All the world’s a stage,
And all the men and women merely players
They have their exits and their entrances
And one man in his time plays many parts
The greatest action is not conforming with the world’s ways…
The greatest effort is not concerned with results…
—the Buddhist teacher Atisha
It is now 4 months since I wrote The Decline of the American Empire. The time is ripe for a follow-up. I will tell a sad story first, talk a little about our precarious banking system, and then relate the lessons learned back to my Decline theme. At the end I will talk about what all this means for the loosely structured peak oil “movement”.
This is important stuff, folks. America’s tragic decline is affecting your life everyday. I urge you to read through this through from beginning to end, even if doing so is painful. (As usual, I feel compelled to document everything I write so that current and future readers fully understand the context of my remarks.)
CIT Files For Bankruptcy, Taxpayers Lose
I was watching Tech Ticker’s Aaron Task and Henry Blodget interview Professor William Black, a former top federal banking regulator, on the CIT bankruptcy (AP, Yahoo). Why should you care about CIT? “For over 100 years, CIT has provided lending, leasing & advisory services to small and middle market businesses.” But now—
[CIT's] Chapter 11 filing is one of the biggest in U.S. corporate history, following Lehman Brothers, Washington Mutual, WorldCom and General Motors…
CIT is the financier for about 2,000 vendors that supply merchandise to more than 300,000 stores, many of which are gearing up for the critical holiday shopping season. They rely on the lender to cover costs ranging from paying for orders to making payroll. Any disruption caused by bankruptcy could wreak havoc on their operations, [said] Joe Alouf, a partner with Eaglepoint Advisors…
“CIT is the 600-pound gorilla in the industry,” Alouf said.
Put that in your pipe and smoke it.
CIT received $2.3 billion from the U.S. Treasury on December 31, 2008 when the Treasury purchased CIT preferred stock and warrants (Bloomberg). CIT’s senior bondholders will receive 70 cents on the dollar but we taxpayers will not get any of that money back.
“We will be following developments very closely with an eye towards protecting taxpayers during the bankruptcy proceeding,” Treasury spokesman Andrew Williams said today in an e-mailed statement. “But as the company’s disclosure on the prepackaged bankruptcy makes clear, with debt holders receiving less than face value of their instruments, recovery to preferred and common equity holders [including the taxpayers] will be minimal.”
[My note: Recovery for preferred equity holders will be "minimal", that is to say — zero.]
Professor Black comments—
We put ourselves on the hook in a completely inept way where we lose first. We lose entirely as the taxpayers. It’s just like the AIG bailout… [we shouldn't have had to pay the AIG counter-parties at par, i.e. 100% of claims.]
Why do we keep a Treasury secretary [Tim Geithner] who negotiates supposedly on behalf of the United States of America that does the opposite of what any commercially reasonable person would do … it’s like he burned billions of dollars again in government money, our money, gratuitously.
Blodget then asks “what was the thinking, if we assume that this was not just bad faith, that in fact it’s just incompetence, what was the thinking [by the Treasury] at the time?” Here is the gist of the discussion that follows. Black believes the Treasury, flying in the face of reality, would argue that—
If we [the Treasury] had put ourselves up as senior bondholders in CIT charging a high rate of interest on our $2.3 billion investment, we would have simply increased CIT’s debt obligations rather than providing equity to the company, and CIT would have died. Since CIT could not meet its debt-carry already, we would have made it obvious that they were insolvent.
The Treasury would not admit that CIT was insolvent. Instead, they pretended CIT had a temporary liquidity problem, so they gave them $2.3 billion of the taxpayer’s money. If the Treasury had protected the taxpayer money they put into CIT, it would have exposed CIT as insolvent, which of course they were! Got it?
And now CIT is officially bankrupt, an outcome which was unavoidable. Black comments on the Treasury’s apparent “logic”—
I’m not a psychotherapist… [laughs] … It’s the insanity of not resolving insolvent places, and instead feeding money in, good after bad… it’s a trap, I can’t cause a liquidity crisis by charging much interest, I can’t make myself [a] senior [bondholder], we just hose money down the drain… The answer to accounting fraud is more accounting fraud… You hide the losses, and you let them grow, and you hope they’ll get better.”
Hiding the losses, letting them grow, and hoping they’ll get better is known as Extend & Pretend. Black believes “the [denial] problem stems from regulators’ fears that if the banks recognize a loss on the bad assets [they hold], it will create a domino effect that will wipe out the entire financial system.”
So in the story above, where it says CIT, you could substitute Citigroup, or Bank of America, or Wells Fargo, or JP Morgan Chase, etc. The only difference between CIT and Citigroup is that the latter was deemed Too-Big-To-Fail whereas CIT was not.
