Tuesday, April 14, 2009

Of Crashes, Failures and Bailouts - Round V: Blacker Than Ever


The following is excerpted from an interview in Barron's (click the title to go to the original) of William Black by Jack Willoughby. What Black says isn't so amazing. Others have said it, and far earlier. I have previously posted comments and links to The Automatic Earth (which is where I found the original article from Barron's), Karl Denninger, Peter Schiff and others saying essentially all the same things. It's that he's the one saying it. William Black has gravitas. He has the pedigree. Those who would dismiss, and have dismissed, the voices in the wilderness noted above, can't so easily do the same to William Black.

There's not really anything new here that wasn't in Of Crashes, Failures and Bailouts - Round IV, but it's all worth repeating just for emphasis.

My comments below the interview.

Barron's: Just how serious is this credit crisis? What is at stake here for the American taxpayer?

Black: ...The scale of fraud is immense...

So you are saying Democrats as well as Republicans share the blame? No one can claim the high ground?

We have failed bankers giving advice to failed regulators on how to deal with failed assets. How can it result in anything but failure? ...Tim Geithner, the current Secretary of the Treasury, and Larry Summers, chairman of the National Economic Council, were important architects of the problems...

So you aren't a fan of the recently announced plan for the government to back private purchases of the toxic assets?

It is worse than a lie. Geithner... is really pandering to the interests of a select group of banks who are on a first-name basis with Washington politicians. The current law mandates prompt corrective action, which means speedy resolution of insolvencies. He is flouting the law, in naked violation, in order to pursue the kind of favoritism that the law was designed to prevent...

...It is like Gresham's law: Bad money drives out the good. Well, bad behavior drives out good behavior, without good enforcement.

...By promoting this notion of too-big-to-fail, we are allowing a pernicious influence to remain in Washington...

Summarize the problem as best you can for Barron's readers.

With most of America's biggest banks insolvent, you have, in essence, a multitrillion dollar cover-up by publicly traded entities, which amounts to felony securities fraud on a massive scale.

These firms will ultimately have to be forced into receivership, the management and boards stripped of office, title, and compensation. First... a Pecora-style fact-finding mission conducted without fear or favor... Then... pursue criminal cases...

What, then, is staying the federal government's hand? Have the banks become too difficult or complex to regulate?

...to do so would force it to put some of America's biggest financial institutions into receivership... these banks are some of the most well-connected in Washington...

Can you explain your idea of control fraud, and how it applies to the current banking and the earlier thrift crisis?

Control fraud is when a seemingly legitimate corporation uses its power as a weapon to defraud or take something of value through deceit.

...These accounting frauds create huge bubbles...

Why then is there so much smoke and so little action?

...The reason we don't see it -- aren't told about it -- is that if they were honest, prompt corrective action would kick in...

You say the evidence of a breakdown in the regulatory structure comes from the fact that America avoided an earlier subprime crisis in the 1990s.

Exactly. Why had no one heard of the subprime crisis back in 1991? Because America's regulators also faced down the crisis early... the problem didn't spread -- because regulators intervened.

What needs to be done?

Well, these international behemoths need to be broken down into smaller units... And a new seriousness must be put into regulation... We just need folks who can enforce the ones already on the books.

The bank-compensation system also creates an environment that leads to mismanagement and fraud... the top 20% get the bulk of the benefits and the bottom 10% get fired... Compensation systems... discourage whistleblowing -- the most common way that frauds are found in America -- because the system draws upon the cooperation of everyone.

This whole thing isn't over. Those in government or the financial industry saying we are past the bottom and will be coming out of recession within months, or maybe the end of the year, are liars or fools. The proof is in the pudding.

Question: How can the recession end when loan defaults - of all kinds and all sectors of the economy - are still raging? Take a look at this Mortgage Reset Chart. We are currently at a lull in resets. They surge again through 2010-2011.

Which brings us to inventory. John Mauldin at Minyanville observes:

No Housing Recovery Lurks in Shadow Inventory
- The Shadow Inventory of Homes

...a strange thing is happening: We're seeing what's being called a "shadow inventory" of foreclosed homes.

