October 2008- Part III
Friday, 14 August 2009 10:20
administrator
| The Path to Hell is Paved with Good Intentions Part 3 of 3 |
So now what do we do?
What will happen? Some companies will fold from the lack of access to the credit markets, others will struggle and others will hobble along. The narcissistic banker will then explain the situation prophesying that small businesses fail because they can't survive in the marketplace. What remains unsaid is that the banker closed the doors to the marketplace. He did not support his customer. The banker created the failure. Just as we promulgate that sometimes the next loan will cause the company to collapse; the corollary is
that without a window at the credit department they will fail for lack of inventory, ability to collect receivables
Every small business person knows he has been estopped by the banks from obtaining new or increased credits. They have been shut out
for the last year even while the media was talking about how good things were. They know they will be cash restricted for the next 15
-18 months without access to the credit markets. They will have to work to provide internally generated cash to self-finance their
operations.
The real estate and mortgage markets will survive. The real estate market will recoup. Real estate has an average nine year cycle from
nadir to zenith. With notable exceptions for Florida, Arizona and Las Vegas as retirement, recreational and high growth areas and New
York and Los Angeles as the "go to the big time" hubs of business and entertainment; the balance of the country's real estate
market provides a safe investment opportunity when liquidity returns to the system. The media will be satisfied only when their NYC or
LA house value returns to their home prices to their original purchase price or the value on their last mortgage refi.
The government legislators, regulators and quasi-governmental agencies will survive. They will not accept any responsibility or
accountability for the massive problem they created. However, they will go to the media and explain how they are working to change and
save the system, how they will enact new legislation to fix this problem and they will investigate the collapse and all those who broke laws. In fact they are now in serious work "fixing" the financial crisis - that they created. $700 billion! The devil in the details includes the usual cast of characters to profit from the bailout (ACORN and TV and Movie Industry tax credits) and some newcomers (American Samoan Industrial Development Fund and NASCAR tax credits). Yep, this fix has all the makings of a Congressional boondoggle that will get mired in political mud and detris. It may also provide some market relief to the liquidity of the banking industry.
The banks on the other hand, have taken direct hits. There are those banks that found new ways to make money while reducing or eradicating portfolio risks in the last ten years. The most prolific tools to this have been:a.The usage of the Intermediary Markets. A fancy term for saying they passed along mortgage and chattel mortgage backed paper (auto and equipment loans) to the Investment Bankers in the form of Long Term Collateral Backed Securities. Traditional Auto Loans and Mortgages were transferred to Investment Banks, Fannie, or investment funds for fee income.
b.Small Business Lines of Credit were sold to larger bank credit card programs for a fee. c.The traditional lending criterion of "Capacity, Capital and Character" was replaced by a "Credit Score, Computerized Credit Analysis and Committee Approvals" providing reduced portfolio risk and no personal accountability to the approving officer.
d.Limited Direct Lending and greater reliance on Participation Agreements with larger banks that provided customers, loans, analysis and documentation and an income stream. Problem is with the reliance on that stream of loan activity is two-fold: 1. when the stream of participation loans slows the bank has no income; and 2. the larger banks use the participations to spread existing loans and the associated risks to smaller banks who assume greater credit risks.
e.The greater sales of Investment Funds in the banking centers converting insured bank savings accounts to uninsured money market funds for fees.
f.In effect, the bank took core deposits and let them be transferred to other institutions, now while those funds decline, the bank is
in the unenviable position of explaining to their depositors that they are uninsured non-bank funds are not in the bank;
g.The effect of reducing the portfolio risks by limited direct lending is there is a downturn in bank income. Did you ever think when you took out that 20 year mortgage you would survive the bank?
Banks are bearing the brunt of the losses most notably because as the train left the gate, they all tried to play catch-up. They
wanted more business and income. They became intoxicated with the income they could receive for doing less. As any teenager will
attest, if you make more for doing less - this is a good thing, Yes? Didn't anyone ever understand that the train was going to
slow down? Or more analogous, crash into the train that was the light at the end of the tunnel.
Business changes rarely come with advanced media attention, brass bands or bulletins from the Fed. Most business advances come quietly
and swiftly to provide the greatest advantage to the group that develops the widget. Several institutions have already fallen, more
are on the watch list at the Comptroller of the Currency's office and there are those that will fail for the reasons enumerated
above as collateral damage. They tried to play it safe, tried to elevate their status by associating with larger institutions or were
too lazy to do their own marketing and analysis.
The survival of the individual bank will depend on whether that bank is waiting for directions from Washington, the Fed, the State,
other Banks or they sit down now and develop a new action on its own. The key component should be a Survival Plan for the institution.
