How far will you ride the market down ?

[Gone4Good]

"Close them down, get them out of business. If they're dead, they ought to be buried," Shelby told ABC's "This Week" program. "We bury the small banks. We've got to bury some big ones and send a strong message to the market."

Lets just take one bank. Citigroup. Currently they have almost $800B of debt and preferred outstanding. That debt would become nearly worthless in a bankruptcy. It would be like extracting all of TARP in one single day. That default blows a hole in the balance sheet of other large insurance companies, pension funds, and banks. Do they have the capital to survive that hit? Close them down too?

Then lets move on to Citigroup's other $1,000,000,000,000.00 in liabilities. How many companies and countries get taken down when Citi defaults on those? To put this in perspective, Citigroup's liabilities are roughly the size of Italy's GDP.

Remember when folks thought it might be O.K. to let Lehman go? Before money market funds started breaking the buck, before the comercial paper market shut down, and before our entire financial system faced a "run on the bank." Well Citigroup is 3 times larger than Lehman.

Bank of America, the next big bank in line for Shelbyville, is only about 7% smaller than Citigroup.

The financial world ends the day we decide to take Mr. Shelby's advice.

 

[ERD50]

. I used to be more of a strict asset allocation guy, but I'm becoming a convert to the "X years of safe investments" school of thought.

But I think most people would be well-served ... to have 10+ years of anticipated withdrawals in less volatile investments.

But doesn't a "strict asset allocation" do the same thing? I think it's just different ways to view it.

For example, with very rough numbers, say you picked a 50-50 AA and planned to stick to it. Well, when the market drops, a rebalance means pick off some of the fixed investments, so use that for your living expenses.

Using the 4% SWR, net worth is 25x expenses, so a 50-50 gives you 12.5 years of less volatile investments to draw on. That is a simplified example ignoring inflation and returns, just trying to get the point across.

I think the market gained something like 55% in 1933 -- probably closer to 60% with dividends. Imagine throwing in the towel in mid-1932 and missing THAT recovery.

Yes, I think that is the REAL danger of market timing versus Buy & Hold. With B&H you are in. With timing, the danger is being out at the wrong time. Probably the main reason I'm able to hold on in this stinkin' rot of a market

-ERD50

 

[Maurice]

I simply will not sell. My question is when to pile more cash in.

 

[RonBoyd]

I simply will not sell. My question is when to pile more cash in.

FWIW, my tent is pitched in this camp also.

 

[ls99]

I simply will not sell. My question is when to pile more cash in.

Ditto.

 

[audreyh1]

Good for you. I used to be more of a strict asset allocation guy, but I'm becoming a convert to the "X years of safe investments" school of thought. Given enough time, the markets will recover.

That's where I have been from the start of my investment strategy, although frankly I hoped never to see the event in my lifetime where my portfolio took such a bad hit that rebalancing to my target AA would mean going below my "X year of safe investments" threshold.

Keeping that "X years of safe investments" pushed my stock allocation down last time I rebalanced, and will do so again if I get brave enough to put one more years expenses into equities at this level since my allocation is way out of balance again.

So now I'm kind of wondering whether I should just stick with this new lower stock allocation that I have been "forced" to when the market recovers.

Who knows how long I may be mulling over that question? It's kind of mute until we start to recover.

Audrey

 

[Martha]

Lets just take one bank. Citigroup. Currently they have almost $800B of debt and preferred outstanding. That debt would become nearly worthless in a bankruptcy. It would be like extracting all of TARP in one single day. That default blows a hole in the balance sheet of other large insurance companies, pension funds, and banks. Do they have the capital to survive that hit? Close them down too?

Then lets move on to Citigroup's other $1,000,000,000,000.00 in liabilities. How many companies and countries get taken down when Citi defaults on those? To put this in perspective, Citigroup's liabilities are roughly the size of Italy's GDP.

Remember when folks thought it might be O.K. to let Lehman go? Before money market funds started breaking the buck, before the comercial paper market shut down, and before our entire financial system faced a "run on the bank." Well Citigroup is 3 times larger than Lehman.

Bank of America, the next big bank in line for Shelbyville, is only about 7% smaller than Citigroup.

The financial world ends the day we decide to take Mr. Shelby's advice.

You don't have them go under, you nationalize them and then sell them. If there is a negative value, then the government either helps contribute capital or it pull out some of the debt and deals with that.

