Have the Financials Bottomed?

Nicely structured reasoning via Barron’s Randall Forsyth:

Borrowings at the Federal Reserve’s discount window averaged a record $16.4 billion in the week ended Wednesday, up $2.5 billion from a week earlier. A spokesman for the New York Fed had no explanation for the jump.

That, by the way, doesn’t include any of the new-fangled lending to securities dealers, which were nil in the latest week. (The Fed’s $29 billion of financing of the Bear Stearns assets in the JPMorgan Chase acquisition resides under the quaint heading of "holdings of Maiden Lane LLC.")

Keeping the borrowing from the so-called PDCF, or Primary Dealer Lending Facility, would seem to be a significant impetus behind the Securities and Exchange Commission’s crackdown on naked short-selling of big financial stocks, observes Joan McCullough of East Shore Partners.

In SEC Chairman Christopher Cox’s op-ed piece in The Wall Street Journal last week, McCullough writes, "he spilled the beans as to why naked shorting has been forbidden in that select litany of names. According to Mr. Cox, the list ‘applies to precisely those financial firms that the Fed has designated as eligible for access to its liquidity facilities — and for which the taxpayer could be on the hook.’

"So there you have it. Under the guise of not wanting to further burden the taxpayer, they put together that very telling list of [primary dealers] and [government sponsored enterprises]. Of course, they don’t give a fig about the taxpayer." The real aim was to avoid wasting the Fed’s powder on institutions targeted by evil short sellers, McCullough comments.

In any case, the myriad woes of the credit system strongly suggests that the stirring stock market rally led by the financials in the wake of the Fannie-Freddie bailout and the crackdown on short-selling was mainly the product of short-covering.

Not exactly an original notion, but one well-supported by the data. Bespoke Investment Group points out that banks were the most heavily shorted group among the Standard & Poor’s 1500 index in the latest short-interest numbers through July 15 — the day the financials made their lows. Short interest hit 19.6% of an average bank stock’s float; no doubt much of that has been bought back in the subsequent week. Last Thursday’s wicked selloff suggested that’s likely played out.

As the credit crisis prepares to mark its first anniversary, it’s only fitting that the bulls claim the bottom has been reached. MacroMavens’ Stephanie Pomboy notes similar declarations after bear-market bounces, as with the Nasdaq in 2001 and the Nikkei in 1990.

But, given the banking system’s record exposure to real-estate assets, which continue to deflate, the fate of the financials — and indeed the stock market — seems tied to the housing market.

"As long as real-estate values continue to decline, banks will continue to frantically reduce their exposure," says Pomboy. " This is why it seems irrational in the extreme to anticipate a bottom in financials before the bottom in housing is in!"

Irrational, indeed . . .

Source:
Isn’t It Rich? 
RANDALL W. FORSYTH    
BARRONS JULY 28, 2008   
http://online.barrons.com/article/SB121702614341886209.html

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  1. Wall Street Weather commented on Jul 26

    Banks going to the discount window is why the SEC should extend the naked short prohibition to include all banks (ideally all stocks). All this talk about concern for the taxpayer’s money, yet the SEC/gov’t chooses to look the other way if a bank should collapse as the result of naked shorting. Deborah

  2. Steve Barry commented on Jul 26

    Bottom my ass…pardon the pun. Two rinky dink banks went bust yesterday and ate up another close to $1 Billion of the FDIC funds. Excerpts from Reuters:

    U.S. regulators seize two more banks, engineer sale By John Poirier
    Sat Jul 26, 12:08 AM ET

    U.S. regulators took over two banks on Friday and sold them to Mutual of Omaha Bank, the sixth and seventh bank failures this year as financial institutions struggle with a housing bust and credit crunch.

    Two weeks after the Federal Deposit Insurance Corp seized IndyMac Bancorp Inc (IDMC.PK), the Office of the Comptroller of the Currency said it closed First National Bank of Nevada and First Heritage Bank NA of California.

    First National, characterized as undercapitalized, had total assets of $3.4 billion and $3 billion in deposits. First Heritage, described as critically undercapitalized, had assets of $254 million and $233 million in deposits, regulators said.

    The FDIC said the cost of the transactions to its insurance fund is estimated to be $862 million, adding that the two failed banks represent just 0.3 percent of $13.4 trillion in total industry assets at about 8,500 FDIC-insured institutions.

