Adam S. Posen points out the important difference between capital from a persistent trade deficit that is utilized for investment versus capital that is used for consumption, and considers the consequences of America’s decade of wasteful over-consumption. See American Saving Is No Excuse for Schadenfreude.
Follow the money: The E.U. has agreed to begin talks with the United States on a pact to share counterterror info on European citizens’ bank transactions, but past CIA covert activities render some wary, The Irish Times tells — while Deutsche Presse Agentur has the very prospect “uniting disparate parts of the German political spectrum in opposition.” The Swiss government has extended a list of individuals and groups linked to al Qaeda or the Taliban who are banned from travelling through Switzerland or having Swiss accounts, Dow Jones Newswires relates. Foreign terrorists’ and insurgents’ “use of third party countries for training, fundraising, and transit is not merely an operational phenomenon, but an economic one as well,” the author of a paper titled “Foreign Fighters and Their Economic Impact” summarizes in The Counterterrorism Blog.. Somali pirates are probably using the ransom money they collect from hijacking western ships to finance Islamic terrorists, The Daily Telegraph has a parliamentary committee reporting.
With so much complexity, and uncertainty about future performance, it is not surprising that the securities are difficult to price and that trading dried up. Without market prices, valuation on the books of banks is suspect and counterparties are reluctant to deal with each other.
The policy response to this problem has been circuitous. The Federal Reserve originally saw the problem as a lack of liquidity in the banking system, and beginning in late 2007 flooded the market with liquidity through new lending facilities. It had very limited success, as banks were still disinclined to buy or trade such securities or take them as collateral. Credit spreads remained higher than normal. In September 2008 credit spreads skyrocketed and credit markets froze. By then it was clear that the problem was not liquidity, but rather the insolvency risks of counterparties with large holdings of toxic assets on their books.
The federal government then decided to buy the toxic assets. The Troubled Asset Relief Program (TARP) was enacted in October 2008 with $700 billion in funding. But that was not how the TARP funds were used. The Treasury concluded that the valuation problem seemed insurmountable, so it attacked the risk issue by bolstering bank capital, buying preferred stock.
But those toxic assets are still there. The latest disposal scheme is the Public-Private Investment Program (PPIP). The concept is that private asset managers would create investment funds of half private and half Treasury (TARP) capital, which would bid on packages of toxic assets that banks offered for sale. The responsibility for valuation is thus shifted to the private sector. But the pricing difficulty remains and this program too may amount to little.
The fundamental problem has remained untouched: insufficient information to permit estimated prices that both buyers and sellers find credible. Why is the information so hard to obtain? While the original MBS pools were often Securities and Exchange Commission (SEC) registered public offerings with considerable detail, CDOs were sold in private placements with confidentiality agreements. Moreover, the nature of the securitization process has made it extremely difficult to determine and follow losses and increasing risk from one tranche and pool to another, and to reach the information about the original borrowers that is needed to estimate future cash flows and price.
This account makes it clear why transparency is so important. To deal with the problem, issuers of asset-backed securities should provide extensive detail in a uniform format about the composition of the original pools and their subsequent structure and performance, whether they were sold as SEC-registered offerings or private placements. By creating a centralized database with this information, the pricing process for the toxic assets becomes possible. Making such a database a reality will restart private securitization markets and will do more for the recovery of the economy than yet another redesign of administrative agency structures. If issuers are not forthcoming, then they should be required to file the information publicly with the SEC.
Mr. Scott is a professor of securities and corporate law at Stanford University and a research fellow at the Hoover Institution. Mr. Taylor, an economics professor at Stanford and senior fellow at the Hoover Institution, is the author of “Getting Off Track: How Government Actions and Interventions Caused, Prolonged and Worsened the Financial Crisis” (Hoover Press, 2009).
Why Toxic Assets Are So Hard to Scrub – Kenneth Scott & John Taylor, WSJ
To download a Microsoft Excel file containing the full results of the CFO Midcap 1500 Machinery Industry Scorecard, click here.
Hit by a 22 percent drop in first-quarter revenue, the machinery industry provides an example of how corporations are struggling to hold the line on cash in a bad year. But a look at 41 companies out of the CFO Midcap 1500′s machinery segment with first quarters ending March 31 of this year reveals that in some cases, these manufacturers succeeded.
The Machinery of Cash CFO Online
Jun 262009
At this gut-check moment for corporate decision-makers, one tactic to boost their confidence is to demand better cash forecasts from their treasury department. How ironic, then, that the same economic instability that’s producing the angst also works against effective forecasting. Knowing what sales will look like next month or whether the credit markets will thaw soon is, for the moment, uncomfortably elusive.