Bankruptcy isn't an appropriate model because much of the bank debt needs to be paid. But the bailout should not be through dribbling cash to current owners. The owners have to go. That was the problem with Japan. Sweden successfully nationalized and then re-privatized almost immediately, IIRC.

 

[REWahoo]

You don't have them go under, you nationalize them and then sell them.

I believe that's what Shelby and McCain are saying, without actually using the N word. Essentially what the FDIC does when a bank 'fails'.

 

[Bikerdude]

You don't have them go under, you nationalize them and then sell them. If there is a negative value, then the government either helps contribute capital or it pull out some of the debt and deals with that.

Bankruptcy isn't an appropriate model because much of the bank debt needs to be paid. But the bailout should not be through dribbling cash to current owners. The owners have to go. That was the problem with Japan. Sweden successfully nationalized and then re-privatized almost immediately, IIRC.

Anybody know if the credit default swaps (written on Citi) have to be paid if the government takes over Citigroup or are they wiped out.

 

[Maurice]

Anybody know if the credit default swaps (written on Citi) have to be paid if the government takes over Citigroup or are they wiped out.

THey'd need to be paid, but it would be a more-or-less trivial event since their bonds would be worth almost what treasuries are.

CDS pay Notional-Recovery, with Recovery being the value of the bond at the time of default. (therefore the bond holder is made whole). Once the gov't takes over Citi, it counts as a credit event, but the bonds shoot up in value, because its the gov't on the hook not Citi.


Fannie and Frddie worked the same way.



Bill Gross made over $1B on the Freddie/Fannie default by hoovering up their bonds when he saw naitonalization coming.

 

[Jacey]

I enjoyed the Ventures "Wipe Out." I don't recall seeing them perform this. If I did, it is lost in the fog of time. The drummer is amazing - his hands a blur throught most of the song.

 

[dex]

Lets just take one bank. Citigroup. Currently they have almost $800B of debt and preferred outstanding. That debt would become nearly worthless in a bankruptcy. It would be like extracting all of TARP in one single day. That default blows a hole in the balance sheet of other large insurance companies, pension funds, and banks. Do they have the capital to survive that hit? Close them down too?

Then lets move on to Citigroup's other $1,000,000,000,000.00 in liabilities. How many companies and countries get taken down when Citi defaults on those? To put this in perspective, Citigroup's liabilities are roughly the size of Italy's GDP.

Remember when folks thought it might be O.K. to let Lehman go? Before money market funds started breaking the buck, before the comercial paper market shut down, and before our entire financial system faced a "run on the bank." Well Citigroup is 3 times larger than Lehman.

Bank of America, the next big bank in line for Shelbyville, is only about 7% smaller than Citigroup.

The financial world ends the day we decide to take Mr. Shelby's advice.

I think this is how it would work with Citibank - it isn't letting them go bankrupt but what was done previously.

Hussman Funds - Weekly Market Comment: The Economy Needs Coordination, Not Money, From the Government - February 23, 2009

For example, throwing government money at financial institutions that are insolvent simply gives taxpayers a loss that should be borne by the bondholders of that financial institution. I can't stress emphatically enough that the largest bank failure in U.S. history – Washington Mutual – was arranged last year with absolutely NO cost to the government, and no loss to the bank's customers. What happened there was exactly what I've been advocating since the Bear Stearns crisis: the government took Wa-Mu into receivership, wiped out the stockholders and most of the bondholders, sold the bank's assets along with the customer liabilities to J.P. Morgan for $1.9 billion, and handed those proceeds over as partial recovery for the senior bondholders. For more details on this sort of transaction, see the March 31, 2008 comment What Congress should Understand About the Bear Stearns Deal, and the September 22, 2008 comment, An Open Letter to Congress Regarding the Current Financial Crisis.
Take a look at Citibank's balance sheet as of the third quarter of 2008. The company had about $2 trillion in assets, versus about $132 billion in shareholder equity, for a gross leverage ratio of about 16-to-1. That's not a comfortable figure, because it indicates that a decline of about 6% in those assets would wipe out Citibank's equity and make the bank technically insolvent. Unfortunately, we saw credit default spreads screaming higher last week, while the bank's stock dropped below $2 a share, so evidently the market is deeply concerned about the possible immediacy of that outcome.
But keep looking at the liability side of Citibank's balance sheet. There is over $360 billion in long-term debt to the company's bondholders, and another $200 billion in shorter term borrowings. None of that is customer money. That puts the total capital available to absorb losses at $132 + $360 + $200 = $692 billion, which is about 35% of the $2 trillion in assets carried by Citibank. That's a huge cushion for customers, who are unlikely to lose even if Citibank becomes insolvent. Should that occur, the proper response of government will not be to defend Citi's bondholders at taxpayer expense, but rather, to take Citi into receivership, wipe out the shareholders and most of the bondholders, and sell the assets along with the liabilities to customers to another institution.

