Banks Brace for Stress Tests

This post first appeared on Minyanville.

As financial markets reel, equities probe lows unseen in over a decade, and optimism wanes on Main Street, President Obama and Treasury Secretary Tim Geithner are rolling out a series of so-called “stress tests” to firm up confidence in the country’s banks.

The tests, designed to ensure banks will survive even if economic conditions continue to deteriorate, focus on the books of 20 of the country’s largest banks. According to Bloomberg, the stress tests begin today.

The approach harkens back to tactics used during the Great Depression - yet another reminder of just how bad things have gotten for the US banking system.

Last week, Federal Reserve Chairman Ben Bernanke explained how a similar approach in 1933 solidified confidence in the nation’s banks:

“Roosevelt shut down the banks for a week and said we are just going to check the books and open them up only when we think they are solvent. And a lot of the banks opened up pretty quick. So, it's not really clear how much they really looked through the books, but when they opened them up again, people felt much more comfortable, and more confident in the bank.”

The current plan doesn’t just aim to “check the books.” Instead, regulators will evaluate the strength of banks like Citigroup (C), Bank of America (BAC) and JPMorgan (JPM), already up against the ropes, based on how the'll perform if put through a more “stressful” economic test.

In other words, what happens if the wheels really fall off the wagon.

For example, let’s assume most economists believe housing prices, which have already corrected more than 20%, will stabilize after having fallen 30%. The last 10% of declines would have a certain effect on residential mortgage losses (among other assets), so Treasury bean-counters try to estimate whether banks could withstand the losses such a scenario would create.

The next step is to assume things get worse than expected - say, a 40% peak-to-trough decline in property values. More losses would ensue, and, after tallying each bank’s projected losses, officials can try to determine how much capital banks need to to remain solvent through this “worst-case scenario.”

After injecting the requisite capital to keep banks alive if things get really, really bad, newfound confidence could entice private capital back into the market. At least, that's the theory. If instead they find out certain banks wouldn't survive without massive amounts of capital, they could then become targets for nationalization.

Myriad troubles arise with this approach, bold as it may be. A few to consider:

First, selecting the “worst case” is problematic, particularly since conditions during this crisis have gotten worse than almost anyone expected. Anyone in Washington, that is, since many private commentators had been saying the sky is falling for years. Still, regulators have to make guesses about how bad things could possibly get, and their guesses could be wrong.

Second, any assumptions about future losses are based on guesses based on assumptions based on guesses based on assumptions based on wild stabs in the dark. In short, the complexity of the global financial system, the unintended consequences of various government actions, and a general difficulty predicting the future, make predictions exactly that - predictions.

Third, and possibly most importantly, regulators have lost almost all credibility over the past 18 months.

Some may argue that the guys in charge are different, but that’s just not the case. Ben Bernanke still runs the Federal Reserve, Tim Geithner ran the New York Fed for the past 5 years, Lawrence Summers is back at the economic helm, and Barney Frank and Chris Dodd are still mouthing off on Capitol Hill. Sure, there's a different face in the White House - but by and large the same folks who got us into this mess are now trying to get us out.

The American public recognizes this, investors recognize this, and the world recognizes it.

Even if the stress tests go off without a hitch and Geithner and Obama loudly proclaim the banking system is safe and sound, the market may simply, quietly shrug - and continue heading south.

AmEx to Customers: Take the Money and Run

This post first appeared on Minyanville.

Ask a Manhattanite what a “lease buyout” is, and most will blithely respond that it’s when a landlord pays a tenant to vacate his or her apartment. After all, why wouldn’t that little old lady next door -- the one paying $800 a month for a rent-controlled loft on the Upper West Side -- want to take a hundred grand to go find some new digs?

This phenomenon, formerly reserved for big-city landlords in New York or San Francisco, appears to be migrating to the financial industry.

According to Reuters, American Express (AXP) is offering select clients $300 to close their credit-card accounts. The company didn’t disclose how many such offers it planned to send out - but did say customers will have until the end of the month to accept, and until the end of March or April to pay off their balances. In exchange, they’ll receive a $300 pre-paid American Express gift card.

Rivals Capital One (COF), Discover (DFS) and JPMorgan (JPM) haven’t announced similar programs, but efforts to rein in consumer credit lines are ongoing throughout the industry. The once-steady stream of new card offers that used to fill our mailboxes has finally dried up.

Besieged by higher defaults and rising delinquencies, American Express is regretting its decision a few years ago to start offering cards to customers with sketchier credit records. Once known as card company of the well-to-do, the firm expanded its offerings down the credit spectrum at just the wrong time.

Surprised by a sharp downturn in economic conditions and the new allergy to structured credit card debt, American Express has seen its stock decimated in recent months: Shares are down more than 75% from their high last year. Capital One is off a more dramatic 86% since peaking at over $63 per share last year; Discover is off a mere 72% from its high.

The relative success of the new program could have 2 noteworthy effects. First, if successful, other card companies may rush to mimic AmEx's bold initiative.

