some level of confidence, and activity, in the credit markets by using government’s guaranty as a trigger – and the instruments appropriate (attracting private capital should ensure better efficiency of the funds disbursed), the diagnosis itself is questionable.

“[..] The excessive discounts embedded in some legacy asset prices are now straining the capital of U.S. financial institutions, limiting their ability to lend and increasing the cost of credit throughout the financial system. The lack of clarity about the value of these legacy assets has also made it difficult for some financial institutions to raise new private capital on their own.”

To talk about a “lack of clarity” about the value of legacy assets right after stating that “excessive discounts” are embedded therein clearly indicates that Tim Geithner believes this is a crisis of confidence more than one that is triggered by the  invisible hand of a market that rediscovers the unescapable law of gravity.

Let’s face it, most banks, including the biggest, are overloaded with junk. Starting from the assumption that former AAA-rated assets (in the old economy, ie 2 years ago) still deserve an A or AA rating in the current economy seems really like a wild bet, on which the government is prepared to go all in.

If the plan works, the deflationary pressure coming from falling asset prices and destruction of wealth will lose steam, and we will be left with the inflationary pressure coming from the intense money creation that is currently taking place (and will have to continue for quite some time). This could lead to further devaluation of the US dollar, and create upward pressure on interest rates. In an economy where depressed investors and consumers alike have been paying a heavy price to learn that markets always end up adjusting back to fundamental values, the likely outcome is stagflation.

If it does not work, we will be back to square one, and, considering the pace of money infusion into banks, insurance and car companies,  probably lighter of a few trillion dollars by then.

The question is: is there any better alternative? Some like Paul Krugman advocate a swedish-style nationalization of the banking system, others believe that the government should stay on the fringes in a pure regulatory role and let the market forces find the bottom themselves, whatever the short-term cost is.

It is really tough to form an opinion when nobel-prize economists can’t seem to agree on anything. Current market volatility is just a reflection of this fact. The current rally in the equity markets does not matter, really. Until at least some form of consensus emerges in the form of a long flat, our approach will remain the same: prudence.

Filed under: Economy, Markets , Credit Markets, Economy, Equity Markets, Public-Private Investment Program, Treasury

Welcome to our blog!

Well, the title of this post is not entirely original, to say the least, but this is our first post for Socoa on the bloggosphere and you need to start somewhere.

This page will be reserved for our views and analysis on the state of Commercial Real Estate in Southern California. We will also comment on the facts, events, trends or opinions that are shaping the Global, National or local Economy and directly or indirectly influence Commercial Real Estate values or trends. Finally, we will also provide the reader with outside information, comments and/or links that we believe are worth a look.

Filed under: Other