The plan will be difficult to generate as the key contributors are the Chief Executive, Operations, Financial, Lending and Auditing
Officers of the bank. It will require the approval of the Executive Committee and the Board of Directors. It needs to be done
immediately and quickly. Changes have to be implemented now. If the Survival Plan is bogged down by who is responsible, all is lost.
Someone will have to accept the responsibility and accountability later. After all, if I were to make a $50,000 loan and it collapsed,
a security officer would meet me at the office door with an empty box. He would load my personal items into the box, collect my Id
card and keys and escort me to the door of the unemployment office where I would register for $186 / week. If I lose a billion
dollars, I would expect no less.
Banks have to return to their communities and to traditional banking roles; Return the 3 "C's" of Lending: Character, Capacity
and Capital - remembering that the banking system has diminished the borrowers' Capacity and Capital by its actions and inactions.
It's time to stop the short cuts to quick, easy profits, short term profits in conflict with sustained long-term profitability and
restore our financial institutions to their previous levels of stability. Once this is done, the retail, construction, manufacturing
and services industries will recover..
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October 2008 - Part II
Friday, 14 August 2009 10:19
administrator
| The Path to Hell is Paved with Good Intentions Part 2 of 3 |
The Current Situation
Many months ago, in this newsletter we discussed the sources of problems in the economy restricting small business lending. The news media today asks, who is to blame? In that article we told you. It is a combination of: the Hedge Funds, the Banks (both Commercial and Investment) and the Government (both Legislators and Regulators). The financial credit market collapse is the result of the collective efforts of all of these sectors.
How?
Well, the Path to Hell Is Paved with Good Intentions.
What were those intentions? Create an arena for increased home ownership for everyone from the mighty rich to the down trodden poor. This wonderful concept would make it easier for everyone to own their own home. The poor would no longer be subservient or dependent on czarist landlords. The plan was advanced by leading politicians including President Clinton, Messrs Kennedy, Shumer, Dodd, Frank, Ms Pelosi and others. It was approached as the humanitarian thing to do with of the goal of raising the living standards of all Americans.
They proposed a plan and left it to their congressional legislative aides to craft and enact laws to support the plan. Once enacted, the law was transferred to the banking regulators to establish the operating rules and regulations to meet the standards of the law who would use all the governmental and quasi-governmental resources (FNMA and FHLMC) available to implement their regulations. They met the intentions of congress. They met the intentions of the standing president. They met the intentions of the organizations involved including governmental, quasi-governmental, non-profits, fund raisers - in all everyone. A perfect plan; UNTIL...
Bankers are heavily regulated. They hire teams of extremely good attorneys to assure they are meeting all the rules and regulations and to defend the banks from over zealous regulators exceeding their operational authorities. These are the best legal contract minds - the Wall Street Lawyers. These folks are hired because they were the best of the best in their class. They "apprenticed" for a long time before being loosened upon a client on their own. They KNOW how to read laws, regulations, notes, congressional testimony, etc. They are paid well because they KNOW, not because they FEEL.
What happens next? Well politicians celebrate and go to the media to tell everyone how great they are. The press exults them, they pat each other on their backs and ride that media release to reelection.
Wall Street has new rules to follow. What do they do? They call legal to assure they are in compliance and to see how the law effects their future operations. Is it not understandable then that the Wall Street lawyers break down the laws and regulations to meet their clients' needs?
So if everyone is only assuring that they are in compliance, how does it get out of hand? Good question. First, understand all the financial institutions know how the industry and the systems interact and how they work. They have worked in the industry and learned the intricacies of the nuts and bolts. The legislative attorneys have worked in the political arena and have textbook knowledge of all industries. That is, no practical financial operational experience. That is why they leave the details to the regulatory departments to prepare and promulgate the:
who, what, when, how, etc of the law.
The regulators' intrinsic prejudices are added to the enacted law as regulations, including a loathing of specialty financial products such as no-docs, leveraged loans and limited doc loans. These loans have been in the marketplace for decades but their use has been limited to small business people are unable to timely produce the paperwork requested by bankers, newly minted doctors and attorneys whose income will triple within three years. To regulators these products are to an elite class of people. These laws and regulations are the source of the current problems.
It does not take a rocket scientist to conclude that when you have the best legal minds that know how markets and internal systems work, they will develop the list of holes in the laws and regulations proffered by those who do not.
Once products are developed and approved by regulators with the approval of the legislators they are useless until they are supported and marketed by the quasi-governmental finance units, including Federal Reserve, Fannie, Freddie, Ginnie and the IMF. Anyone who does not believe these are political offshoots? See my thirty year old thesis on Politics equals Economics. Check who are the appointees and their sponsors. This Politics = Economics is not Free Market or Supply Economics it is basic Marxist Ideology. Washington insiders are the apparatchik. They like power and control but not responsibility nor accountability.