Second, consumers' willingness to voluntarily close credit lines, precisely at a time when logic would dictate a desire to keep available as much rainy-day credit as possible, provides stark evidence of the ongoing rejection of debt, credit and excess.

As consumers return to more sustainable, responsible buying patterns -- first by necessity then by choice -- purveyors of the just-not-really-necessary aren't likely to fare well.

But as is the case in a broadly deflationary environment, even purveyors of the kind of things that you stockpile in case of apocalypse are facing hard times. Campbell's Soup (CPB), for example, reported weaker-than-expected earnings and offered less-than-inspiring guidance for 2009.

Consumers, it seems, are just buying less. Of everything. Maybe closing that credit card isn't such a bad idea after all.

Government Moves Into Citi?

This post first appeared on Minyanville.

It may not be nationalization, but it’s pretty close.

Last night, the Wall Street Journal reported the federal government is considering taking a large step closer to outright control of Citigroup (C). Having already sunk tens of billions of dollars into the troubled bank, the Treasury Department may now convert its non-voting preferred stock into Citgroup common stock. This would give government officials voting rights and more control over management's decisions. The Journal reports the government could own as much as 40% of the company, although bank executives are hoping the stake will come out closer to 25%.

And while taxpayers wouldn’t be asked to pump in additional funds, the move would further dilute current shareholders. But there isn’t much left to dilute: The company’s shares traded below $2 Friday, and were off more than 50% as recently as February 10.

Reeling from credit losses and worsening economic conditions in the US and abroad, Citigroup is at the leading edge of the financial storm. And nervous politicians are taking a more active role in bank management, concerned that capital injections, debt guarantees and loss-sharing agreements may not be sufficient to allow banks to retain their independence.

The Obama administration did say on Friday, however, that nationalization isn't in the cards for Citi and Bank of America (BAC). Nevertheless, nationalization calls are being heard loudly across the globe. Politicians, academics and pundits are weighing in, many arguing state control is the system's only hope to survive.

Banks, for their part, claim they don’t need the help: They claim that fear, rather than fundamentals, are driving their shares into the ground. In addition to Bank of America CEO Ken Lewis, JPMorgan (JPM) chief Jamie Dimon and Wells Fargo (WFC) CEO John Stumpf have asserted that their institutions are solvent enough to go it alone.

In his public remarks on Friday, Stumpf even managed to sound upbeat about the future. “There is so much to look forward to. I don’t know what we’re going through today, but it will probably define our generation. This can be the next greatest generation.”

Indeed. As Toddo often says, “In order to get through this, we need to go through it.” And with stress tests on tap for the nation's biggest banks, we may soon find out just how much we'll have to go through to get to the other side.

Keepin' It Real Estate: A Real Fix for Housing

This post first appeared on Minyanville and Cirios Real Estate.

While pundits and politicians debate the various aspects of President Obama’s $275 billion housing bailout, one piece of data proves just how misguided federal efforts to revitalize the housing market are: $275 billion could buy more than half of all American homes already in foreclosure.

Such an undertaking would remove distressed homes from the market and spur community revitalization efforts throughout areas desperately in need of the hope they were promised in November.

According to real-estate analytics website Realtytrac.com, foreclosures were filed on 2,330,483 homes in 2008, up 83% from the year before. The median home price in the US is $180,100 - which means 1,526,929 of those homes could be bought with $275 billion. And since foreclosures are centered primarily in areas with low home values, the true number of properties the bailout money could be used to buy is likely much higher.

While the logistics for such an outrageously common-sense solution to the nation’s housing woes are daunting, they’re no less challenging than the massive loan modification efforts already in place. And their results continue to prove underwhelming, at best.

Such a solution also addresses the rapidly mounting discontent over bailing out those homeowners who made bad decisions. Distressed borrowers wouldn't directly receive any taxpayer money - though they would indirectly benefit from the massive government expenditure in their community.

Cash would be funneled down to the local level, where cities and counties could more effectively distribute it. To be sure, local governments can be as bureaucratic and inefficient as Washington -- not to say corrupt -- but by allocating capital to localities, each community would be responsible for its own clean-up efforts.

Private investors, developers, nonprofits and real-estate professionals could compete for business, adding a free-market component to rescue efforts - and even spurring a little sorely-needed economic activity.

Some cities aren't content to wait for federal money to trickle down from the White House. Menlo Park, California, best known for its devotion to the bubble lifestyle, is considering using city money to buy and refurbish foreclosed homes.

The town, like many others in America, is split by a highway that acts as a major dividing line between the haves and the have-nots. While there are just 97 homes in foreclosure in Menlo Park, the vast majority are on “the other side of the tracks,” away from the mansions and quiet, tree-lined streets of West Menlo. The proposal will use money from a $2 million fund already seeded by developers who opted not to allocate units for low-income housing.

The city plans to tap Habitat for Humanity to refurbish the homes, using community volunteers and local experts to oversee the improvements. The president of the local Homeowners Association, Ash Vasudeva, said “When rehabilitation is going on, it uplifts the entire community.” A simple statement, but true.

And while this is one small city undertaking one small project, it could serve as a model for other communities around the country. Not to mention the fact that the mere announcement of $275 billion in real-estate investments would hasten the price discovery the housing market so sorely needs.