The San Francisco Chronicle reports:"We believe there are in the neighborhood of 600,000 properties nationwide that banks have repossessed but not put on the market," said Rick Sharga, vice president of RealtyTrac...

A RealtyTrac survey found that only 30% of foreclosures were listed for sale in real-estate listings, like the MLS (Multiple Listing Service). Add in homes that people would like to sell but simply can't find buyers for and must either hold or rent, and the unsold inventory numbers that are public are likely far below actual available homes.

Might some homes in foreclosure be held off the market because banks eventually want to negotiate with the homeowner? Possibly. But other surveys show that anywhere from 30%-40% of homes in the foreclosure process in many areas are actually already vacant. There's no one with whom to negotiate...

...Normally there are about 160,000 homes a year in foreclosure sales. We're now seeing 80,000 a month, or 6 times normal levels, and rising.

Second, lenders could be deferring sales to put off having to acknowledge the actual extent of their losses. "With banks in the stress they're in, I don't think they're anxious to show losses in assets on their balance sheets," one observer said.

Finally, banks may not want to flood the market with foreclosures, driving prices down even more...

But it gets worse.

And it does. He goes on to list some of the things I'm already writing here, and more. You should read the article.

And what about commercial real estate? Prices are crashing and defaults rising as we speak. Credit card debt? Credit lines are being canceled or slashed as banks look to control losses or costs. Being a good risk is now a liability: they earn no interest and/or fees from you if you don't carry a balance, yet have money out to you. Liquidity is at issue. Every bank and financial entity wants cash. They need cash. You lose.

More importantly, as Meredith Whitney has pointed out, credit cards and credit lines have been what enabled many families the flexibility to manage tricky finances. As more restrictions are placed on personal credit, the more families that will be forced into default.

Few doubt the importance of consumer spending to the U.S. economy and its multiplier effect on the global economy, but what is underappreciated is the role of credit-card availability in that spending. Currently, there is roughly $5 trillion in credit-card lines outstanding in the U.S., and a little more than $800 billion is currently drawn upon. While those numbers look small relative to total mortgage debt of over $10.5 trillion, credit-card debt is revolving and accordingly being paid off and drawn down over and over, creating a critical role in commerce in America.

Just six months ago, I estimated that at least $2 trillion of available credit-card lines would be expunged from the system by the end of 2010. However, today, that estimate now looks optimistic, as available lines were reduced by nearly $500 billion in the fourth quarter of 2008 alone. My revised estimates are that over $2 trillion of credit-card lines will be cut inside of 2009, and $2.7 trillion by the end of 2010.

Where is the recovery?

Global trade is still falling as can be seen in import and export numbers around the globe, which also reflects in shipping. Manufacturing - JOBS - will continue to fall in lockstep. Unemployment continues to rise even as extended benefits are running out for those early in the unemployment line. Real unemployment is now just below 20%.

Where is the recovery?

The financial sector is insolvent, but won't admit it. Housing and commercial real estate are so overbuilt squatters are taking over homes everywhere. Where the hell is the recovery supposed to come from? Foreign companies? Foreign countries? The U.S. is the consumption engine of the world. It is 20% or more of the global economy and 70% of that is consumerism. Service industries. In other words, pointless, useless and producing almost zero infrastructure/real capital. Do the math. That's 14% of the global economy that is kitsch and junk. Price/Earnings ratios are shot.


Where is the recovery?

I call this blog A Perfect Storm Cometh. The financial unwind is only one part. Let's say we do go into recovery within the next six-to-eight months. Growth takes energy. Cheap energy. The densest energy we currently can tap cheaply and easily is oil. However, oil production is falling due to both above ground (non-geological) and below ground (geological) reasons.

The natural decline rate of crude oil production is at over 9% per year. That's over 6.5 million barrels a day. New production each year brings that number down to 6+% or 4.5 to 5 million barrels a day lost each year. Let's put that in perspective. That's a full Saudi Arabia every two years. We aren't finding anywhere near that much oil and haven't for decades. For now, the drop in production because of recession is masking the drop in production due to Peak Oil. Keeping this in mind, the recession **helps** with Peak Oil in the immediate future, but not in the longer term.