    The FDIC said the 28 offices of the two banks will reopen on Monday as Mutual of Omaha Bank. Over the weekend, customers can access their money by writing checks, using automatic teller machines or debit cards.

    Mutual of Omaha Bank currently has more than $750 million in assets and operates 14 retail branches in Nebraska and Colorado with commercial lending offices in Dallas and Des Moines, Iowa, the FDIC said.

    Top banking regulators have warned of additional insolvencies this year and next, but for now do not expect failures the size of IndyMac, which had $32 billion in assets and $19 billion in total deposits at the end of March.

    IndyMac, the third largest U.S. bank failure, was regulated by the Office of Thrift Supervision and is expected to deplete the FDIC’s insurance fund by between $4 billion and $8 billion.

    The FDIC oversees an industry-funded reserve of about $53 billion used to insure up to $100,000 per deposit and $250,000 per individual retirement account at insured banks.

  3. dblwyo commented on Jul 26

    Yes indeed. But also irrational and narrow to just restrict one’s attention to housing. In the intermediate term losses and writeoffs (cf AmEx) will be mounting from consumer and commercial loans as well as commercial RE. We’ve gotten thru the credit crisis and are headed for a credit crunch which’ll feedback on the economy and visa versa.
    In the long-term, as a few have noticed but nobody has reflected, the basic business models of many segments/sectors are broke. Of the major segments how many were built around excess leverage and terrible pricing of risk ? As risk is priced more properly and leverage reduced by orders of magnitude most of the previously most profitable segments are not going to be so in the future. Is any of that reflected in any talk of bottoms in financials ?

  4. Owner Earnings commented on Jul 26

    Let’s see, some of their revenue streams are gone forever or at least a few years.

    Also, most of them now have higher interest and dividend expenses.

    That means significantly lower margins going forward.

    SKF

  5. Philippe commented on Jul 26

    Bank’s ordeal is identified but not cured and far from it, two sets of banks those with liquidity and a « normalised » capital adequacy ratio and the others.
    Yes a time for investors having access to large capital funds and willing to have a managerial role in the banks consolidation at lower cost, investment banks are not the priority.

  6. dugafish commented on Jul 26

    RANDALL W. FORSYTH gets it right-there cant possibly be a bottom in financials until the bottom in the very collateral (housing) whose fate they have tethered themselves to has bottomed OR at least begins to bottom. We haven’t seen anywhere near a bottom in Housing as of yet, and thus the risk of an upwardy spreading soporific credit infection to alternative asset classes such as credit cards, home equity loans, and prime mortgages rises by the day, as over leveraged homeowners default on their other debt obligations. The government authorities haven’t yet found the Penicillin required to arrest the housing price decline and thus the infection spreads and worsens in combination with Pimco’s Paradox of Deleveraging-its a vicious spiral more elegant in its symmetry than a mutant strand of DNA.

    Say Finito, Sayanora, Adios, Arivaderchi, Ciao, Smell You Later, to the US Dollar, say hello to $1600 Gold price (for starters) and buy the most undervalued asset on the planet at this moment in time-high quality(not an oxymoron IF you have the skill set for the appropriate due diligence) junior gold mining stocks. And Pick up some RGLD also

  7. Mike in NOLa commented on Jul 26

    As someone pointed out in a comment to the previous post, NAB appears to be doing the right thing in recognizing it’s losses now rather than dragging it out. NAB sends a bleak message to the world

    Trouble is, it still has huge exposure to corporate debt, which is a big unknown at this point, e.g. Chrysler has had to cancel it’s leasing program because of trouble refinancing and we’ve already seen GM’s trouble. It also has exposure to commercial real estate, which is just starting to tank.

  8. mark mchugh commented on Jul 26

    I have to take issue with something in this excerpt. According to Reuter’s UK, there was a TSLF auction on thurs 11/24. It was the biggest since the program’s inception.

    excerpt:
    “Primary dealers submitted $51.72 billion of bids for the $25 billion of Treasuries offered at the auction in exchange for riskier Schedule 1 collateral, generating a bid-to-cover ratio — an indication of demand — of 2.07, the highest ever and well above the 0.85 bid-to-cover at a similar auction of the same size earlier this month.”

    Isn’t that a “new-fangled lending” program? Interesting side note: I found this article through Google News on Thursday, when I read this post, I looked for it again and it was gone (swear to God), and now it’s back again.

