Friday, January 23, 2009

10Yr Gov’t Bond Spreads in the EU

Above is an interesting chart showing the widening spreads of some of the most at-risk EU countries including Italy, Greece, Spain, and Ireland. Reflecting the country’s deflating housing bubble and weakening economy, S&P downgraded Spain’s sovereign credit rating from AAA to AA+. Shockingly, Ireland’s rating is still AAA, despite the recent nationalization of Anglo Irish Bank (Ireland’s 3rd largest bank) and expectations for a GDP deficit of as much as 9.5% in 2009. As pointed out by several pundits, Ireland is contending with a deflating housing bubble far more severe relative to the size of its economy than is the United States.

With the diverging fortunes of the countries composing the EU, I wouldn’t be surprised to hear rumblings about breaking up the union. Two key tests must be met in order to comply with EU rules: 1) government deficits must be less than 3% of GDP and 2) government debt must be less than 60% of GDP. However, preliminary forecasts suggest that all the aforementioned countries will violate one or both of these provisions in 2009. While failing to meet these minimum thresholds will likely be tolerated in 2009 (what choice do they really have!), the strength of the euro could be compromised if creditor nations begin to lose confidence in the currency. My own personal belief is that the likes of Germany will not want to be dragged down by its weaker peers.

In my opinion, Spain appears most at risk and I have reflected that view by being short the etf EWP over the last year. This September 2006 WSJ article awakened me to the impending housing bubble facing the country. ("Spain's Housing Boom Faces Test".)

The following paragraph from the article sums up the mess pretty clearly - “Despite millions of empty homes, construction activity appears to be picking up. Spain has been building more houses than France, Britain and Germany combined for the past five years straight. In the first half, housing starts accelerated to 15%. Spain, with 44 million inhabitants, is on track to build 760,000 new homes this year, nearly half as many as the U.S., which has a population that is seven times as large."

The canary in the coal mine came with the July 2008 bankruptcy of Martinsa-Fadensa, Spain’s largest property company. As the slow moving train in the US has taught us, it is only a matter of time before a slowdown in the construction sector begins to infect the rest of Spain's economy.

Thursday, January 22, 2009

Political Interference Misallocates TARP Money

I always wanted to know how Japan’s economy could remain in a multi-decade recession despite clear evidence that the government was propping up an insolvent banking system. As suggested in today’s front page WSJ article (“Political Interference Seen in Bank Bailout System”), it appears the US is poised to go down the same route should the government continue infusing capital in institutions that would be better off failing (at least from the standpoint of the overall economy). Government actions are preventing the free flow of capital to institutions best equipped to lead the restoration of our banking system and ultimately our economy.

Political Interference Seen in Bank Bailout Decisions
JANUARY 22, 2009
Barney Frank Goes to Bat for Lender, and It Gets an Infusion

Troubled OneUnited Bank in Boston didn't look much like a candidate for aid from the Treasury Department's bank bailout fund last fall.
The Treasury had said it would give money only to healthy banks, to jump-start lending. But OneUnited had seen most of its capital evaporate. Moreover, it was under attack from its regulators for allegations of poor lending practices and executive-pay abuses, including owning a Porsche for its executives' use.
Nonetheless, in December OneUnited got a $12 million injection from the Treasury's Troubled Asset Relief Program, or TARP. One apparent factor: the intercession of Rep. Barney Frank, the powerful head of the House Financial Services Committee.
Mr. Frank, by his own account, wrote into the TARP bill a provision specifically aimed at helping this particular home-state bank. And later, he acknowledges, he spoke to regulators urging that OneUnited be considered for a cash injection.
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The Washington Times /Landov
Rep. Barney Frank (D., Mass.), seen here leaving a December news conference, urged regulators to consider TARP money for a local bank.
As President Barack Obama's team sets about revising the $700 billion TARP program, following last week's release of the second half of the money, among the issues it faces is widespread dissatisfaction with way the program has been implemented. Treasury Secretary nominee Timothy Geithner, testifying Wednesday at his Senate confirmation hearing, acknowledged "there are serious concerns about transparency and accountability...confusion about the goals of the program, and a deep skepticism about whether we are using the taxpayers' money wisely."
Bankers, regulators and politicians complain of a secretive and opaque process for deciding which banks get cash and which don't. The goal of aiding only banks healthy enough to lend -- laid out by the Treasury when the program began -- clearly seems to have shifted, but in a way that's hard to pin down and that the Treasury has declined to explain. Part of the problem is that some powerful politicians have used their leverage to try to direct federal millions toward banks in their home states.
"It's totally arbitrary," says South Carolina Gov. Mark Sanford. "If you've got the right lobbyist and the right representative connected to Washington or the right ties to Washington, you get the golden tap on the shoulder," says Gov. Sanford, a Republican.
Several Ohio banks received funds after Ohio's congressional delegation complained bitterly about the treatment of Cleveland-based National City Corp., which regulators forced into a merger rather than provide with cash. And in Alabama, the state's top banking official says a windfall there -- five banks are slated to receive funds -- is testament to the influence of two powerful Alabama lawmakers who sit on key congressional committees.
TARP Funds by State
Click below for a sortable chart and interactive map detailing allocations by state and by institution.