Furthermore, banks stand to gain little from such a use of public funds - which could be why such a plan has yet to be proposed on Capitol Hill. When a bank forecloses on a home, JPMorgan Chase (JPM), Wells Fargo (WFC) or Citigroup (C) is forced to write the asset down to at least the amount of the outstanding loan. But since most properties are worth far less than the loan amount, selling the property at market prices would require further writedowns.

So, as banks soak up billions in bailout money under the auspices of massive loan modification efforts aimed at stemming foreclosures, vacant homes lay in disrepair, vagrants loot the pipes - and communities continue to deteriorate.

But instead of allocating funds for such grassroots efforts, Washington continues to issue broad, vague orders aimed at helping many, but in very small amounts. Such programs have failed before, and they'll fail again.

Maybe it's time for a new approach.

Hollywood Hits the Bailout Trough

This post first appeared on Minyanville.

Even as California teeters on the edge of insolvency, state lawmakers are considering tax breaks aimed at lining the pockets of Hollywood filmmakers.

According to the Wall Street Journal, states like Louisiana, Michigan and Minnesota started offering attractive tax incentives for studios to film within their borders. Feature-film production days in Hollywood hit a 15-year low in 2008.

Now, in an attempt to lure big-name producers and directors back to its sunny shores, California is proposing a 25% tax credit of its own. The proposal would reimburse studios for a portion of their expenses, in the hopes that peripheral spending and job creation will help prop up the state’s flagging economy. Besieged by the housing market collapse, California has one of the nation’s highest unemployment rates at 9.3%.

The new proposal could be funded partially out of California’s allocation from President Obama’s economic stimulus package, although it isn’t likely to put money into the pockets of the country’s most downtrodden. High-profile actors aren’t exactly standing on bread lines just yet.

And while the initiative could provide employment to gaffers and dolly grips throughout Hollywood, critics argue movie shoots rarely generate long-term, sustainable jobs.

Instead, they argue, bloated payments to actors and eye-popping special effects have raised movie budgets beyond reasonable levels. Meanwhile, states vie for filmmaker dollars with ever-more-outsize kickbacks - kickcbacks that simply perpetuate the unsustainable economics of making movies.

Big studios like Disney (DIS), Universal (GE), Columbia (SNE) and Warner Brothers’ (TWX) are smarting as consumers rein in spending on luxuries of all kinds. Movies do offer a semi-affordable entertainment option.

California's attempts to win back the industry it birthed decades ago is further evidence of the private sector's increasing dependence on government handouts for survival. And while tossing a few bucks to filmmakers to generate local jobs may seem like a worthy trade-off in a rough employment environment, it creates a dependency - and perpetuates unsustainable business practices.

It's no wonder movie budgets soared as states upped their kickbacks: Spending someone else's money is a lot easier than spending your own.

Stanford Takes Page from Ponzi Playbook

This post first appeared on Minyanville.

It turns about Bernie Madoff wasn’t the only one cooking the books: Texas banking icon R. Allen Stanford is the latest to be charged with a massive, multi-billion dollar fraud.

In a story conveniently drowned out by President Obama’s signing of the $789 billion economic stimulus package and the auto industry’s latest plea for taxpayer money, the Securities and Exchange Commission raided Stanford’s Houston headquarters yesterday morning, alleging he perpetrated an $8 billion fraud based on “false promises and fabricated historical data.”

According to the Wall Street Journal, Stanford lured in investors by promising steady, safe returns for cash deposited in a bank he owns in Antigua, one of the many Caribbean banking havens. Instead of investing in liquid, low-risk assets as promised, Stanford allegedly funneled the money into high-risk private equity and real estate deals. Oversight was scant, as decisions were reviewed by 2 people: the bank’s chief financial officer, James Davis, and Stanford himself.

Much like Madoff’s much-publicized Ponzi scheme, consistently high returns that seemed impervious to market gyrations were the hallmark of Stanford’s scam.

The SEC claims Stanford International Bank returned between 6-10% from 1992-2006 on its certificates of deposit, or CDs. Yields on comparable investments issued by American banks like JPMorgan (JPM), Bank of America (BAC) and Wells Fargo (WFC) are significantly lower - but carry FDIC insurance to protect depositors from loss.

Strong returns on its investment portfolio, Stanford claimed, allowed the bank to pay out the oversized returns. In 2008, a year that saw the S&P 500 lose 39%, the bank said its portfolio lost just 1.3%.

The SEC says Stanford used these inflated returns to woo investors, many of which hailed from Latin American countries. Shaky banks in South America led many wealthy individuals to invest with Stanford, believing he could earn them strong returns with little risk.

But as their North American counterparts have learned from the ongoing Madoff affair: Where there’s return, there’s always risk.

This lax attitude towards risk, one that was fostered for decades by the Federal Reserve's overly accommodating monetary policy, was instrumental in sowing the seeds of our current financial crisis. It also helps explain how so many investors around the world were so easily duped by cons that, in retrospect, seem so easy to identify.

