Off Topic - A good way to Bicycle in the North Chicago Suburbs

It is so simple, I can't believe it took me so long to figure it out.

1. Drive with your bike to Sheridan Road.,

2. Park.

3. Ride around on the other side of Sheridan. Toward Lake Michigan.

The older suburbs on Lake Michigan are great places to cycle. On the other side of Sheridan, there is no on street parking (at least in places like Lake Forrest). So, park on the other side of the street and you can bike in a fabulous setting.

These suburbs don't do something gauche like have gates. They carefully filter out the traffic and people by subtle barriers. By the time you get to Sheridan, you have made it. They use all tactics -- one way streets, 3 increasingly more efficient ways of going north/south (I94, 41, Green Bay Road) to discourage through traffic. etc.

I just started biking close to my vehicle since the weather has been shaky lately. This encouraged me to just randomly park the vehicle (too embarrassingly large to admit-but a rental) on an attractive street and just go from there. I keep as close as it seems prudent to the vehicle and just explore.

The streets next to the Lake are very well maintained. The landscaping is immaculate. Very little traffic. This is the perfect place to casually cycle.

From the Archives:

On May 8th of last year, Richard Kline had this to say to me:

May 8, 2009 at 6:12 am
So cap vandal, there are so many problems with the putative positives you advance here regarding the stress-less tests that I’m going to pass on the rest of that list. But let’s just review:

No one said that most of the $8T in assets in the banking system are bad. The problem is that the concentration of loss is in the major financials which are holding the rest of the system, the government, and the country hostage to their busted dreams. Your rhetorical attempt to stuff the desperate losses of the Big Few under the skirts of the weary solvent many does you no credit.

Your reference to mortgage backed securities and their supposed absence from the system as a cause for relief is misconceived. This is well known, yes: most of that paper was on-sold. —And then the Big Lost Few turned around and wrote CDS swaps against those securities for face or against the bonds of those securities purchasers for face, so guess where the ‘loss’ on those securities will progressively boomerang back to? Now the bulk of those losses haven’t been realized yet because the tranching structures of those MBSs were designed to absorb the first losses internally and on the small players. Which is exactly why the Big Few are putting us through this whole dismal charade of ’solvent today, my friends’ to raise capital _before those swap losses_ are put to them. Think that THOSE exposures were adequately accounted for in these ‘tests,’ my friend? If so, I’m sure that Citi has a slice of preferred they’d love to sell you cheap. Or even dear (I mean why not, the public gets the bill?).

Then there is the matter of securitized LBO debt you haven’t managed to drag into the discussion, quite a lot of which is left on the sometime ’speculation’ banks (which is what they should be called). Think that those are marked to market, especially when the minders of accounting standards were dragooned into ‘mark and let mark’ practices?

In view of these small further matters, without even going into other relevant Concerns, that $6B at Wells, yes that $75 headline ARE COMPLETELY MEANINGLESS NUMBERS. They are numbers for the media and the rubes, but not meaningful estimates of probable losses. If you added a zero on the right end to that Wells raise we might be talking the real money. If it was indeed large private capital standing on the sidelines about to buy in to the six at Wells, I would tell its deployers, Please don’t: start your own clean major bank with it, and make a killing. Although given all the money floating around from the public put to the Big Few which they aren’t investing in the real economy, I suspect that we will have considerable shadow purchases funneld through the hedges to prop up each others equity, here. No smart money is going to buy into Wells, but others in the same boat have every incentive to take public money and quitely support each others’ capital to make the whole show go on.

The problem we have here, my friend, is that the entire core of the financial system has become an aggregated slime mold of formerly distinct Enrons, bloated 100 times larger.

And your assurance that large private capital would ne-eev-eerrrr invest in the banking system again if they were nationalized is . . . music to my ears, that sounds about right. We need a banking system which serves the country, not a greed parade that hollows it out. Most of those folks: they’re working with Other Peoples Money anyway, not their own. That money will flow to real return, and real returns will return to the banking system to attract them when said banking system is sound. Which it is not and will not be so long as sham shows like this ‘fooled yah’ examination are promoted by a government which still, as of today, refuses to regulate the financial industry in any meaningful fashion. And that outcome, my friend, sucks dynamite.