More on the Bailout
On Dec. 3, Rep. Spencer Bachus (R., Ala.) forwarded a Dec. 2 letter from Alabama bank regulators complaining about the complexities of applying for federal funds. Alabama banks later received billions in funds.The FDIC and Massachusetts slapped OneUnited Bank in Boston with a cease and desist order on Oct. 27, 2008, less than two months after it received $12 million in capital from Treasury.A link between such lobbying and the release of TARP cash can't be proved. Treasury officials have said that political influence plays no role in the selection process. "The decisions are made by a committee of officials at Treasury based on recommendations and data provided by the regulators through the applications process," said Brookly McLaughlin, who was a spokeswoman for the Treasury until the Bush administration ended on Tuesday.
Restoring Credit Flow
Treasury and Federal Reserve officials have repeatedly said the TARP program was successful in its primary purpose, which was to bring the credit markets back from the precipice.
The task of further restoring credit flow now falls to Mr. Obama's team, which has spoken in favor of pumping more money into banks, as has Fed Chairman Ben Bernanke. The new administration is weighing a range of ideas, including using at least $50 billion of the TARP money to prevent foreclosures, and possibly other measures such as setting up an "aggregator bank" to hold toxic assets now burdening banks' books.
The federal plan to invest in banks was controversial from the start. The Treasury said it would acquire preferred stock in banks, and sometimes warrants for common stock as well, but not any voting or management rights. Within the broad structure known as TARP, this is called the Capital Purchase Program.
At a hastily arranged meeting on Oct. 13, then-Treasury Secretary Henry Paulson basically forced the chiefs of the country's nine biggest banks to accept cash infusions. The government invested $125 billion in the nine. Citigroup Inc. and Bank of America Corp. subsequently returned for more money.
A further $125 billion was committed under the Bush administration to buy stakes in some of the remaining 8,500 U.S. banks and thrift institutions. More than 250 have received cash or commitments so far, totaling about $68 billion. The recipients range from large regional banks to Saigon National, a 12-employee lender catering to Vietnamese-American businesses in Southern California.
The procedure for getting a capital injection is complex. State and federal regulators sometimes complain that even they don't understand how it works.
A bank applies through its federal regulator, which either recommends to the Treasury that the bank receive money or quietly tells the bank to pull its application. A public turndown could be a death sentence because it would tell investors and consumers the government thinks the bank isn't viable.
If the regulator forwards the application, the Treasury decides whether to approve it. If the Treasury's reviewing team is uncertain, it sends the request to a panel of federal regulators to debate the matter.
The results have many in the industry scratching their heads. Two banks in Green Bay, Wis., have received federal investments. But in Arizona, a state hit hard by the housing slump, officials say they are perplexed that a dozen or so state-chartered banks haven't heard back from Treasury about the status of their applications.
Arizona's banking superintendent, Felecia Rotellini, says she is teaming up with local bankers and state legislators who plan to start lobbying Arizona's congressional delegation for help. "Some states are getting better treatment, and we just want it to be a level playing field," Ms. Rotellini says. "I think it's just a question of advocacy. It has to be a congressional voice."
A body set up to monitor the program, the Congressional Oversight Panel, has said the process of allocating money lacks transparency and accountability. The Treasury declines to explain why one bank is chosen for a federal investment and not another. Those that receive federal cash sometimes boast they have a government seal of approval, leaving banks that are shut out facing awkward questions about why they didn't.