That’s the end of this sad story. As you read on, remember Henry Blodget’s important qualification: if we assume that this [CIT deal] was not just bad faith.
Extend & Pretend
This chart from Rolfe Winkler’s Banks’ Capital Cushions: Thicker, But Still Not Comfy scares the bejesus out of me (Figure 1 and the quote below).
Figure 1 — Leverage = Tangible Common Equity/Tangible Assets. From Winkler: “Measured by tangible common equity, the biggest banks are levered [on average] 20 to 1, a solid improvement from last quarter’s 24 to 1 and a giant leap from 30 to 1 in the third quarter a year ago. (These figures exclude off-balance sheet assets, which will increase leverage when they are consolidated beginning next year)… Now it’s up to regulators to deliver higher capital requirements so that banks can withstand the end of government support. After all, 20 to 1 leverage is still very high. It only looks prudent against the insane levels reached last year.”
Tangible common equity is the crucial measure of bank capital because it is the primary cushion banks have to absorb losses. When it gets too low, creditors panic and bank runs ensue. From a systemic risk perspective, it’s great that banks are rebuilding this cushion.
The crucial question is how they’ll fare in a less favorable monetary environment. While consumer prices show little sign of inflating, asset prices are another story. Interest rates near zero have encouraged investors to chase risky assets. If that trend continues, the Fed may have to unwind its balance sheet and raise rates sooner than it would like, putting banks in a tough position.
FBR Capital Markets points out in a recent note to clients that many banks have poured excess liquidity into their securities portfolios, “which could present significant interest rate risk” when the Fed reverses course.
Compared with last year, the top 10 commercial banks have increased the size of their securities portfolios nearly 40 percent, with JPMorgan Chase’s rising over 150 percent.
I discussed the dangers of the carry-trade asset bubble fueled by free dollars in Big Crash Coming? If asset values suddenly deflate once the Fed unwinds its balance sheet and raises interest rates, the banks will be imperiled to the extent that they have purchased these risky assets to inflate their balance sheets. There are also concerns about increased bond purchases by the banks—see Bank Insolvency Is Not A Dead Issue by Daniel Aaronson and Lee Markowitz.
For bank solvency, loan portfolios may be a greater danger than investments in Treasury bonds or riskier securities (Figure 2).
Figure 2 — As of September 1, 2009, the banks held $3.776 in outstanding real estate loans. Source: FRED.
Here is the crucial passage from Winkler—
And while securities prices are more immediately sensitive to monetary policy, loan portfolios would be impacted as well. Early next year, after the Fed turns off its printing press and after the home-buyer tax credit expires, real estate prices could resume falling. This will put more owners upside down on their loans, keeping default rates high.
Banks are extending loans, pretending that asset prices will recover past peaks, an unlikely prospect if the Fed does its job.
[My note: "Upside down on their loans" refers to negative equity in which you owe more on your mortgage than your house is worth. This is also called being underwater.]
Extend & Pretend. This is a variation on the CIT theme presented above, in which the Treasury extended credit (through stock purchases) to CIT and pretended they were solvent.
The real estate market in the United States continues to be very shaky. I could write an entire column on this subject, so I will just touch on a few high points here, relating the market weakness to officially sanctioned delays in which banks do not fully account for their actual losses. To wit—
Of course a bank can not re-finance (extend) an Option ARM home mortgage and pretend everything will work out once the property goes into foreclosure. But it is the deteriorating CRE market that makes the Fed nervous.
Prices of existing commercial properties have already declined substantially from the peak in 2007 and will likely decline further. As job losses have accelerated, demand for commercial property has declined and vacancy rates have increased…
As a result, Federal Reserve examiners are reporting a sharp deterioration in the credit performance of loans in banks’ portfolios and loans in commercial mortgage-backed securities (CMBS). At the end of the second quarter of 2009, approximately $3.5 trillion of outstanding debt was associated with CRE, including loans for housing developments. Of this, $1.7 trillion was held on the books of banks and thrifts… Also at the end of the second quarter, about 9 percent of CRE loans in bank portfolios were considered delinquent, almost double the level of a year earlier…
Of particular concern, almost $500 billion of CRE loans will mature during each of the next few years…
[My note: Read Jon D. Greenlee's full testimony (link above) for all the grim details. He is the Fed's top bank regulator.]
This is where things get interesting. Federal regulators have issued new guidelines for Extending & Pretending! These guidelines are apparently a kind of “how-to” guide for the banks. The Wall Street Journal reported on the new rules in Banks Get New Rules on Property on October 31, 2009.
Federal bank regulators issued guidelines allowing banks to keep loans on their books as “performing” even if the value of the underlying properties have fallen below the loan amount.