 

[Gone4Good]

I can't stress emphatically enough that the largest bank failure in U.S. history – Washington Mutual – was arranged last year with absolutely NO cost to the government, and no loss to the bank's customers. What happened there was exactly what I've been advocating since the Bear Stearns crisis: the government took Wa-Mu into receivership, wiped out the stockholders and most of the bondholders, sold the bank's assets along with the customer liabilities to J.P. Morgan for $1.9 billion, and handed those proceeds over as partial recovery for the senior bondholders.

Except when the government did that the market immediately began puking the equity, preferred, and bonds of every other questionable financial institution under the assumption they were going to get wiped out too. Without the ability to raise equity, preferred or debt financing every company eventually dies. Financials do so at an alarmingly rapid rate.

It becomes a pretty easy thing for the market to single out the weakest of the herd and aggressively sell their securities. Once that firm dies then the next one on the list gets targeted. Rinse, repeat.

There is a reason the government didn't do to Wachovia what it did to Ma-Mu and why it tried it's best to preserve equity value at Citi. It's because the Ma-Mu transaction was a failure.

 

[Gone4Good]

You don't have them go under, you nationalize them and then sell them. If there is a negative value, then the government either helps contribute capital or it pull out some of the debt and deals with that.

That is what we currently have with Citi in everything but name.

And the Sweden example isn't entirely appropriate. They had three banks. We have 8,300. You can nationalize three banks. Where do you draw the line when you have 8,300 knowing that the market will target for extinction every single one that is even remotely in a gray area?

 

[Gone4Good]

Anybody know if the credit default swaps (written on Citi) have to be paid if the government takes over Citigroup or are they wiped out.

It's highly technical and fact specific but in all likelihood a nationalization would be a triggering event under the contracts.

 

[Martha]

That is what we currently have with Citi in everything but name.

And the Sweden example isn't entirely appropriate. They had three banks. We have 8,300. You can nationalize three banks. Where do you draw the line when you have 8,300 knowing that the market will target for extinction every single one that is even remotely in a gray area?

I understand the difference. What is the alternative?

 

[Gone4Good]

I understand the difference. What is the alternative?

Unfortunately you're witnessing the alternative. The government prevents the wheels from absolutely coming off the financial system. Smaller institutions are restructured like normal. Systemically large institutions are given time and capital to shed assets and earn their way out of the mess.

Unless there is any doubt about this, here is part of Bernanke's response to a question earlier this week:

RUBENSTEIN: How would you say the Federal Reserve today is going things differently than the Federal Reserve you studied during the Great Depression?

BERNANKE: . . . There are many people in economics who say, "Well, you can let large financial firms fail. The market will take care of it," or "These effects are second order."

I hope that view is no longer seriously maintained -- (laughter)

. . . To respond to your question, I learned basically two lessons from my studies of the depression. The first is that monetary policy needs to be supportive, not contractionary. . . .

The second lesson is that -- to reiterate what I said before, is that when the financial system breaks down, becomes highly unstable, then that has very severe adverse effects on the economy.

Once again, this is something that was not handled. The Federal Reserve did not intervene to stop the failure of about a third of all the banks in the United States. Globally, there were massive bank failures. I think perhaps the most critical, in May of 1931, the Creditanstalt, which was one of the largest banks in Europe, failed, which generated a wave of financial crisis around the world. Up till early 1931, arguably the 1929 downturn was just a ordinary -- severe but ordinary downturn. It was the financial crises and the collapse of banks and other institutions in late 1930 and early 1931 that made the Great Depression great.

And so we must have a commitment to stabilize our banking system, to prevent the failures of any large systemically critical firms, and, going forward, to find stronger rules, regulations, mechanisms to make sure we're not put in this situation where we are dealing with these "too big to fail" firms, which is obviously very detrimental to the market discipline and to the functioning of the economy in the longer term.

 

[Martha]

Unfortunately you're witnessing the alternative. The government prevents the wheels from absolutely coming off the financial system. Smaller institutions are restructured like normal. Systemically large institutions are given time and capital to shed assets and earn their way out of the mess.