In mid-October, days after summoning the nine big-bank executives to Washington to accept aid, the government took a far different approach with Cleveland's National City, which was struggling with soured real-estate loans.
National City executives consulted with their examiners at the Office of the Comptroller of the Currency, which is a division of Treasury, about whether they should apply for a capital injection. Local OCC officials gave them the green light, according to people familiar with the matter.
In Washington, National City got a chillier reception. The company was facing mounting losses stemming in part from its ill-timed purchases of two Florida banks shortly before the state's real-estate market imploded. Comptroller of the Currency John Dugan informed National City executives they shouldn't apply because their bank was too weak. Instead, he told the bank to sell itself. Within a week, it agreed to a $5.6 billion takeover by PNC Financial Services Group Inc. in Pittsburgh. (PNC declined to comment.)
A political firestorm erupted in Ohio when it became clear the government had turned down National City, a 163-year-old bank with deep roots in Cleveland. Ohio's congressional delegation sent dozens of letters to Messrs. Dugan and Paulson and threatened to hold hearings on how the Treasury had supposedly wrecked a bank they said wasn't in immediate danger of collapsing.
Some lawyers, bankers and analysts say the case marked a turning point in the Treasury's handling of capital injections. For one thing, since then, some weak regional banks have pocketed billions of dollars in TARP funds.
In addition, Ohio banks are now faring better. Twelve Ohio banks have subsequently received a total of $7.7 billion in taxpayer funds. In neighboring Michigan -- like Ohio, hurt by the auto-industry slump -- only two banks have had federal infusions and a third has preliminary approval, for infusions totaling $638 million.
Among the Ohio beneficiaries is Huntington Bancshares Inc., of Columbus. It received a $1.4 billion federal investment in November, even though, like National City, it was hurt by souring real-estate loans and the weak regional economy. Amid mounting losses, the bank last week replaced its chief executive.
In Alabama, Colonial BancGroup Inc. asked for Treasury cash in November. With its application blessed by its state regulator and the Federal Deposit Insurance Corp., the Montgomery bank figured it was a shoo-in for funds, say people familiar with the bank.
Real-Estate Loans
But because Colonial was weighed down by real-estate loans, the Treasury sent the bid to its panel for reviewing controversial applications, consisting of four federal regulatory bodies: the FDIC, the Fed, the OCC and the Office of Thrift Supervision. Negotiations lasted several weeks. Eventually, the Treasury gave preliminary approval to Colonial's request for $550 million in capital.
The slow process infuriated Alabama officials. The same day that Colonial announced its application had been approved, Trabo Reed, Alabama's deputy banking superintendent, wrote a letter to Rep. Spencer Bachus of Alabama, the top Republican on the House Financial Services Committee, complaining that the government had dragged its feet and kept banks and state officials in the dark. The letter didn't specifically cite Colonial (which had no comment).
Rep. Bachus's office forwarded the letter to the heads of bank regulatory agencies and asked them to examine the situation. Since the letter was forwarded, two more Alabama banks have received TARP funding. Five Alabama banks, including Colonial, are slated to collect a total of about $4.2 billion.
In all, about 50 state-chartered Alabama banks applied, according to state banking superintendent John Harrison. He says his office helped shepherd them through the process, figuring that "the more applied, the more had the chance to get it."
Mr. Harrison says that in addition to Rep. Bachus, Alabama Sen. Richard Shelby, the ranking Republican on the Senate Banking Committee, "has been a big proponent for Alabama state-chartered banks...and he was really concerned that the TARP money went here." The banking official added: "We're blessed with a U.S. senator that was on the banking committee and Spencer Bachus being the ranking Republican" on the House panel. "I think [the Treasury] got the message."