“Malinvestments,” a term popularized in recent years by Texas Congressman Ron Paul, occur when cash is poured into assets that return a yield that isn't commensurate with their risks.

When times are good, losses remain low and Washington comes to the rescue of the financial industry every time it gets into trouble, investors become accustomed to earning high rates of return without taking much risk. As this belief becomes the status quo, more and more money is funneled towards these seemingly low-risk, high-return opportunities.

Peddlers of financial instruments, from Madoff and Stanford to Goldman Sachs (GS) and Morgan Stanley (MS), dream up increasingly complex places for investors to park their money. Risk, they claimed, was as low as ever, thanks to their financial wizardry.

When real losses did occur, loan defaults began to rise, and the government wasn't deft enough to stem the tide, investors got burned. Badly.

Assets that suddenly become very risky lost value rapidly, since they carried such a low rate of return. Losses beget losses, which beget more losses. We all know how the story ends.

Meanwhile, even as it acted as enabler to Wall Street's (and Main Street's) incessant greed, the federal government now insists on pointing fingers and acting as savior for a system it was complicit in creating.

Where was the SEC to root out Madoff and Stanford before investors lost billions? Where was the Federal Reserve to act on its own findings about the risks of exotic mortgage lending?

Yet, even now, we're counting on these same institutions and politicians to invest nearly $1 trillion of our money to rescue us.

How low-risk is that investment strategy?

Auto Bailout: Part Deux

This post first appeared on Minyanville.

The turnaround plans are in, and it doesn’t look good: No more Hummers.

In a scene reminiscent of last year’s near-collapse, General Motors (GM) and Chrysler LLC told government officials that, without more than $20 billion in additional rescue money, bankruptcy is their only option. Required to submit restructuring plans under the terms of the first federal bailout, GM and Chrysler outlined a strategy for revitalizing their firms and returning to profitability.

Twenty billion dollars, GM’s CEO Rick Waggoner argues, is a paltry sum when compared to the estimated $100 billion the firm would need to make it through a traditional bankruptcy process, according to the Wall Street Journal. Chrysler, for its part, said $24 billion would suffice to skate through bankruptcy proceedings, should Washington fail to produce the requested funds.

In addition to squeezing taxpayers for more cash, the firms announced tens of thousands of layoffs and other cost-cutting measures.

GM plans out phase out its Hummer brand as early as this year, since no buyer emerged for the production facilities that crank out the oversized gas guzzlers. Saturn could be gone by 2011, as could Pontiac, and the company is trying to sell Saab. Five factories will be shut, 47,000 jobs will be cut, and dealerships will be closed as GM tries to rein in its bloated cost structure.

Chrysler is fighting battles of its own, as Congress is becoming increasingly hostile toward the company’s majority owner, private-equity firm Cerberus Capital Management. Lawmakers want to see Cerberus pony up cash for its struggling investment before any additional taxpayer funds are put to work.

Progress has been made by GM, Chrysler as well as Ford (F) in negotiations with the powerful United Auto Works union, but there are still outstanding items that need to be resolved before any restructuring can be pushed through.

Earlier this week, President Obama announced that the so-called “car czar” would never be crowned, opting instead to task Treasury Secretary Tim Geithner and Lawrence Summers, chairman of the National Economic Council, with cleaning up Detroit’s mess.

And quite a mess it is.

With the economy in free fall and the nearly $1 trillion stimulus package now approved, allowing the automakers to fail could be a severe setback for the Obama administration. On the other hand, growing public discontent over handouts to industries that brought about their own demise makes this a prickly political issue.

Ultimately, Obama may be looking to treat the situation in Detroit as a trial run: The relatively simple task of unwinding 2 cash-starved companies will be child’s play compared to fixing the country’s ailing financial system.

The nation's biggest banks, Bank of America (BAC), Citigroup (C), JPMorgan (JPM) and Wells Fargo (WFC), continue to reel as losses mount, and the economic crisis deepens. And as Treasury Secretary Geithner muddles along with his bank-rescue package, officials may be biding their time and sharpening their management skills.

Americans to More Debt: Talk to the Hand

This post first appeared on Minyanville.

Washington just doesn’t get it: We don’t want more debt.

While congressmen berating bank CEOs for their unwillingness to lend out their bailout money makes for a nice media clip, it reflects the growing disconnect between our elected officials and any semblance of reality. Not that the relationship was ever particularly close - but lawmakers are floundering for good press while the nation’s economic future slips further and further from their tenuous grasp.

Bloomberg reports American consumers are wary of taking on more debt, as expectations about eroding economic conditions are forcing people, to *gasp* make responsible decisions about their personal finances.

Bloomberg cites Midsouth Bancorp (MSL) president C.R “Rusty” Cloutier, who says that, despite aggressive marketing, town hall meetings, and $20 million in TARP money, Midsouth's customers just aren’t taking out new loans.

This is the rejection of debt Professor Depew speaks of when discussing the structural deflation we’re currently experiencing.

Credit is based on trust. And while conventionally we view this relationship as one in which the lender must trust the borrower to repay his debt -- at least to an extent that’s commensurate with the interest rate -- it does go both ways.