The irony doesn’t end there. Treasury departments haven’t been exempt from the depletion of human and monetary resources that has plagued almost every corporate function. One solution, the consulting firm Treasury Strategies suggests, is to put faith in the 80/20 rule; that is, 20% of a company’s cash-flow line items are likely to be responsible for 80% of the company’s results. So if treasurers focus strictly on the 20% without wasting precious time and effort on the rest, their forecasts may be pretty accurate, according to John Herrick, a principal of the consultancy. And that may be good enough.
For Good Cash Forecasts, Use 80/20 Rule CFO Magazine Online
Jun 102009
It’s starting to look like the spring awakening in bank stocks may not be enough to save the CEOs of America’s biggest troubled banks, Citigroup’s Vikram Pandit and Bank of America’s Ken Lewis.
A top banking regulator is agitating for Pandit’s removal, according to a report Friday in the Wall Street Journal. The clash between Pandit and Sheila Bair, the head of the Federal Insurance Deposit Corp., comes just a month after restive shareholders at Charlotte-based BofA (BAC, Fortune 500) stripped CEO Lewis of his chairmanship.
The FDIC told CNN it had no comment on the story. Citi (C, Fortune 500) says it stands behind Pandit, who took over as CEO at the end of 2007 and has spent much of his tenure trying to clean up the messes left by his predecessors Chuck Prince and Sandy Weill.
In a statement to CNN Friday, Citi chairman Dick Parsons said the company was “confident in our management.”
BofA has similarly endorsed Lewis, and the three-month-long rally in bank stocks has quieted talk of wholesale government takeovers of these firms.
But given the massive investor losses at these banks and the failure of their top managers to anticipate the industry’s meltdown last year, few would shed a tear at either executive’s departure.
“These companies are sort of the poster children for the excesses that created this crisis,” said Eric Jackson, an activist investor and managing member of Ironfire Capital in Naples, Fla. “I think it’s appropriate for the regulators to push for substantial changes in management and on the boards.” Jackson’s firm does not own shares of either bank.
Citi and BofA have been the two biggest bank recipients of federal aid since the financial crisis erupted last fall. Together they have taken some $500 billion in federal aid, the lion’s share of which has come in the form of federal guarantees of their troubled assets.
Recently, both firms have shown some signs that they have broken out of what earlier this year looked like terminal decline.
Shares of Citi have tripled since Pandit surprised Wall Street by saying Citi was on track for its first quarterly profit since mid-2007. BofA’s stock price has quadrupled during the same time frame.
Both banks went on to report better-than-expected first-quarter results in April. Those surprises further boosted the shares even as many observers warned the numbers were padded by one-time gains and legal but incredible accounting maneuvers, such as profits tied to the declining value of the banks’ own debt.
The hopes of a banking sector recovery only intensified after regulatory stress tests showed banks didn’t need that much more money. The findings helped spur a surge of capital raising from the private sector that has bolstered the balance sheets of many big institutions.
Citigroup’s Vikram Pandit Is On the Hot Seat – Colin Barr, Fortune
From Bloomberg:
Foreclosure filings in the U.S. rose to a record for the second consecutive month in April as banks increased efforts to seize homes from delinquent borrowers.
A total of 342,038 properties received a default or auction notice or were seized last month, RealtyTrac Inc. of Irvine, California, said today in a statement. One in 374 households got a filing, the highest monthly rate since the property data service began issuing such reports in 2005.
“What you’re seeing is the inevitable result of severe job losses,” Nicolas Retsinas, director of housing studies at Harvard University in Cambridge, Massachusetts, said in an interview. “Until we stem the job losses, we can expect to see continuing foreclosures.”
Unemployment is hampering the housing market as property prices fall. The U.S. jobless rate rose to 8.9 percent, the highest in more than a quarter century, the Labor Department said May 9. Home prices fell the most on record in the first quarter to a median $169,000 amid sales of foreclosure properties, the National Association of Realtors said yesterday.
Foreclosure filings jumped 32 percent from the year-earlier period, RealtyTrac said. Filings were little changed from March as some states delayed seizures. Ten states accounted for three- quarters of all foreclosures in April, with California leading the nation.
Declines Slowing?
U.S. Housing and Urban Development Secretary Shaun Donovan and former Federal Reserve Chairman Alan Greenspan said yesterday there are signs the real estate market is recovering.