Aides to Rep. Bachus said he did nothing more than forward Mr. Reed's letter and ask for consideration. Sen. Shelby has consistently opposed the financial-system bailout. His office denied that he was involved in helping Alabama banks get money. "Sen. Shelby has never intervened on anyone's behalf for TARP money," an aide to the lawmaker said.
The bank that Rep. Frank of Massachusetts went to bat for, OneUnited, saw its capital level sink in early September after the U.S. took control of the overextended mortgage giants Fannie Mae and Freddie Mac. OneUnited, a closely held Boston-based lender with offices in Florida and California too, held large amounts of Fannie Mae preferred shares. Their value plunged after the U.S. put Fannie and Freddie into a federal conservatorship, acquired preferred shares in them and took warrants entitling the government to nearly 80% of their common stock.
The moves left OneUnited's capital badly depleted. A measure called "Tier 1 risk-based capital" equaled only 1.88% of assets at the bank, versus a desired level of about 6%. A OneUnited lawyer, Robert Cooper, says he called Rep. Frank and Rep. Maxine Waters of California, both Democrats, to complain that the Treasury's move had hurt the bank.
Rep. Waters heads the House Financial Services subcommittee on housing, and until last spring her husband, Sidney Williams, was a OneUnited director. Rep. Frank, besides heading the Financial Services Committee, has longstanding ties to OneUnited, and recalls having had a deposit account at a predecessor bank in the 1960s.
Later that month, Rep. Frank was intimately involved in crafting the legislation that created the $700 billion financial-system rescue plan. Mr. Frank says that in order to protect OneUnited bank, he inserted into the bill a provision to give special consideration to banks that had less than $1 billion of assets, had been well-capitalized as of June 30, served low- and moderate-income areas, and had taken a capital hit in the federal seizure of Fannie Mae and Freddie Mac.
"I did feel that it was important to frankly try and save them since it was federal action that put them into the dumper," Mr. Frank says.
Porsche for Executives
On Oct. 27, the FDIC and Massachusetts bank regulatory officials, alleging poor lending practices and executive-compensation abuses by OneUnited, slapped it with a strong enforcement action, a cease-and-desist order. Among other things, the officials told the bank to get rid of a 2008 Porsche for executives.
Mr. Cooper, the bank's attorney, dismisses the order as a "hastily cobbled together" action. "What we are talking about is a hiccup, a blip on the screen of an otherwise-stellar enterprise," he says. Asked whether the bank had sold the Porsche, he said only that it was complying with the order.
Mr. Frank -- who has played a leading role in both the initial design of TARP and current planning to revamp it -- says he spoke with a federal regulator and asked that OneUnited be given consideration for TARP money, "without in any way impinging on their general safety and soundness rules." Mr. Frank said he didn't remember which federal regulator he spoke with.
On Dec. 19, OneUnited received $12 million from the Treasury, on condition it raise $20 million from its shareholders, which it did.
Ms. McLaughlin, the spokeswoman for the Bush administration Treasury, said that OneUnited's application was subject to the same review process as other banks faced.
Mr. Frank said he didn't try to interfere with the regulatory process. "We have never told the regulators that they should ease up on them or not order them to do this or that," he said.
He cites the bank's status as the state's only financial institution owned by African-Americans. "We did say, yes, I thought it would have been a social tragedy if the one minority bank in Massachusetts that has been working so hard and had been overextended into housing was to be wiped out by a federal action, the Fannie-Freddie preferred [shares] thing, and that's why I think it was important to try to help them."
Rep. Waters said she was unaware that the bank received money. OneUnited was "just a small" bank, she said.
Write to Damian Paletta at and David Enrich at