    My pencil ain’t sharp enough to interpret this. Maybe, I’m just pissed about the SEC’s list, but here’s a link in case it vanishes again:

    http://uk.reuters.com/article/marketsNewsUS/idUKN2431585020080724

  9. mark mchugh commented on Jul 26

    Oh, and could someone please recommend a “run-proof” bank?

  10. Mark E Hoffer commented on Jul 26

    …hello to $1600 Gold price (for starters) and buy the most undervalued asset on the planet at this moment in time-high quality(not an oxymoron IF you have the skill set for the appropriate due diligence) junior gold mining stocks. And Pick up some RGLD also

    Posted by: dugafish | Jul 26, 2008 10:37:33 AM

    From, Jim Sinclair, below
    http://www.jsmineset.com

    Dear Friends,

    A serious event occurred today. This event was the very public international recognition of more off balance sheet so called “assets” revealed as having little, if any, value.

    This event is arguably the most serious financial upset ever. If you have not protected yourself, it is getting very late – maybe too late.

    Your best hope is that this event is so complex that the herd of self anointed experts has no clue what that vehicle is, how large it is and therefore the profound meaning it has.

    Gold, serious junior gold shares (the only seriously underpriced and therefore real value in equities) and non-dollar short term federal currency instruments are your sanctuary. You better get there, and get there FAST!

    The meaning of this is not only are Freddie and Fannie’s troubles much costlier than realized, but now there is an entirely new definition of market-less financial entities with off balance sheet assets that undermine primarily the US and now international banking systems. Conduit mortgage OTC derivatives will have to be marked down now that the sun is shining on them.

    The U.S. mortgage industry transformed itself in a way that has opened dangerous SIV sub prime real estate conduits to global capital markets.

    A conduit loan is priced by swaps and swap spreads, thereby becoming a package of various OTC derivatives generally derived from a formula that would make Einstein look like a kindergarten mathematician.

    By turning mortgages into securities, lenders created vast distances between homeowners and their mortgage holders, who can be anywhere in the world such as Australia.

    US banks have written down $450 billion in bad housing loans. The revelation from NAB means that they will now certainly need to take provisions to $1,000 billion. Write-downs of $1,300 billion and perhaps even more are in the cards.

    That guarantees the USDX at .6200 and more likely at .5200.

    That guarantees gold to reach at least $1650 much sooner than I anticipated.

    This strongly suggests that my estimate of $1650 is significantly below the price of gold coming soon.

    This opens the probability that a modernized and revitalized Federal Reserve Gold certificate ratio tied to the M3 will evolve into the monetary system.

    The greatest economic crime ever committed is OTC derivatives. Those that proffered these will have killed more people than most wars.

    This is it and it is NOW!

    Respectfully yours,
    Jim Sinclair

  11. rikardo kurvio commented on Jul 27

    I just see powerful resistance on BKX in 67-68 points area

  12. Philippe commented on Jul 27

    May have been a little bit of jockeying for the TLSF?

    “The TSLF is a single-price auction, where accepted dealer bids will be awarded at the same fee rate, which shall be the lowest fee rate at which any bid was accepted. Dealers may submit two bids for the basket of eligible general Treasury collateral at each auction. The FRBNY reserves the right to reject or declare ineligible any bid, entirely at its own discretion. At the TSLF auction, each dealer aggregate award is limited to no more than 20 percent of the offering amount.”

  13. Kurt Brouwer commented on Jul 28

    On one point, I disagree that financial stocks cannot turn around until the housing bottom is reached. In fact, I suspect financial stocks will turn ahead of the housing bottom. The stock market tends to anticipate both good news and bad news and discount it to the present. I don’t think we are at or even near the bottom in housing, but I do believe financial stocks will turn around before the housing price bottom is reached, whenever that comes. Stock market investors will see better days coming six months or more before they actually hit.

  14. Kurt Brouwer commented on Jul 28

    On one point, I disagree that financial stocks cannot turn around until the housing bottom is reached. In fact, I suspect financial stocks will turn ahead of the housing bottom. The stock market tends to anticipate both good news and bad news and discount it to the present. I don’t think we are at or even near the bottom in housing, but I do believe financial stocks will turn around before the housing price bottom is reached, whenever that comes. Stock market investors will see better days coming six months or more before they actually hit.

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