“Since January we’ve seen both home sales moving up and down around a relatively stable number and we are seeing the first signs that the rapid decline in home prices is starting to abate,” Donovan said at an NAR conference in Washington.
March prices fell less than in February and 17 states showed sales increases, yesterday’s NAR report showed, as buyers took advantage of mortgage rates below 5 percent. The Federal Reserve is purchasing mortgage-backed securities to spur lower rates.
While price declines are slowing, it’s likely bank seizures will increase in the coming months, RealtyTrac Chief Executive Officer James Saccacio said.
“Lenders and servicers are beginning foreclosure proceedings on delinquent loans that had been delayed by legislative and industry moratoria,” Saccacio said.
California was No. 1 in April with 96,560 filings, a 42 percent increase from a year earlier, RealtyTrac reported. Florida climbed 75 percent to 64,588, Nevada rose 111 percent to 16,266 and Arizona rose 40 percent to 16,245.
State Rankings
Illinois ranked fifth in filings with 13,647, up 54 percent from a year earlier. Other states among the top 10 were Ohio with 12,324, Georgia with 11,521, Texas with 11,314, Michigan with 10,830 and Virginia with 6,254.
Nevada had the highest foreclosure rate as one in 68 households there received a filing, more than five times the national average. Bank seizures dropped 44 percent from the previous month, RealtyTrac said.
Florida had the second highest rate at one in 135 households, almost three times the national average, and bank seizures fell 7 percent from March. California ranked third at one in 138 households, and Arizona was fourth at one in 164.
Utah, Georgia, Illinois, Colorado and Ohio were among the other with the 10 highest foreclosure rates.
Connecticut had the 19th highest rate, one in 662 households. Filings rose 25 percent from a year earlier to 2,174.
New Jersey’s Rate
New Jersey had the 22nd highest rate, one in 695 households, and filings fell 4 percent to 5,034. New York ranked 36th at one in 1,420 households, and filings fell 1 percent to 5,591.
Las Vegas had the highest rate for metropolitan areas with populations of 200,000 or more. A total of 14,073 properties, or one in 56 households, received a filing, almost seven times the national average, RealtyTrac said.
Cape Coral-Fort Myers in Florida ranked second at one in 57 households. The city also had the steepest price decline in the first quarter, down 59 percent from a year ago, the NAR said yesterday. Miami and Orlando ranked ninth and tenth.
California cities ranked third through eighth: Merced, Modesto, Riverside-San Bernardino, Bakersfield, Vallejo- Fairfield, and Stockton, according to RealtyTrac, which collects default data from 2,200 U.S. counties representing about 90 percent of the population.
“The housing problem is now an economic problem,” Retsinas said. “On the margins you have some investors who think they may have found the bottom, but on the other side are foreclosures.”
May 062009
Via the Seattle PI:
The stress tests are done
Surprise — many banks are fine
Now, go buy that bridgeH/T Corrente
Richardson and Roubini Call for Bank Resolution, Diss Stress Tests
at Naked Capitalism
‘Conceived By Someone Who Never Worked in a Real Job’
Financial Armageddon has long highlighted the disconnect between Main Street and Wall Street. Even now, after an extraordinary number of banks and brokers have failed or are still being bailed out, and thousands of financial industry workers have lost their jobs (excluding those at the top, who should have been the first to go) or had bonuses and salaries slashed, there are still plenty of clueless “experts” running around — including those who have the power to invest other people’s money — who claim to see all manner of “green shoots” sprouting up throughout the economy. While I could be wrong when it comes to my admittedly pessimistic views about where the bottom is (and when we might reach that point), even a cursory glance at what is happening around the country makes me feel reasonably confident that we aren’t there yet. To cite just one example, I refer to the following post from Clusterstock, entitled “About That GDP Inventory Decline…”
An executive who works for a massive global industrial company observes that the much-celebrated decline in inventories in the GDP numbers should not be taken as a sign that GDP is suddenly about to start accelerating:
I watched with some amusement as analysts decided that reduced Inventories in the GDP data boded well for future GDP figures. While, all else equal, certainly lower would be better, the fact is we are slashing inventories (and trying to do so even more) because there are no orders. None. We do take “orders” (non-binding, no cash down payment) which are what is optimistically shared with the Street but binding orders with cash down payments do not exist today, haven’t for over 8 months now. When one lands it is company news and because a government entity somewhere backed it. And trust me, if we aren’t getting orders neither are the next 5 guys.