As lenders like Citigroup (C), Bank of America (BAC) and Wells Fargo (WFC) are increasingly being painted as corporate marauders out to rape and pillage the American public, would-be borrowers are wary of putting their financial future in the hands of these men of questionable repute. And with credit-card companies rushing to alter terms, it’s no surprise consumers are reluctant to extend themselves further.

Still, lawmakers are pushing through an economic stimulus package that depends, in part, on a willingness on the part of consumers to keep spending. Their delusion is only outmatched by their hubris - the belief that a bunch of self-interested politicos can coerce the average American into making ruinous financial decisions for the betterment of the country.

Floundering industries -- notably automakers and homebuilders -- are counting on government subsidies to encourage Americans to keep borrowing to buy their products. But what General Motors (GM), Ford (F), Centex (CTX) and KB Homes (KBH) don't understand is this: We just don't want what they're peddling. And we certainly don't want to borrow against it.

The transition from a debt-dependent, credit-drunk consumerist society won't be immediate: It's taken 18 months of financial panic for evidence of the shifting social mood to make its way into the mainstream.

But as the economic outlook continues to darken, the country becomes more disenfranchised, and the government grows ever-more addicted to sound bites and empty promises, reality will set in.

For the past 20 years, we've been blithely driving along an economic road that ends in a cliff. And that cliff is now in our rear-view mirror. We're tumbling, groping for any branch that can save us from the fall. But each one of these new government programs, bailouts and rescues simply tries to set us gently back on the road from which we only just plummeted.

We already know where that path ends, and it ain't pretty. What say we try another road?

The Mortgage Rescue Plan: Will It Work?

This post first appeared on Minyanville and Cirios Real Estate.

The answer? An emphatic no. This is simply the latest example of legal plunder perpetrated by the federal government against law-abiding, tax-paying citizens.

The Obama administration’s scheme to help troubled borrowers centers on subsidizing interest payments, which would help borrowers make ends meet without angering those investors expecting full payments each month. This marks the first time the government is intervening directly with taxpayer funds to ease the burden of monthly mortgage payments.

Bloomberg reports the plan will be voluntary for lenders like Wells Fargo (WFC), Citigroup (C) and Bank of America (BAC), and will employ many of the tactics previous modification efforts have used (ineffectively), such as loan extensions and principal reductions. Modifications identified as having a net present value will be targeted, where foreclosing would be more expensive than changing the loan terms.

The program aims to establish a standard for loan modifications that can be used industry-wide. That's an absurd claim, which demonstrates the extent to which lawmakers misunderstand the scope of the problem. It's a bit like saying every American must cut their hair the same way: It would be laughable it weren’t so sad.

Each mortgage, each borrower, each lender, each home is unique; each situation is different. Individual banks can barely standardize the documents required to close a loan, so the notion that there can be one standard for approving a loan modification -- an intensely complicated procedure involving countless interested parties -- is ridiculous.

It would be one thing if the plan offered even the remotest possibility of stabilizing the housing market. It doesn't. The few borrowers who may be helped will have little effect on a massive, disjointed housing market that remains determined to run its course despite government efforts to stop the bleeding.

The societal implications of this program are downright frightening.

Washington cutting checks to borrowers who can’t make their mortgage payments sounds like a benevolent act attempt to reach down to struggling families -- and in some cases, it may certainly help. But it also fosters dependency on the federal government and incentivizes bad behavior.

It now appears we've reached a point in this crisis where differentiating between those worthy of help and those left to pick up the tab is determined primarily by how poorly one managed their personal finances. The worse the decision, the greater the federal assistance - and it's true for government bailouts of bad choices on the part of individuals and institutions alike.

The message this sends to the rest of us - those who are still living up to their obligations and trying in good faith to eke out a living during tough times: Throw in the towel.

Keepin' It Real Estate: How Good is Zillow?

This post first appeared on Minyanville and Cirios Real Estate.

Americans finally get it: Home prices are falling.

This may seem like a preposterous statement, what with the entire global financial system in disarray after the collapse of the US housing market, but we Americans are stubbornly optimistic people, content to ignore calamity as long as we possibly can.

A study released this week by Zillow, a real estate information website best known for its wildly inaccurate estimates of property valies, shows Americans have finally succumbed to the notion that home prices aren't going up anymore. 57% of homeowners polled believe their own home lost value during 2008, up from 38% who felt that way just 6 months earlier.

Interestingly, when asked about the future, respondents were upbeat: Only 30% estimate the value of their house will decrease in the next 6 months. Of course, their neighbors aren’t so lucky: Forty-seven percent believe home values in their local markets will fall during the same time period.

Zillow has become something of a cult phenomenon in the past few years, as it allows homeowners to go online and see how much their house is “worth.” By its own admission, Zillow’s values are merely estimates based on amalgamating sales data from nearby homes, comparing bedroom counts, living area, lot size and other salient characteristics.

What few people realize, however, is that Zillow’s valuation algorithm isn’t just used by John Q. Homeowner: Every big lender in the country uses a similarly opaque formula to price real estate.

