Here's my top 10 links from around the Internet over the last couple of days at 10 am.
1. Now we're seeing what went on behind the scenes with the stress tests for US banks. WSJ.com
reports that the Federal Reserve initial results showed the biggest banks had massive capital black holes, but the Federal Reserve scaled their figures down dramatically after complaints by the banks. Here's a taste.
When the Fed last month informed banks of its preliminary stress-test findings, executives at corporations including Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. were furious with what they viewed as the Fed's exaggerated capital holes. A senior executive at one bank fumed that the Fed's initial estimate was "mind-numbingly" large. Bank of America was "shocked" when it saw its initial figure, which was more than $50 billion, according to a person familiar with the negotiations.
At least half of the banks pushed back, according to people with direct knowledge of the process. Some argued the Fed was underestimating the banks' ability to cover anticipated losses with revenue growth and aggressive cost-cutting. Others urged regulators to give them more credit for pending transactions that would thicken their capital cushions.
Yet somehow the markets rallied on this news. Who do the Americans think they are kidding? Their banks are still insolvent zombies and the credit crunch will not be over until they are sorted.
2. Paul Krugman at the New York Times
is similarly sceptical about the results.
I won't weigh in on the debate over the quality of the stress tests themselves, except to repeat what many observers have noted: the regulators didn't have the resources to make a really careful assessment of the banks' assets, and in any case they allowed the banks to bargain over what the results would say. A rigorous audit it wasn't.
But focusing on the process can distract from the larger picture. What we're really seeing here is a decision on the part of President Obama and his officials to muddle through the financial crisis, hoping that the banks can earn their way back to health.
It's a strategy that might work. After all, right now the banks are lending at high interest rates, while paying virtually no interest on their (government-insured) deposits. Given enough time, the banks could be flush again.
But it's important to see the strategy for what it is and to understand the risks.
Remember, it was the markets, not the government, that in effect declared the banks undercapitalized. And while market indicators of distrust in banks, like the interest rates on bank bonds and the prices of bank credit-default swaps, have fallen somewhat in recent weeks, they're still at levels that would have been considered inconceivable before the crisis.
As a result, the odds are that the financial system won't function normally until the crucial players get much stronger financially than they are now. Yet the Obama administration has decided not to do anything dramatic to recapitalize the banks.
Can the economy recover even with weak banks? Maybe. Banks won't be expanding credit any time soon, but government-backed lenders have stepped in to fill the gap. The Federal Reserve has expanded its credit by $1.2 trillion over the past year; Fannie Mae and Freddie Mac have become the principal sources of mortgage finance. So maybe we can let the economy fix the banks instead of the other way around.
But there are many things that could go wrong.
It's not at all clear that credit from the Fed, Fannie and Freddie can fully substitute for a healthy banking system. If it can't, the muddle-through strategy will turn out to be a recipe for a prolonged, Japanese-style era of high unemployment and weak growth.
Actually, a multiyear period of economic weakness looks likely in any case. The economy may no longer be plunging, but it's very hard to see where a real recovery will come from. And if the economy does stay depressed for a long time, banks will be in much bigger trouble than the stress tests "” which looked only two years ahead "” are able to capture.
3. Nouriel Roubini gives his 10 reasons why the stress tests are "schmess tests".
This is a comprehensive demolition of any credibility the stress tests have left.
What shall we make of the recently announced results of the stress test? Are they credible? Will they restore confidence in our battered financial system? Will the current approach to resolving the financial crisis work, be effective and minimize the fiscal costs of the financial bailout?
For a number of reasons these results are a significant underestimate of the capital/equity needs of these 19 large US banks. Also this underestimate of the losses and the current "muddle-through" approach to the banking and financial crisis may accelerate the creeping partial nationalization of the US financial system, exacerbate moral hazard distortions, not resolve the too-big-to-fail problem, increase the fiscal costs of this financial crisis, make the credit crunch last longer and lead some near insolvent financial institutions to become zombie banks.
Meanwhile, Nassim Taleb, the writer of the 'Black Swan' book, reckons the current financial crisis is 'vastly worse' than the 1930s because financial systems are more interdependent than they were then, Bloomberg reports.
4. Brian Gaynor gives a useful explanation here at NZHerald.co.nz
of why the Aussie-owned banks are not passing on the last cut in the Official Cash Rate. This is the new information.