The problem is that the recession is not only reducing oil consumption, thus production, as a result of lowered demand, it is cutting future production. New wells aren't being drilled as fast. Old wells aren't being improved with technology. Expensive wells are being shut down while waiting for higher prices. IF a recovery started, it would run into the brick wall of slow-to-recover production and decline. The longer the recession (PC talk for depression, it seems) goes on, the more likely no new peak in production can be hit. The reason is simple: we have produced about half of all oil we can reasonably get to for reasonable prices. The rest is in smaller fields that are harder to reach. Consider my modified haystack analogy.

Imagine a giant haystack. Rather than the proverbial needle, in the hay are ten basketballs, 100 tennis balls and 1000 marbles. (Imagine our magic haystack keeps all objects suspended so they don't all fall to the floor.) The result?

  • We will absolutely find all of the ten basketballs before we find all 100 tennis balls. Or even a majority.
  • We will absolutely find all the tennis balls before we find all the marbles.
  • We will find some of each from the very start.
  • We will find all the basketballs in the early part of our search, say the first 25 - 40% of total time spent looking.
  • The basketballs will equal a majority of all balls/marbles by volume.
    (Take a look at the Discovery/Production graph at the bottom of the blog.)

We've already found all the basketballs and a bunch of the tennis balls. We're down a few tennis balls and a bunch of marbles. Regarding production, the basketballs are going seriously flat and a bunch of tennis balls are getting flat or are empty. There's a lot of oil, but it's just not going to be possible to increase how fast we can get at it.

Where is the recovery?

Economic impacts? In the two large recessions of the 70's, GDP and oil production reflected one another, falling by similar percentages. In historical terms economic growth, food production and population have all tracked along with oil production. Both GDP and oil production are falling at this time. Again, by similar amounts. (See graphs at the bottom of this blog.)

The historic interplay of oil and economy is also seen in oil prices and recessions. Check out the graph at the beginning of the post below.

Oil Addiction and Recession

Vulnerability to oil prices helped cause this collapse

Poorly regulated real-estate lending wasn’t the only cause of the economic meltdown now gripping the industrial economies. Oil addiction also contributed.

The extraordinary rise in oil prices since 2003 has sucked hundreds of billions of dollars out of the US economy (and the Cascadian economy).High oil prices have been a contributing cause of most recessions: Since 1948, “all large oil price increases but two have been followed by recessions,” as Andrew Hoerner and Nia Robinson of Redefining Progress (RP) write (pdf). “Four of the five recessions since 1970 . . . were preceded by big jumps in oil prices.”

Oil prices are now down 4 - 6%. Fourth quarter '08 GDP was falling at an annual rate of around 6%. Coincidence? These two posts discuss the connections between oil prices and the economy.

The oil shock and recession of 2008: Part 1
The oil shock and recession of 2008: Part 2

When, not if (barring a Dark Ages-level global collapse), production declines overtake falling demand, the prices will rocket upward. Again. Price volatility should be the norm, as it has been, now and in the future.

Where is the recovery?

The third part of the Perfect Storm is Anthropogenically-driven Climate Change (ACC.).

Without going into it too far, all of the above have a negative impact on ACC. Obviously, economic limits will affect the building of "green" infrastructure as credit is tight and resources are dwindling. It is important that governments understand that the long term health and safety of their nation and people depends on not losing sight of what happens if we don't successfully transition to sustainable energies and sustainable societies.

It has been reported that climate scientists are privately far more pessimistic about the future than they are letting on. Public pronouncements parrot the 2C warming locked in even if we successfully manage Green House Gas (GHG) emissions this century. Privately, there is talk that 3C or 4C is more likely. This is very bad news, of course, which illustrates that action can't wait, but with the economy crashing and energy decline likely to keep it crashing for the next 5 to 10 years (if renewables don't ramp up, it could last decades), how are we supposed to manage the transition to a low- or no-carbon society?

The answers might be simpler - though not necessarily easy - than one might think: Just say no.

More on that later.


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