Wells Fargo (WFC) -- now the biggest US home lender in the country after its acquisition of Wachovia -- holds tens of thousands of mortgages on its books, each backed by a unique house. It’s impractical to regularly review each home for a fresh value, so Wells and other big banks like Citigroup (C), JP Morgan (JPM) and Bank of America (BAC) rely on analytics firms to provide property values churned out by what are called Automated Valuation Models, or AVMs.

AVMs rely heavily on recent sales data to drive their valuation estimates. This works reasonably well in a vanilla market, one where home prices move uniformly in a single direction - namely up. Even rapidly rising prices are well accounted for, since liquid markets provide reliable, normal data sets upon which calculations can be made.

AVMs are a bit behind the curve in an appreciating market, offering a conservative estimation of a home’s value. But in a declining, choppy, illiquid market like the one we’re in now, AVMs fall apart.

As sales volume dries up and prices gap down, transactions that are even 3 months old become woefully out of date. Even in distressed markets that are now seeing frenetic buying activity, active listings -- and therefore true market prices -- are well below all but the most recent sales.

By using AVMs to value housing assets, banks are constantly underestimating losses in a declining market. Unfortunately, there isn’t much of an alternative.

Small, independent valuation firms offer the most reliable estimations of value, but they specialize in local markets by definition, which limits the scale with which huge lenders can effectively use their results to evaluate nationwide portfolios of loans.

Next time you laugh at Zillow’s estimation that a home that just sold for $250,000 is really “worth” between $315,000 and $375,000, remember that your bank is looking at the same data. No wonder they keep asking Uncle Sam for so much money.

Cloud Computing: Freedom From the Matrix

This post first appeared on Minyanville.

The cloud cometh.

Cloud computing, the notion that computers will eventually serve as gateways to online storage, software and communications, is gaining mindshare throughout the technology world. Pioneers of remote applications like Salesforce.com (CRM) have seen users flock to their online services, which facilitate communication and the sharing of files without regard for proximity.

As our mobile phones become increasingly powerful, modern computers with beefy hard drives are finding their usefulness begin to dwindle. To that end, handset makers are rapidly expanding the capabilities of their iPhones (AAPL), Blackberrys (RIMM) and Treos (PALM) to accommodate this trend toward computing -- and generally living -- in the cloud.

Nokia (NOK), the world’s largest handset maker, is said to be pursuing a deeper partnership with the leader in social networking, Facebook. The companies hope to capitalize on one other’s access to the end-user. Facebook and rival MySpace have already built popular applications for the iPhone and Blackberry.

One potential snag in the Nokia-Facebook deal centers on access to valuable consumer- behavior data: Nokia is reticent to part with information about the browsing patterns and buying trends of its users.

Even though mobile-phone software makers are, by in large, still trying to come up with the magical formula that will allow them to make money from the use of applications, competition is fierce to create the next dominant cell-phone widget.

As the US catches up with Japan and Europe in terms of dependence on mobile phones (yes, it's possible to be more reliant on cell phones than we already are), devices will continue to tresspass on the turf of the Dells (DELL) and Hewlett Packards (HPQ) of the world.

Future generations will no doubt listen to our stories about things like wires, mice and keyboards and mock us mercilessly.

Will Restaurants Go Hungry?

This post first appeared on Minyanville.

It’s a tough time to be peddling $10 crab cakes and $12 cocktails: Just ask restaurants throughout Manhattan, and nationwide.

As the economic downturn picks up speed -- and consumers continue what's now becoming a historic retrenchment -- dining out is increasingly becoming a luxury many Americans are choosing to do without. This is forcing restaurateurs to get creative, get friendly, and get back to basics.

The New York Times reports diners are now finding waitstaff vastly more eager to serve, acutely attentive managers, and a dining experience that's positively enjoyable. Gone are the days when just getting a reservation was a feat unto itself. The only problem: Stomaching the fact that most meals could be eaten at home for a fraction of the cost.

Restaurants are notoriously challenging to run successfully: Razor-thin margins and fleeting trends mean only the savviest chefs are able to consistently retain their clientele.

New York is particularly hard hit, as Wall Street prepares for what are likely to be lean years ahead. It’s estimated that fine-dining tabs are down as much as 12% to 15% in Manhattan - which could mean the different between scraping by and folding for many eateries. Owners are calling this January the worst on record.

Many highbrow bistros and cafes are succumbing to the pressure, lowering prices and offering deals unthinkable just a few months ago. Others, like the popular Chanterelle, are holding out, hoping name recognition and cachet will see them through.

Typically, investors aiming to profit from changing consumer preferences seek out affordable dining options during tough times; trading down from Chipotle (CMG) to Taco Bell (YUM), or from California Pizza Kitchen (CPKI) to Domino's (DPZ). This type of shift towards thrift isn’t uncommon during economic slowdowns - but the speed at which consumer preferences have changed seems to have caught many restaurants off guard.

These patterns aren’t just a coincidence: Necessity breeds change. With credit lines being cut, be it by Capital One (COF) or Target (TGT), consumers simply don’t have the disposable income -- or disposable debt -- to keep on spending at the breakneck pace retailers had grown accustomed to.