I suppose either the analysts – and the market, which has been juicing our stock (thanks for that) – are correct and the orders are about to start rolling in, or they are going to be somewhat disappointed later this year when our backlog starts to run dry. I hope they’re right. But I assure you the absolute last thing that’s going to happen is for us to start *growing* inventories without the orders - that strategy can only possibly be conceived in a cubicle somewhere, occupied by someone that never worked in a real job. [MP here: don't you just love that last bit?]
The temporary boost to operating cash spurred by the bonus depreciation deduction enacted last year just starting to show up on corporate financial statements. Some companies are benefiting mightily, according to a new study by RiskMetrics Group.
At least for now. The temporary bump in cash flow companies are getting by deferring tax payments will reverse over time – albeit at a slower pace and, perhaps, when the economy has improved a bit.
The bonus depreciation deduction, which was passed in 2008 as part of the Economic Stimulus Act, was extended for another year in February, when the American Recovery and Reinvestment Act of 2009 (ARRA) was signed into law. The aim of the provisions have been to encourage companies to increase spending on major pieces of equipment by allowing them to accelerate the depreciation of long-lived or capital assets.
Specifically, companies are allowed to claim a deduction equal to 50% of the cost of a qualified asset. A qualified asset is a piece of capital equipment that has been bought and put into service in the year in which the bonus applies. The deferred tax payments are spread out over the remaining life of the asset, starting in year two. The other 50% of the asset’s cost is subject to the regular depreciation schedule set by the Internal Revenue Service. To qualify for the 2009 deduction, companies must buy the equipment and put it into service, before Jan. 1, 2010.
While the bonus deduction is temporary, that’s a small price to pay for what can be a considerable increase in cash flow, according to study author Zhen Deng, a RiskMetrics analyst. She calls the bonus depreciation deduction a government-sponsored “freebie,” that is especially useful during a credit crunch when many companies are fighting off liquidity problems. She also explains that the deduction is “a pure tax play,” meaning that it does not affect net income or earnings.
Rather, the deduction is a “timing issue,” says Deng, referring to the opportunity companies have to postpone their tax payment. “Considering the time value of money, deferring cash payments - even when there is not a liquidity crunch - is always a good thing.”
The research company worked up two metrics to illustrate the effects of the deduction, according to Deng. The report looks at a ratio that compares the estimated cash benefit of the deduction to a company’s capital expenditures. In addition, it examines a ratio that compares the cash benefit to operating cash flow.
Finding the companies to examine were a challenge, says Deng. “You can see signs but you cannot be certain” which companies claimed a bonus deduction unless it is revealed in the financial statement footnotes, she told CFO.com.
The study highlighted 10 companies that quantified the impact of the bonus depreciation in their 2008 financial statements, including CSX Corporation, Ryder System, and Southwest Gas. For example, CSX has a 6% cash-benefit-to-operating cash-flow ratio, which means that for every $100 the railroad company reports in operating cash flow, $6 is attributable to tax savings.
Similarly, a 9% cash benefit-to-capital-expenditure ratio means that for every $100 of reported capex, CSX gets $9 of tax savings. Meanwhile, Southwest Gas came in at 8% in both categories, with Ryder System registering 6% in each category. Utility company Vectren has a 13% cash- benefit-to-capex ratio, the highest of the group, while at 22%, OGE Energy has the highest cash benefit-to-cash flow ratio.
The study also named 16 other companies that will likely benefit from the 2008 deduction, identified by criteria that make the companies good candidates for claiming the deduction. That group includes Comcast, Fluor, Pactiv, and PepsiCo, all companies that carried a deferred tax liability and recorded more than 10% increase in its DTL in 2008 but did not record a corresponding increase in capital expenditures. Further, all of the companies attributed a significant portion of the hike in DTL to either depreciation or property, plant and equipment.
Of the group of 16, the study gleaned enough information from financial statements to estimate the cash benefit as compared to the operating cash flow. Comcast had the highest ratio at 7%, while Pepsi was flat at 0%. Both Iron Mountain and Pactiv came in at 5%.
CFO: http://www.cfo.com/article.cfm/13479177?f=home_featured
The largest bank recipients of U.S. government aid are offering less credit to businesses and consumers, the Treasury Department said Wednesday, reflecting and exacerbating the tenuous state of the current economic environment.
In a monthly snapshot of lending by the 21 largest banks receiving Troubled Asset Relief Program funds, the Treasury said credit being offered fell 2.2% across all commercial-lending and consumer-lending categories in February, compared with the prior month.
Particularly problematic: continued deterioration in commercial real estate and general business lending, as well as the credit being made available for student and auto loans.