In recent months banks in both countries have experienced a share decline in offshore funding as illustrated by the following figures:
The New Zealand-based banks' offshore funding plunged from $142.0 billion at the end of February to $128.8 billion at the end of March. This is a worrying development as the banks haven't been able to attract sufficient domestic funding to replace these foreign-sourced funds.
Offshore funding by the Australian-based banks fell from A$701.6 billion in January to A$686.7 billion in February, the latest available figure.
5. Some New Zealand banks are taking control of funds in the accounts of rental property investors without their permission, Rob Stock at the Sunday Star Times reports.
Sue Tierney, president of the Auckland Property Investors Association, reported three "can you help?" calls from desperate investors in the last month, distraught at the plans their banks had for their money.
The callers were customers of three big banks BNZ, ASB and National Bank. "It's across the board," she said.
In each case, the bank decided part, or all of the net sale proceeds, would be used to reduce the investor's other debts. Those other debts were other mortgages and, in one case, a business debt.
"What you think can happen and what the banks will allow to happen are quite different now," said Tierney.
She said people did not realise mortgage agreements gave lenders a great deal of power, and now the crunch had come, they were using it more frequently.
"One bad example was a client in business. He wanted to sell his home to buy a new one, but the bank wanted to use all the equity from the sale to reduce his business debt.
"That's of particular interest to all the small business owners out there," Tierney said.
6. Susan Pepperell at the Sunday Star Times
reports that some bosses are using the recession to squeeze staff down to lower wages, longer hours and are forcing some into early resignations to avoid redundancy payouts. She cites an unnamed Westpac senior manager.
A senior manager at Westpac has told the Sunday Star-Times of large numbers of staff receiving written warnings for minor mistakes. The manager, who would not be named, also said the bank's setting of unrealistic sales targets put intense pressure on staff.
The manager said he believed the motive was to make the working environment so unpleasant, staff would leave of their own accord, avoiding the need for redundancy.
Finance sector union Finsec's national organiser Michael Wood told the Star-Times there were deep concerns that the culture had changed at Westpac from customer-focused service to selling as many of the bank's products as possible.
He said the new procedures were putting huge pressure on sales staff and "people were being kicked in both directions".
7. A US economist Harry S Dent is predicting a full scale depression through late 2009 and into 2010 as the bear market rally peters out and the market collapses again, Seeking Alpha reports.
8. Here's some more commentary on the very poor US Treasury auction on Friday (our time) on Seeking Alpha. Here's a taste.
What the Federal Reserve and Treasury have set in motion is the mother of all crowdings-out. The Fed is compelled to buy substantial amounts of Treasuries to prevent the federal deficit from turning into a $1.8 trillion black hole that sucks in all the free savings of the world and then some. The moment that yields start to rise, the stock market reacts negatively. There is no "give" in the economy for any substantial rise in yields: the penalty to growth expectations is exacted immediately.
By ballooning the deficit and tying the credit of the United States to the balance sheet of the banking system, the Fed has avoided panic, but has crippled the economy for the long term. There is no way to finance the deficit except by suppressing financing for everyone else. The massive amount of liquidity created by the Fed has no inflationary effect as long as the market does not want to hold real assets "” and it will not as long as the federal government sucks up the available savings. The most likely scenario is a paralytic, zombie-like stasis.
9. John Authers at FT.com
also believes the current stock market rally is a bear market rally. He muses on what could be the trigger for the next leg down.
What will ultimately derail this rally? Russell Napier, author of Anatomy of the Bear, a history of bear markets, suggests in an interview that bond yields could do this.
Once bond yields go above a certain level "“ Mr Napier suggests about 6 per cent "“ it becomes difficult to justify buying stocks. They could reach this level when the Treasury bond market finally chokes on the huge new issuance governments are trying to push down its throat to fund the deficit.
Thursday saw a preview of what this might be like, when the US had to pay a higher yield than expected at the auction of 30-year Treasury bonds. This pushed up bond yields (to 3.33 per cent for 10-year bonds) and also prompted a brief sell-off for stocks.
The moment when the bond market finally chokes can be delayed for a long time. The Federal Reserve itself is committing to buying bonds, and 6 per cent is a long way away. So stocks maybe could keep rallying for a while. But, once the bond market calls time, Mr Napier suggests the S&P 500, now above 900, would need to reach 400 to get as cheap as at previous bear market lows. Enjoy the rally while it lasts.
10. Quoteable Value's latest numbers for April show prices stabilising. Alastair Helm at realestate.co.nz
says it's premature to call the bottom in prices, while I give 10 reasons why we haven't seen the bottom yet in my NZHerald blog