As consumers at every social level face their changed economic reality, superfluous purchases are the first to go.

So much for that foie gras. Anyone for tap water and free bread?

Fighting Debt With... Debt?

This post first appeared on Minyanville and Cirios Real Estate.

Our elected officials appear convinced that Americans should buy stuff they don’t need with money they don’t have.

The Senate, in passing its version of the over $800 billion economic stimulus package yesterday, threw a great deal of cash at 2 industries whose products we have far too much of already. Despite the fact that we have too many cars on the road and far more homes than we do people to buy them, lawmakers are determined to prop up both the auto-making and home-building industries.

According to Bloomberg, Ford (F), General Motors (GM) and Chrysler, the latter 2 already suckling the government teat just to stay alive, will benefit from a provision that allows consumers to deduct car-loan interest payments and local sales taxes from their income tax.

Meanwhile, Centex (CTX), DR Horton (DHI) and other homebuilders are salivating at the prospect of a $15,000 tax credit for those brave enough to buy a new home. The new, more generous tax break replaces a $7,500 credit granted last year.

In what shouldn’t come as a surprise, Brian Catalde, the president of the National Association of Homebuilders (or NAHB) is pleased that his group’s intense lobbying efforts paid off.

“We’re pretty happy with the way the Senate bill is shaping up," Catalde said. "We think it will entice a lot of those people sitting on the sidelines into the marketplace.

”NAHB members nervously await the disposition of the final bill as their balance sheets remain bloated with unsold homes priced well above prevailing market prices.

Lawmakers seem determined to dig our way out our debt problem with yet more debt. By encouraging Americans to borrow more to buy the cars and homes irresponsibly manufactured by these industries in the first place, Congress and the President alike reward the very poor financial decisions that brought our economy to its knees in the first place.

To borrow the analogy from Professor Succo's piece yesterday, Economy: Code Blue, this is akin to handing an obese person a donut, telling them to munch away as long as they stay away from pizza. It just doesn't make any sense.

Among the Senate bill's numerous differences from the House’s version passed last week -- most notably the handouts earmarked for homebuilders and automakers -- it also excises more than $20 billion in funding for new public-school construction.

Once again, lawmakers display their unparalleled financial acumen: Only more McMansions will counteract the vast oversupply of schools this country is struggling to get out from under.

Living in a Bubble

This post first appeared on Minyanville.

I grew up in a bubble.

My hometown, once a typical middle-class suburban city not unlike countless others around the country, got swept up in Silicon Valley's tech boom, altering the fortunes of its residents forever.

My parents didn't come from money, nor did they make tech-bubble millions. They were, and are, simple folks who worked hard, saved their money and shied away from extravagance. They just happened to choose to put down roots in a town that, unbeknownst to them, was about to enjoy a period of unprecedented prosperity.

I go back home these days and barely recognize my childhood stomping grounds. A 2500-square-foot, 4-bedroom, 2-bath house is now considered a tear-down; formerly quaint shops and restaurants are now highbrow boutiques and French bistros.

Most residents, after 3 decades of kindly financial markets and vast fortunes that virtually fell from the sky, still live in that bubble. In the words of a local wealth manager, "[This area] mints more millionaires in a year than any other 20-mile radius in the world."

It's this attitude, that somehow attaining wealth and collecting vast sums of cash puts a person -- or a community -- above his neighbors, that saddens me when I return home. What used to be a humble community of families and creative entrepreneurs has transformed into endless rounds of keeping-up-with-the-Joneses.

The local public schools even go so far as to publish monthly newsletters with each parent's donations itemized in the back pages, as if to shame the less generous with the lavish gifts of their neighbors.

Insulated by multi-million dollar suburban estates, upscale organic grocery stores, and a great deal of money, the lives of the new rich had never been touched by the struggling masses.

Until now.

But even after 18 months of turmoil on Wall Street, their travails exist mostly on paper: How can one empathize with the loss of a home, when all you've lost is a couple zeroes from the end of your net worth?

This isn't quite fair, of course. Many of our parents, baby boomers headed for retirement, are active philanthropists, and spend the great majority of their time giving back to a community that has given them so much. Some of the most dynamic charitable organizations and international development groups were founded by this region's brightest minds.

They arrived in the Bay Area before debt and excess became mainstream; when simplicity, humility and respect were still valued traits.

Nevertheless, our streets are now overrun by the swollen egos of too many thirty-somethings, drunk on hubris and determined to ignore the country's economic plight. Ignorant of the conditions outside their bubble of wealth and comfort, they remain convinced that the worst is over, that the gentle bath of government money will solve the problems of those subprime people they keep reading about.

After all, the alternative scenario is unimaginable - particularly to someone whose life's meaning is derived from the price of their home and the commas in their brokerage account.

To be sure, location isn't everything; many of the kids who were raised with the most now have the least. Growing up, I saw the other side of wealth - the high-school drug habit supported by an egregious weekly allowance, truly impressive laziness, and families that seemed to increase in dysfunction the higher up the social ladder they climbed.