I'm not going to address Richard's points in detail. In fact, as critics go, his post was articulate and representative of the better as opposed to the worse [from my perspective] commenters.

It sounds alarmist today. On May 8th, it wasn't far from the blogosphere mainstream.

That's one reason I quit blogging. I just didn't have the energy to keep up with the shrillness. Plus, some of my premature bullishness started to be confirmed by the markets, and just sitting on my long positions was proving more profitable than trading.

What a difference in 4 months.

I'm Back....

To my loyal readers, I am back from an extended break.

No one wants to hear, "I told you so." and being right is not a good way to be popular. Still, there are times that you just can't resist.

As far as I can tell, I'm the only financial blogger that praised the "stress tests." The KBW index looks good since May 7th.

So, I'll just say it.

I was right. Find someone else with something good to say about the stress tests from that period, if you can. Or else, a little credit from my critics on "naked capitalism"

Especially those that accused me of hopeless naivete. That plus being oblivious to the facts and an apologist for banking swine.

However, owning long positions for one's own account and acting on one's opinions can provide a certain highly pleasurable reward that is MUCH better than extracting some sort of recognition from the blogosphere.

More on Roubini....

With regard to the stress test being consistent with the IMF estimates, consider the following from the blog Alea:

Still, it is useful to know whether our estimates are consistent with what has been found by others. Two studies released within the last few weeks essentially bracketed the supervisory estimate. The International Monetary Fund estimated lifetime losses that would imply a loan loss rate for U.S. banking firms of about 8 percent in a stressed scenario. One of the major rating agencies estimated an annual loan loss rate of about 4-3/4 percent in a stress scenario for the next two years.  More broadly, our informal survey of the results of a considerable number of private-sector studies and analyst reports published over the past several months generally placed our projected loss rates for key portfolios near the midpoints of the ranges of these independent estimates.

Major Roubini Goof

Professor Roubini stated that: 

The IMF recently estimated that retained earnings (after taxes and dividends) for all US banks – not just these 19 ones – would be only $300 bn total over the 2009-2010 period. The stress tests – instead – assumed much higher retained earnings - $362 bn - for these 19 banks alone for the 2009-2010 period in the more adverse scenario. Since these 19 banks account for about half of US banks assets if one were to use the IMF estimate of net retained earnings for these 19 banks their net retained earnings for 2009-2010 would be $150 bn rather than the $362 bn assumed by the regulators. While the IMF may have been too conservative in its estimates of net retained earnings it appears that regulators may have been too generous to these 19 banks in forecasting their earnings in an adverse scenario.

Professor Roubini should realize that you don't pay taxes on losses, and the funds available for loan losses are much higher than $362 billion.  The IMF figure includes dividends, which you don't pay if you are in financial difficulty and loss provisions.   In 1Q2008, BAC had about $18 billion in loan losses and pre tax, pre dividend earnings and Wells had about $10 billion. That's $28 billion for the two per quarter or or $224 billion over the two years from these two banks alone. This figure may be way too optimistic, but $150 billion from the two banks certainly isn't.

Some of the banks may have to book huge portions of their pre tax, pre provision earnings but that is a big number.  Just consider the $8 trillion in RWA and use a conservative net interest rate margin (say 2% per year) and you end up with $320 billion over the two years.  

More on the Stress Test

As the only blogger that had anything close to unequivocally favorable to say about the stress tests, I did manage to get a few hits, but not many.  I suppose people are just sick to death of yesterday's news.

There is no upside in saying anything favorable and to appear to take it seriously is to risk seeming hopelessly naive.

However, I think betting against the Fed/Treasury is a bit naive.  

The way to read it is to start backwards.  Total 2 year losses of $600 billion.  Together with the $400 or so that have already been booked, thats $1 trillion.  If these financial institutions have 1/3 of the assets exposed to the "crisis" -- that would put the total at $3 trillion.  Or big enough to be in the range of plausibility.

The next step is looking at how the $600 is going to be "funded."  I already went through this in the last post, and it seems reasonable.  