Friday, January 9, 2009

Germany's Failed Bond Sale - Ominous Sign?

On January 7th, an auction of 10-yr bonds by the German government failed to attract enough bids to meet its €6 billion goal. According to the Financial Times (German bond sale’s fate signals trouble ahead), "bids of €5.24bn amounted to the second worst auction on record in terms of demand." This is a particularly ominous sign for governments around the world that hope to raise an estimated $3bn of debt in 2009.

Several countries should be concerned by this recent development, including the US (obviously!), the UK, Spain, Italy, and Belgium. The FT notes that Spain and Belgium had to cancel recent offerings due to a lack of demand, while the UK and Italy were able to meet their auction targets, but at higher yields than initially targeted.

Undoubtedly, the US could face similar pressures in the weeks and months to come. Two key factors will likely keep rates low in the near-term: 1) Significant risk aversion on the part of investors and 2) the Fed's signaling that they will buy longer term treasuries. However, an absence of foreign buyers (i.e. Japan and China) in upcoming auctions and growing concern over the US's balooning budget deficits (i.e. "trillions of dollars for years to come" as suggested by Obama), will most certainly undermine these countervailing forces in due time.

As Jim Grant likes to quip, treasuries are poised to offer "return-free risk." Absent a Japan-like depression in the US, I'm guessing that he will most certainly be proven correct.

Thursday, January 8, 2009

China Losing Taste for Debt From U.S.

The New York Times (see "China Losing Taste for Debt From U.S.) published an article this morning that highlights China's declining appetite for US debt. Currently, approximately 60-70% of China's $1.9 trillion surplus is invested in US government and agency debt. For the last few months, China has been quietly reducing its exposure to US agency debt, but continued to be a voracious buyer of treasuries. In fact, in September China surpasses Japan as the largest holder of US treasury bonds (incidently, Japan has been reducing its exposure to US gov't debt). China holds $585mm of US treasuries vs. Japan at $573mm.

However, recent comments from Chinese policy makers signal that perhaps China may seek (or be forced) to reduce its exposure to US treasury bonds. A couple key points support this argument:

1. China will need to fund its recently announced 4 trillion yuan (~$600mm) economic stimulus package. Reducing its holdings of foreign currency reserves is a natural way to pay for this ambitious spending plan.

2. A slowdown in the Chinese economy will reduce the growth in the country's foreign reserves. China's average monthly trade surplus could fall to less than $20bn/month, well short of the $50bn/month China invested abroad during the 1st half of 2008.

3. China predominately funds its foreign reserves by requiring the banking sector to essentially hand over 20% of its deposits to the country's central bank. However, the article suggests that "the central bank is rapidly reducing this requirement" and pushing banks to lend directly to domestic Chinese companies.

4. Finally (and certainly the greatest long-term threat to the US dollar) is China's concern over the US's ballooning national debt (currently $10.6 trillion). With a $1+ trillion deficit expected in 2009, China and other surplus countries are rightfully asking themselves whether they want to increase their exposure to the US economy. This reticence to buy US debt could lead to a rise in treasury rates, particularly as the stimulative actions of the Obama administration begin to take hold.

Wednesday, January 7, 2009

Bernie Madoff & Social Security

Unfortunately, there is a lot of truth to this cartoon. We could draw similar parallels to Medicare and the entire US Treasury in terms of government-sponsored ponzi schemes.

Apartments for Rent & Vacancy Rates

Interesting chart from this morning's WSJ. While the housing market is in shambles wilth 2-2.5mm excess homes for sale, the supply/demand fundamentals in the rental market remain generally pretty healthy. While rents will likely be pressured in the near-term given the state of the economy, several years of restrained building (less than 100K units per year since 2003), suggest the apartment market is structurally quite sound. This is a notable exception to the mid 80s housing downturn when apartment supply grew by 400,000/yr in each of 1985, 1986, and 1987.

Further, I also believe that homeownership rates will likely decline to the 65-66% range as lending standards remain tight and people seek to rebuild their decimated or non-existent savings (see historical chart of homeownership below). While a 2-3% decline from the current 68% doesn't seem too meaningful, each 1% decline represents about 1mm excess homes and would still be above the long-term homeownership average of 63-64%. This transition of displaced homeowners to rental units should provide support to apartment landlords.