Unless there is any doubt about this, here is part of Bernanke's response to a question earlier this week:

Interesting. How do we prevent the zombie bank issue?

 

[Gotadimple]

Well, federal agencies can make policy, but I suspect Bernanke is looking to Congress to make law, and then administer that law through policy. I would hope, though, that we seek out the EU and the IMF or other such agencies to find a global regulatory solution. As he pointed out, a problem with the banks in one country, if sufficiently large and if that country has a larger economy in the world rankings, can affect the entire world.

In 1930, it was Germany's banks. In 2009, . . .

 

[Gone4Good]

Interesting. How do we prevent the zombie bank issue?

When faced with a no win situation, what do you do?

You lose.

But I'm a bit more optimistic than that. I don't think we'll have a big problem with zombie banks. One reason is that the core banking business is incredibly profitable now. Banks are borrowing at government guaranteed rates (essentially free in the short end) and lending it back out in to an environment that has ridiculous credit spreads on top of a very steep yield curve. Bank of America today said it expects its business to generate $50B in profits before provisions. A couple of years of profits like that will fix a whole host of problems caused by bad legacy assets.

We're also not entirely dependent on banks, zombie or otherwise, to finance our economy the way Japan was/is. Capital markets play a much larger role here. And while they're a bit dysfunctional and panicked right now, there is no reason to think that is permanent (provided we don't let the whole system come crashing down to satisfy either political orthodoxy or populist rage). Certainly some of the excesses are gone forever, but I don't foresee the economy being capital constrained over the long, or even intermediate, term.

Finally, many companies are rendered too big to fail today because of the fragile state of the economy. Absent the massive credit bubble that weakened all financial institutions, we probably could have shouldered Lehman's bankruptcy without too much of a problem - assuming it was a one off event. A couple of years from now, if Citi and others are still basket cases, it's completely possible that they could get wound down without the same impact that would be felt today.

 

[audreyh1]

Yep - if it hadn't been for the ridiculous 30x to 40x leverage coupled with the CDSs, we probably could have let quite a few big ones fail and not had a crisis impact on the rest of the economy. If we get one thing out of this (I hope we get more), I hope we, once again, restrict the amount of leverage with which these "too big" financial institutions can play roulette.

Besides the leverage restrictions which were lifted in by the SEC in 2004, I suspect part of what the Glass-Steagal act prevented was financial institutions becoming too big to fail. AIG would be an example.

Audrey

 

[ziggy29]

Besides the leverage restrictions which were lifted in by the SEC in 2004, I suspect part of what the Glass-Steagal act prevented was financial institutions becoming too big to fail. AIG would be an example.

It also reduced the cross-contamination among the financials. Now if investment banks get sick, for example, they can more easily take community lenders, brokerages and insurers down with them. Under Glass-Steagall there was considerably less cross-contamination.

 

[tulak]

Once again, this is something that was not handled. The Federal Reserve did not intervene to stop the failure of about a third of all the banks in the United States. Globally, there were massive bank failures. I think perhaps the most critical, in May of 1931, the Creditanstalt, which was one of the largest banks in Europe, failed, which generated a wave of financial crisis around the world. Up till early 1931, arguably the 1929 downturn was just a ordinary -- severe but ordinary downturn. It was the financial crises and the collapse of banks and other institutions in late 1930 and early 1931 that made the Great Depression great.

Only because deposits were not insured. It's not suprising that if everbody's bank is going under and individuals lose all their money, that you are going to have fundamental issues with your economy.

I'm skeptical that a collapse today would have the same result.

 

[Dennis]

Ready to Loose 90% The sky is falling! Well Maybe for many.. but If retired persons just followed the 1st basic, they're ok...

> Keep 3 yrs COH for your Bills in MMkt and Shrt term Bonds
> Along with having the Homestead paid for
> Keep Credit Card Debts to a Minimum and get the lowest rate cards every yr
> Keep 1 car paid For, can finance the other

And Don't Lend $ to the Kids or Grandkids.. They can come Live with you instead..That usually changes their minds and go out a get extra Jobs or cut their Cable and Cell Phone Bills....LOL

 

[harley]

Which of those four or five is the first basic?

Seems to me that after your 3 years is up you could be facing some serious issues. I have hopes but no faith that this will be over in 3 years. I think losing 90% of the rest (or even 50%) would be something worth worrying about. I don't disagree with your points, but oversimplifying isn't a good idea. There's worthwhile worrying to be done here. Tell him, Dawg!