How is it that the Good Intentions of Home Ownership for Everyone was a failing proposition? To make it work, the regulations aver 'everyone qualifies for the credit based on a numerical credit score'. The undefined is the amount of the credit. This limit is whatever the applicant says he can afford to pay. Do first time homeowners really know what it costs to own a home? Can their pre-assessment of the home financing including taxes and insurance, repairs and maintenance, utilities be considered accurate? Well those were the rules and regulations.
How did it suddenly become predatory lending? Oh yes, the loans failed. Who made all of these bad decisions? Everyone from those above to the realtors and mortgage brokers, to the commercial lenders who were financing the mortgage bankers (see Countrywide and Bank of America) and onto Fannie and Freddie and ultimately the hedge funds took it to the Money Market Managers to enhance their bottom lines.
Once the train was out of the station, the steaming engine affected everyone throughout the chain: those who interacted with the sellers, the buyers / borrowers the bankers, the realtors and brokers. Life became easier for everyone to increase their sales and commissions because they didn't have to qualify the buyer to the house and if it failed it wasn't their fault!
Now, we are on the train to Dante's Third Ring of the Inferno. I believe some people listed in this article should receive Express Tickets to the Fifth Ring.
So now what do we do?Find out in our Wednesday's Special Edition of the Newsletter
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Last Updated on Friday, 14 August 2009 10:22
October 2008 Part 1
Friday, 14 August 2009 10:18
administrator
| The Path to Hell is Paved with Good Intentions Part 1 of 3 | Background:We are now experiencing the worst financial disaster in decades. For months I have been writing about the multitude of problems and the depth of the problems (see "Of the Bankers, For the Bankers and By the Bankers" and previous articles).
I have received feedback ranging from acknowledging the writer as "a pompous ass" to "wow! I didn't know that". Hereafter, I will assume you are now aware of the depths of the problems of which I have been writing. To date I have tried to direct the conversation to the affects on the average businessperson. The small businesspeople have borne the brunt of the bank actions from the beginning of the downturn for over a year.
Some background in banking economic procedures will help you to understand the economics of a bank's supply, demand and usage of money. There is a linkage between the Bond Market, Commercial Paper Market and Bank Lines of Credit. The credit rating of each is independent of the other. Yet, each credit rating system gives "credits" for having active use of the other credits in a strange way - much the same as when you apply for a mortgage you receive "credit" for having an existing mortgage, a car loan and a credit card.
Large Corporations actively move their debt from long term (bonds) to short term commercial paper and lines of credit) depending on the market conditions for rate, tight money supply, future corporate events (such as acquisitions or sales). This is the duty and responsibility of a CFO to manage the company's cash flow and interest expense. A couple of snapshot definitions of each: Bond - a registered Debt Obligation bearing a term of a minimum of 1 year and 1 day; Commercial Paper - a registered Debt Obligation issued by the Borrower to carry short term cash requirements of the company backed by the company's available bank line(s) of credit and Bank Line(s) of Credit are short term loans to carry working capital needs where the lender sets terms and conditions.
A cursory review of the above will tell you that the company CFO would prefer to borrow using Commercial Paper because he controls the terms and conditions. What is in it for the banks? They provide a Line of Credit, receive an annual fee, create a business relationship and generally, do not advance money to the borrower; a Business Credit Relationship without using cash. Where is the Problem? In tight money markets when they cannot issue their commercial paper, it is better for the CFO to borrow the banks' money. In this case, the bank's CFO now has
to scramble to make cash available to fund borrowing under the line of credit. The bank meets the large corporations' needs leaving little cash for the remainder of the bank's customers. This generally also means that the bank is lending dollars at just above their par foregoing the higher rates paid by the small business community. Bank income drops. To meet the demand, the bank increases the terms and conditions on the small business. In theory, this cuts loan demand. In actuality it begins a spiral of losses to the small business economy.
Following the Commercial Paper Market, one is capable of foreseeing what will happen to businesses across the economy in 12 to 18 months. I have used this Market as the Key Indicator of the economy. What the Stock Market does is not an Economic Indicator, it is the scorecard of the Investment Bankers Marketing Machine. The current Stock Market drop ("da Bears win!") is the result of the money supply conflict created by diminished borrowing capacity of investors and the portfolio managers requirements to keep cash reserves in their portfolios. Smart portfolio managers will earn money profits and take large tax losses while the value of their portfolios shrink. One thing certain: Investment Bankers know and understand numbers. |
Last Updated on Friday, 14 August 2009 10:23
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