The volume of troubled commercial real-estate loans is skyrocketing. Regulators said that the rules were designed to encourage banks to restructure problem commercial mortgages with borrowers rather than foreclose on them. But the move has prompted criticism that regulators are simply prolonging the financial crisis by not forcing borrowers and lenders to confront, rather than delay, inevitable problems… [i.e. Extend & Pretend]
Regulators have been expressing increasing concern that problems in commercial real estate could unglue the nascent economic recovery by slamming financial institutions with billions of dollars in new losses. FDIC Chairman Sheila Bair told a Senate subcommittee earlier this month that reworking the terms of these loans could help banks avoid larger losses. She likened it to the push regulators made last year for banks to rework troubled residential mortgages.
About $770 billion of the $1.4 trillion commercial mortgages that will mature in the next five years are currently underwater, according to Foresight Analytics. As of last week, 106 banks had failed this year, the most since 1992—the peak of the savings-and-loan crisis. Regional and community banks especially have been paying dearly for their aggressive push into commercial real-estate lending during the boom years.
This concludes my brief summary of where we stand concerning the real estate markets and looming bank losses. As with the Treasury’s investment in CIT, the strategy of choice is denial—Extend & Pretend. How does this relate to my original article The Decline of the American Empire? It’s no great surprise that the relationship is simple and straightforward.
More Futility—And Bad Faith, Too
In the Decline article I presented the Vicious Circle of Futility—it’s kind of a Buddhist Wheel of American Suffering. Here it is again with the original caption (Figure 3).
Figure 3 — As problems become more intractable over time, our resistance to making real changes to confront those problems, our social inertia, becomes more entrenched. Thus the solution to debt-based economic problems is more debt. The solution to liquid fuels problems is marginally more fuel efficient cars, not alternatives to driving. We study an expansion of the rail system instead of building one to provide an actual alternative to flying or driving between cities. We dream of hypothetical biofuels in the far-off future to solve an oil supply problem in the here & now.
The only real difference between my remarks here and those in my original article is that this time I am relating the vicious circle to the wacky world of make believe bank solvency. And if you think about it, what’s the difference between Extend & Pretend and Futility’s Vicious Cycle? There is no difference. Conceptually, they are identical.
The problem is Bank Solvency. Social inertia manifests as dithering or active obstruction by banks, Federal regulators, the Fed, the Treasury, and the Congress. The President talks pretty, but does nothing of substance. Unrecognized bank losses continue to pile up but resistance to remedial actions and reform in Finance only becomes more entrenched. Policy-makers act as if the crisis does not exist. Futility reigns as we approach a new day of reckoning.
As Professor Black said above, “it’s the insanity of not resolving insolvent places … [but] instead feeding money in, good after bad.” The longer this unwillingness to come to grips with reality goes on, the more likely it becomes that the banking system will blow up again, and again take all of us down with it.
Let us explore another aspect of America’s decline. You will recall that Tech Ticker’s Henry Blodget qualified his question to Professor Black, assuming that this [CIT deal] was not simply a matter of bad faith. He framed his question in terms of Tim Geithner’s incompetence instead. There is little doubt that Geithner is incompetent, but that’s not the whole story.
I am not criticizing Henry Blodget, whom I respect, when I say out loud what he didn’t care to go into: the entire Finance reform issue has been a charade, a matter of Bad Faith, since the October, 2008 post-Lehman meltdown. Here is the legal definition of Bad Faith—
The fraudulent deception of another person; the intentional or malicious refusal to perform some duty or contractual obligation.
In this case, the fraudulent deception has been carried out against the American People by the Too-Big-To-Fail Banks in cahoots with the Federal Reserve, and the Executive (e.g. the Treasury, the regulators) and Legislative branches of government. It is plainly the duty of the Federal government, if not that of the banks, to reduce our exposure to insolvent banks which pose a systemic risk should they fail.
The law always imputes intentionality. Hence the definition of Bad Faith. But I don’t care whether this is a complex conspiracy—a conscious collaboration—between the banks and policy-makers, or whether it’s just that all these people see things exactly the same way—an unconscious collusion. Nothing relies on this distinction, for it does not change the ultimately destructive effects of an unreformed Finance system.
(However, if you follow the money, apparent influence is exactly where you’d expect it to be. And if you look at Tim Geithner’s appointment book, he does spend an inordinate amount of time on the phone with the heads of Goldman Sacks, Citigroup and JP Morgan Chase. As usual, we can prove nothing.)
In perpetuating this fraud, Wall Street & Washington ensure that we are forever stuck on the Futility merry-go-round.
