2010 Budget Cuts Proposed???

Has a new found sense of fiscal responsibility and frugality overcome the White House?  This Week, President Obama announced cuts to his record setting budget.

In making the announcement,the President said:

We can no longer afford to spend as if deficits don't matter and waste is not our problem," Obama told reporters. "We can no longer afford to leave the hard choices for the next budget, the next administration or the next generation.

In making the announcement, the President proposed ridding the budget of $17 Billion Dollars.   

$17 Billion.  Of Course, the 2010 Budget proposal is already $3.5 Trillion Dollars - which is down from the record setting $3.9 Trillion Dollar FY 2009 Budget.  (See, Holy Cow! $3.9 Trillion Dollar Budget.)   The promise to save $17 billion dollars has nothing to do with cutting waste.  Take a look at how much $17 Billion is in comparison to the budget (chart from Econopic):

Get out your microsope to see that tiny blue line at the bottom of the graph.  That is the hard choices we are making.   Keep in mind that the fiscal 2009 (originally proposed Bush) was $3.1 Trillion, and then increased to $3.9 Trillion by Obama.  The 2010 budget is still $300 Billion greater than the original 2009 budget.  

How's that for fiscal responsibility?

What Stress Test?

Well the bank stress test results are in.  Yesterday, the Fed released the Supervisory Capital Assessment Program results and banks were only short, collectively, about $75 billion dollars.  A sigh of releif?  Our banking system is now safe? Well, lets take a closer look.

We already pointed out that the stress test was really a bank self-assessment.  Now if you take a look at the level of stress acceptable, you need to question the soundness of the system.  Historically, we have held banks to a leverage ratio between 8 to 12 to one.  These stress tests hold the bank to twice that - in other words the capital assets ratio is 25 to 1.  Barry Ritholtz Big Picture blog explained:

Consider this simple fact: 

Treasury and the Fed want these banks to have Tier 1 common stock equal to 4% of risk-weighted assets. In other words, 25-to-1 leverage as safe for the future.

Hence, it is not a big stretch to conclude that the entire stress test exercise is a near charade, with foregone conclusions of deleveraging banks to still wildly over-extended positions.

Recall that before the 2004 SEC Bear Stearns exemption for the 5 biggest investment banks, net cap rules limited leverage to 12-to-1 for investment banks.

Is 25-to-1 leverage appropriate for depository banks? Well, maybe before the repeal of Glass Steagal — but with today’s toxic asset laden banks, 25-to-1 seems awfully friendly

Why the free pass?  The answer is the banks can grow their way out of the mess.  Huh?  Grow their way out?  That is not the purpose of liquidity ratios.  What does that mean for depositors?  Get your money now before the bank runs or wait for the bank to grow its way out.

Contracts, National Debt and Cinco de Mayo

What is Cinco de Mayo anyway?  It is an opportunity to reflect on the value of holding contracts sacrosanct and the dangers of excessive national debt.  Huh?  An abbreviated history lesson (according to Sotus) is in order to set the stage for today’s ramblings. 

 Cinco de Mayo, Spanish for May 5, remembers the Battle of Puebla, which took place on May 5, 1862.  It was a pyrrhic victory for Mexican forces over the French forces that had invaded the Country a few months earlier.  It was the first major battle against the invading army and the defending Mexicans won.  Unfortunately, within a year, the French would have overthrown the government and installed Maximilian as Emperor of Mexico. 

 So, why did France invade Mexico in the first place – and here is the connection to today’s post – it is because Mexico decided not to honor its debt.  In 1861, Benito Juarez was elected President of Mexico (after leading the Country in the Battle of Reform) on a promise of sweeping changes and liberalization.   Mexico was struggling under the burden of its debt it had accumulated since its independence from Spain, and from its more recent constitutional turmoil.  The debt was held mainly by France, Spain and England.  After being elected, Juarez decided to suspend principal and interest payments on the national debt (as well as nationalizing certain private property, etc).  While Juarez was careful to state that Mexico was not "abrogating" its debt, it just was not paying it.  (Try that with your creditors.)

 Seeking payment or territory in lieu of payment, England, France and Spain entered into the Treaty of London in 1861, which authorized the intervention - led by France and supported by England and Spain.  Of course, the United States was involved in the Civil War, and was unable to come to the aid of Juarez, whom it supported.  After landing in Veracruz in December 1861, England and Spain quickly settled out and withdrew, but Napoleon II’s forces remained determined to gain territory for its debt. 

 The Battle of Puebla, Mexico's temporary rout of an invading army, while a victory of sorts, really should serve as a reminder to us all of the dangers of excessive national debt.  Today, our debt exceeds $11 Trillion dollars.  Interest on that debt is soon becoming the single largest line item in our budget – nearly 25% of our revenue goes to pay interest to debt holders.  Who are our biggest debt holders?  Number 1 is China.