I read a bit of the RGE monitor (Roubini) and he is heavily invested in his scheme to do a "good bank/bad bank" reorganization.  Not a bad idea, but I have a feeling that he simply doesn't understand banks.

In fact, most of the disagreements seem to be people who equate banks with New York investment banks and see the rest of the financial sector as simply an appendage of New York.  I tend to see New York and investment banking as a separate business.  A lot of it could disappear with no consequence.  It already has.  The flip side is that the majority of abuses were associated with investment banking and they managed to almost blow up the world financial system.  

Investment banks don't make normal loans.  The only stand alone investment banks are GS and MS.  they have a lot of exposure to securities but not much to loans.  They don't do credit cards.  They don't deal with retail lending customers.  They did facilitate a lot of lending, but no one wants to buy these sorts of products anymore.  The so called originate to distribute model.  

As far as banks that make loans -- they seem to be making them.  I am at a loss regarding whether they should lend more or tighten standards, but they seem to be doing about the right thing.  That is, no more really stupid loans.  They do seem pretty aggressive about loaning to people that can pay them back -- but those people don't especially want to borrow.  

The general playbook of the Treasury/Fed is to subsidize interest rates and force people to either accept zero returns or start taking some risk.  This is all they can do and they are doing it in every way imaginable.  It is also directionally right as a policy move.  In fact, you have fiscal stimulus via deficit spending to go with the liberal monetary policies.  

That is the right thing to do directionally, and they seem to be doing a lot of it, which is, for lack of a better word, good.

Berkshire's 1Q Earnings Announcements

First the basics on how earnings are reported in US GAAP.  This is a big picture, non accountants overview.  They get split into two parts -- one labeled net income and the other labeled other comprehensive income (OCI).  The idea is to put normal stuff in the first bucket or items that have some finality -- like cash losses.  The other bucket gets things like unrealized capital gains and losses, which will fluctuate and make it more difficult to see how the firms operations are trending.

This treatment of unrealized capital gains and losses is not in the least controversial.  For Berkshire, the infamous long term put options would logically fall into OCI (other comprehensive income) -- since they are intended to be held for over a decade, and quarterly movements are noise.

Instead of trying to change accounting, Berkshire has developed a very simple non GAAP metric that it refers to as operating earnings.  Every quarter it puts out a statement opening with operating earnings and reconciling to GAAP.  Operating earnings exclude derivatives as well as other financial "bets" like currency trades.  They are, in fact, operating earnings, which is really what GAAP net income would like to be, if it weren't trying to be uniform across all businesses.    

Right now the volatility of the derivative book they totally overwhelms the changes in the core business earnings.  The Berkshire release saves investors and the media from having to make these adjustments themselves.

This quarter was a bit different.

1.  The earnings release was a week after the annual meeting.

2.  A "preview" of earnings was released, with the emphasis on operating earnings. They were down modestly from $1.9 billion to $1.7 billion.  Given the economy, not bad.

3.  The final published figures contained additional losses of $2 billion ($3 pre tax).  This is based on unrealized capital losses, but since Berkshire has announced that it will sell enough COP stock to get a $600 million tax refund, it labeled these losses as OTTI (Other Than Temporary Impairment) losses.  This means that they can be booked in net earnings BEFORE the stock is sold.  

4.  This huge OTTI clears the decks regarding realized capital losses for the remainder of the year.

The headline numbers should really be Berkshire's non GAAP 'Operating Earnings'.  It is the best way to make sense of the results, and any competent stock analyst would perform a similar set of adjustments.  

The press never seems to read and report on Berkshire's released operating earnings.  This year, it's all that was available when the quarter was discussed at the annual meeting.

Plus, Buffett threw in the kitchen sink by booking the OTTI when 1Q is old, old news.   This is as close as you are going to see Buffett come to spinning bad news. Nothing misleading about it, and in fact, it gives a more accurate picture.  At least the operating earnings.  Taking the OTTI losses as early as possible is something that most CEO's would like to do and Buffett can afford it.  Equity markets hate uncertainty and booking bad news ASAP tends to be good for the stock price.  Buffett may not care very much, but now the foundations have to sell some Berkshire on a regular basis, and there is an economic motivation to keep the stock price at a fair value.