I would have to write a book to fully document the persistent pattern of government catering to Big Finance. Like Kevin Phillips, many people have written one or are doing so now. The entire raison d’etre for Simon Johnson’s Baseline Scenario is to tell you about this stuff everyday. So I will only mention a couple egregious recent examples of Bad Faith here. And away we go—
The “Stability Improvement” act applies to a super-secret list of institutions who will be regulated by the Treasury secretary and other regulatory ne’er-do-wells. The Fed will supervise this group of never-to-revealed-to-the-public super-sized institutions. No one will be accountable to the public for anything this group does or does not do. Perfect!
The Obama administration and the Congress are putting forward a new plan to handle the next, inevitable round of Too-Big-To-Fail bank failures instead of breaking up large institutions that pose a systemic risk. Rather than dispose of the problem, the government proposes to drain the rest of the banking system and put ordinary citizens—those of us who are not Masters of the Universe— at risk again. The Powers-That-Be would rather bend over backwards to preserve the status quo than put JP Morgan Chase or Citigroup out of the rent-seeking business (whereby one obtains competitive advantage through political manipulation).
Nobody, including Barney, seems to have asked a pertinent question. What happens when runs on 3 or 4 Too-Big-To-Fail banks cause them all to fail more or less at the same time? See Rolfe Winkler’s article cited above. This would have happened in October, 2008 if then Treasury secretary and former giant vampire squid CEO Hank Paulson hadn’t extorted us—ah, sorry, I meant “scared us silly”—to get $700 billion from Congress to bail out the banks.
What was it Einstein said? Insanity is doing the same thing over and over again and expecting different results.
Here’s a second item from Yves Smith at Naked Capitalism—
And what happened to genuine reformer Rob Johnson? Congresswoman Melissa Bean (D, Ill), filling in for the curiously absent Barney Frank, cut his testimony short. At first, Johnson refused to quit.
Johnson gamely continued. “When I hear the testimony today that are largely financial institutions and end users, I believe that I represent a third group that comes to the table, which is the taxpayers, the working people of the United States,” he said.
But Melissa, whose 2009-10 campaign committee has collected $107,700 from the Securities and Investment industry, cut Johnson off again. And then came the final insult, not only to Johnson, but to all of us—
The House Financial Services Committee has refused to publish [Johnson's] testimony, offering “the dog ate my homework” level excuses, first that they hadn’t gotten it, then that it was in the wrong format, then that their IT department was experiencing difficulties (always a good one when real reasons are running thin). The last one was pure Catch-22: that he had gotten his written testimony in too late.
You can read Johnson’s statement to the committee, which they themselves never heard or published, at the Roosevelt Institute.
It’s Bad Faith everywhere you look. There is no escaping the Futility’s Vicious Circle in the current, entrenched political arrangement. As with the all-encompassing Buddhist Wheel of Suffering, our tragic Fate appears to be Cast In Stone.
Mike Shedlock (Mish) of Global Economic Analysis asks Where the Hell Is The Outrage? That’s a good question, but it appears that the American people are now incapable of fostering the revolutionary acts required to take down the corrupt clowns that govern us. If we elect a new set of bozos in 2010 and 2012, we will quickly find out that the words have changed but the song remains the same.
If you doubt that entrenched power and corruption runs very, very deep, I suggest you watch Bill Moyers’ interview with Glenn Greenwald. Washington is now a place unto itself. Those of us outside the Beltway are merely a backdrop that lends the Capital a false sense of legitimacy. Empires in decline always go through this phase.
Those of us who have written about the dangers of peak oil, declining domestic oil production, and recessions accompanying oil price shocks must come to grips with the Vicious Circle of Futility. If our goal was to promote public interest and understanding in these problems, we have succeeded to some extent. Sophisticates in the university and investment communities know all about peak oil. It’s mostly denizens of our Nation’s capital who have never heard of it.
We must also come to grips with Bad Faith. If our interest was to foster policy actions to mitigate future oil supply problems, we have failed and will always fail. We are merely bit players on the Wheel of Suffering. In this, we do not differ much from those concerned about health care costs—Congress has done nothing, climate change—Congress has done nothing, and Financial Reform—Congress has done nothing. In this sense, we are like any other group with a cause, no more, no less.
(Of course, many would argue that peak oil is a civilization-changing issue, and they are right. But we are living & doing things now, not a decade from now or two decades from now.)
This is not to say that we have wasted our time raising concerns about energy availability—far from it. I am merely describing the hand we’ve been dealt. We have to play the cards we’re holding. Progress is always an illusion anyway. Oil made lots of stuff possible, but the Really Big Picture tells us that oil comes and oil goes.
Many people don’t realize that it’s hope that’s killing them. Almost invariably, our greatest hopes are dashed. When we realize that our hopes are unattainable, disillusionment and bitterness often follow. And then, maybe, wisdom. This is the Human Condition. It is our Fate to live in Times when we are much closer to the end of the American Empire than we are to its beginning. When life gives you lemons, make lemonade.
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