 With Obama’s emerging penchant for abrogating contracts, what could happen if we decide not to pay our debt?  Could another country invade us?  The French Intervention in Mexico was not the first war started over abrogation of debt.  It will not be the last.  We live in a society that holds contract paramount – and there is good reason for that.  The entire underpinnings of our society and way of life are based on respect for contracts and the rule of law.  Our Constitution specifically prohibits the impairment of obligations of contract.  That is why it is troubling to see our President threaten to bring the full rath of government against investors who insist on their contractual rights.   These investors are companies that purchased contracts with auto maker Chrysler on behalf of the companies’ stakeholders (retirees, pension funds, teachers, mom, dad, apple pie, etc.).  The contracts purchased promising payment of debt and secured them fully with a first lien on assets of Chrysler.  That first lien means that these investors get 100 cents on the dollar.  When Obama’s administration singled out these investors because they wouldn’t reduce their contract to take a quarter of what they would be entitled to, it was disturbing and showed a fundamental disrespect for American values.  More troubling is the threats of SEC and IRS investigations against the hold out investors.  Ultimately, the contract and the Chrysler situation will be resolved in bankruptcy, but the damage to our constitution and rule of law by showing a willingness to ignore contracts could do more harm than the loss of 54,000 union jobs at Chrysler.

 Take the disdain for contracts one step further and wonder what will happen if Obama abrogates our contracts to pay our national debt?  Could a foreign debt holder intervene in US affairs to recover its money?  It happened before. 

 Happy Cinco de Mayo

De-Stressing The Stress Tests

A truism of government, regardless of political party, is that when officials tell you something, they mean the opposite.  The large bank holding company stress tests recently conducted by our government is no different:  it is  simply a whitewash intended to dupe the US taxpayer into continuing to bail out a failed financial system instead of doing the just and proper thing of liquidating the system and starting anew.  

On Friday, the Fed released its white paper of the stress test, The Supervisory Capital Assessment Program: Design and Implementation.  You can read it in full, or for those of us who need assistance deciphering government doublespeak, you can read Tyler Durden's Stress Test Cliff Notes .    Here are a few highlights of Durden's analysis:

(1) “more than 150 senior supervisors, on-site examiners, analysts and economists” spent a month reviewing the 19 BHC’s [Bank Holding Companys] that hold two thirds of the country’s bank assets and account for one half of the loans

More than 150 means at least 151.  .  .  .  A typical single bank examination utilizes hundreds of examiners and takes several months. Clearly the next release of public sector productivity numbers is going to astonish.

(2) ”the firms were asked to project…..the firms were asked to provide…etc.”

In other words, the banks tested themselves and the 150 examiners took their word for it. Any wonder they passed?

.  .  .  

(4) “As a result of the loss recognition framework for assets in the accrual loan book, the results of this exercise are not comparable with those that would evaluate such assets on a mark-to-market basis”.

Absolutely. What does the market know anyway? The banks’ models got us into this calamity so damn if they can’t get us out!

.  .  . 

(6) “Each participating firm was instructed to project potential losses on its loan, investment, and trading securities portfolios, including off-balance sheet commitments and contingent liabilities and exposures over the two-year horizon beginning with year-end 2008 financial statement data. “

Again, Treasury outsourced the testing to the banks themselves. So what was the job of the Treasury staff other than to photocopy , collate and file? Was this a Temp Staff? Kelly Girls?

(7) “Firms were allowed to diverge from the indicative loss rates where they could provide evidence that their estimated loss rates were appropriate. ”

I know it looks bad, but believe me, it’s getting better!

.  .  .

(10) “Under the baseline scenario, BHCs were instructed to assume no further losses beyond current marks”

It’s over! Great news!

In other words, the banks were asked to evaluate themselves using less time than bank regulators typically take, using models that do not truly reflect what would happen under the assumed scenarios.  

So, why are we doing these stress tests if they don't really test stress?  The Fed and Treasury are well aware of the capital required to bail out banks and depositors.  Since the Great Depression, the Fed and Treasury have taken the view that the economy and maintaining deposits in a bank is a game of confidence.  (Indeed, in a larger sense, the utility of paper currency - the Federal Reserve Notes we all keep in our wallets - depends very much on the world's confidence in our political and economic system - but that is another topic that involves a discussion of the national debt and the willingness of other governments to finance the debt).   Con games work as long as people believe the con or until their money is gone.  

The trouble is that people are starting to question the system.  When retirement accounts have lost 45% of their value, homes have lost 30% of their value, and banks in which we keep our deposits are insolvent, people have a right to question whether the system in which we placed our faith and credit can endure.  We have all heard stories from our grandparents how banks closed and the depositors money was not there.  We have been reminded of it all our lives, and now we want to protect what we have.  Systems have crashed before even with semi-rational governements.  The Wiemar republic blew up after a banking crisis.  So did Argentina.  I certainly want to have money if the system crashes - not just a credit from the government for only $250,000 (which, after the massive inflation we will experience at the tail end of the receission as a result of the massive "liquidity injection" {meaning printing of money}, will be worth about $2.50).  Because we operate on a fractional reserve system (meaning that your money is not really in the bank, but the banks maintain a sufficient reserve to meet anticipated withdrawals in normal situations), it is in the Fed's best interest to discourage you from withdrawing your money or from selling your bank stock.  If you knew the bank was insolvent, you would withdraw your money immediately and find another safe haven.  The Fed needs you to have confidence that the bank can provide the money when needed.  That is why these fictional stress tests are created.  

So, what can you do?  Tell your representative to stop the nonsense.  Let the bad banks fail and press the reset button.  In the meantime, secure your assets.