The lone bright spot remained home loans, with consumers eager to take advantage of record-low interest rates to refinance their mortgages.
The Treasury said 16 of the 18 banks surveyed increased mortgage originations in February, resulting in a 35% increase in mortgage lending from January levels.
The February decline in lending adds to pressure on the Obama administration’s efforts to restart the still-fragile credit markets.
The Treasury has committed $95 billion in TARP funds for new programs to boost consumer and business lending, though they are either just getting started or are still in the development phase.
The report suggests that jawboning by federal officials for banks to use TARP funds to boost lending is having a limited effect.
The Treasury blamed the decrease on the broader economic weakness, including low consumer confidence, high unemployment and a decrease in U.S. exports.
It also said lending would have been lower absent the nearly $200 billion in capital injections the government has provided to about 550 banks.
Banks’ diminished appetites for lending are forcing businesses and consumers alike to curb their spending, which risks prolonging the U.S. economic recession.
The median free cash flow for nonfinancial companies could sink by 50% during the next year, especially if the recession continues to choke revenue streams, a new report says.
Up until now, cash-flow margins — free cash flow measured as a percentage of revenue — have remained flat. But recessions have a way of eating away at that ratio, says Charles Mulford, director of the Georgia Tech Financial Analysis Lab and co-author of the study.
Mulford and two co-authors, graduate research assistants Sohel Surani and Jason Blake, analyzed the cash-flow trends of 20 nonfinancial industries, comprising 61 subindustries, for a series of rolling 12-month periods from the first quarter of 2000 through the third quarter of 2008. They plan to track the same indicators each quarter going forward.
The first report, which will be released next week, notes that after bottoming out below 2.5% during the 2001 recession, free cash margin “improved markedly” and has remained relatively stable, hovering above 4.5% since 2002. During the 12 months ended September 2008, the margin dipped slightly below 4.5% to the low end of its recent range. But the authors expect that the current recession will push the margin down to the 2001 recession level or lower — which could mean a 50% drop in free cash flow.
Free cash flow has no strings attached: it is the discretionary cash that companies can use, without disrupting operations, to pay dividends, buy back stock, retire debt, or invest in an acquisition. As a percentage of revenue, the free cash margin is essentially a cash-flow profit margin that indicates what percent of revenue is left for shareholders in the form of discretionary cash flow, the authors say.
The study looked at 3,429 companies, each with a current market capitalization of $50 million or more. Despite the authors’ prediction that the median free cash margin is set to drop precipitously, they saw an improving margin in seven industries for the 12 months ending September 2008 compared with the year before. The industries? Energy, transportation, media, retailing, food and staples retailing, pharmaceuticals/biotechnology/life sciences, and technology hardware and equipment.
The report highlights the pharmaceuticals/biotechnology/life sciences sector, noting that free cash flow grew in that sector by nearly 2 percentage points, from 7.4% to 9.15% for the 12 months ending September 2008. What’s more, four Standard and Poor’s 500 companies from the sector boasted particular improvement: Abbott Laboratories, Bristol-Myers Squibb, Eli Lilly, and Millipore Corp.
In the other industries examined, five companies held steady, while eight groups registered declines in free cash margins: materials, capital goods, automobiles and components, consumer durables and apparel, food/beverage/tobacco, household and personal products, telecommunications services, and utilities. Of those that declined, the materials group stood out, with an overall free cash margin decline to 2.42% for the 12 months ending September 2008, down from 3.68% for the same period the previous year — and down from nearly 4% during the 2001 recession.
The materials group includes the subcategories of chemicals, construction materials, containers and packaging, metals and mining, and paper and forest products. Three companies in that industry were highlighted in the report: AK Steel Holding, Alcoa, and Weyerhaeuser.
All industries, 2002-2008
Materials industry, 2002-2008
Rushing to the Exits?
Bottom Line. The Fed is moving toward the exit as they look toward the conclusion of their securities purchases programs. But it is not clear that such a move is justified by their own forecasts or the inflation/wage/employment data. There may be an internal fear they have gone too far, a fear that the hawks can exploit. To be sure, I see no reason to expect the Fed will raise rates for a long time. And the Fed maintains it policy flexibility, claiming to be ready to revive asset purchases should economic or financial conditions justify. But I now suspect the bar for renewed expansion of Fed accommodation may be much higher than I had anticipated. And that the dominant push for expansion would have to come from financial market conditions, while they would be willing to tolerate persistently high unemployment rates so long as U. Michigan inflation expectations say elevated, regardless of the actual inflation data.
At Tim Duy’s Fed Watch