Now, as my new career carries me back to the quiet, tree-lined streets I grew up on -- the ones now paved with Internet gold -- I watch in wonder as my former neighbors struggle to fight off reality. Their misplaced optimism, along with the belief that their riches have lent them some sort of moral superiority, is manifested in the arrogance of the asking prices for their homes.

What I see every day is a symptom of the tectonic shift that's only just begun to occur.

Debt, which once created artificial prosperity, is once again a privilege, not a right. Extravagance is becoming revolting. Families, friends, and simple -- not to say free -- pleasures are increasingly becoming the vogue.

While some part of me does feel sorry for my former neighbor, whose 3000-square-foot home was listed at nearly $4 million -- and whose open houses have been entirely unattended -- a greater part is horrified. His arrogance and devotion to a way of life now desperately outmoded make him the last of a dying breed.

And good riddance.

Bank Rescue? What Bank Rescue?

This post first appeared on Minyanville.

In a move reminiscent of John McCain’s suspension of his campaign to return to Washington for the vote on the first bailout, Barack Obama is putting the latest iteration of a bank-rescue package on hold while he addresses the economy.

So as not to distract Congress from imminent debate on the $800 billion economic stimulus package, newly minted Treasury Secretary Timothy Geithner delayed a speech outlining his bailout plan for the financial markets till tomorrow.

Details about the latest initiative are still cloudy, but over the weekend, reports by both Bloomberg and the New York Times focused on difficulties pricing illiquid, toxic assets, which seem to be new scheme’s the biggest sticking point.

Banks, laden with hard to price and impossible to sell assets, can’t make new loans since any fresh capital they receive is simply eaten up by mounting losses. And while big lenders like Wells Fargo (WFC) and JPMorgan (JPM) would love to unload troubled assets onto the government above their market price, politicians are wary of the negative press such a taxpayer burden would cause.

Even though the Treasury, the Federal Reserve and the FDIC have guaranteed almost half a trillion dollars in lousy debt owned by Citigroup (C) and Bank of America (BAC), bureaucrats have now found it politically expedient to play hardball with the nation’s bankers. And by hardball, I mean slow-pitch softball.

The Wall Street Journal reports President Obama’s much-heralded executive-compensation restrictions, far from squaring off with Wall Street fat cats in the UFC Octagon, is attacking Manhattan’s uber-rich with kid gloves.

Executive-pay experts and management attorneys have identified loopholes in the President’s plan, which could allow the very executives Obama means to punish to reap the very same benefits he seeks to limit. This shouldn’t come as much of a surprise, since Wall Street’s expertise lies in staying one step ahead of regulators and lawmakers, figuring how to bust new, supposedly tough rules the moment they’re announced.

As the ongoing efforts to rescue the American economy and fix the banking system roll on, the extent to which Washington is waging primarily a public relations campaign, rather than a true battle against the demons of Depression, becomes increasingly clear. Even the most well-designed stimulus takes months to filter into the economy and effect actual economic decision-making, so in the mean time politicians are focused on swaying public opinion.

Oddly, the current tactic is to frighten the public with ominous warnings about the risks of doing nothing. This is just exacerbating the contraction, as purchasing decisions are delayed for fear things may keep getting worse.

The focus on social mood rather than actual, sound policy highlights the extent to which the turmoil of the past 18 months has altered the American psyche.

Consumers are recoiling, shunning debt and extravagance for savings and thrift. Washington and Wall Street, more joined at the hip than ever, know this combination could topple their carefully constructed house of cards - economic expansion founded on unsustainable levels of debt.

We'll know more tomorrow about the latest in a string of attempts to fix our ailing financial system - unless of course something more important gets in the way.

Ford Joins Bailout Parade?

This post first appeared on Minyanville.

It was really just a matter of time.

Ford (F), the only US automaker not currently being propped up by federal loans, may have to contribute $4 billion to its ailing pension fund. That's cash the carmaker dearly needs to stay afloat, given abysmal auto sales from the US to Japan and everywhere in between.

According to Bloomberg, the company reported a loss of $14.3 billion for fiscal 2008 and earler this week drew all of a $10.1 billion credit facility.

As the stock market has tumbled, Ford's pension grew deeper in the whole. Future obligations now outweigh the value of it's assets and the company may have to pony up the difference. Some fear Ford's need for government assistance is inevitable, its cash troubles showing no signs of easing.

Ford is shopping around it's Volvo unit to raise capital, and is said to be in talks with China's Geely Automobile Holdings about a potential deal.

With General Motors (GM) and Chrysler already on the government dole, and once-mighty Toyota (TM) struggling to ofload cars onto cash-strapped consumers, it's a rough time to be in the business of selling cars.

Nor is it a great time to be guaranteeing pensions. The Pension Benefit Guarantee Corp, a quasi-public entity that backs corporate pension plans in the event they fail, estimates that collectively, American pensions have a $46 billion shortfall.

About half that deficit comes from firms connected to the auto industry.

This new economic stimulus package had better work.

Keepin' It Real Estate: Capitulation Now!

This post first appeared on Minyanville and Cirios Real Estate.

Finally, housing is starting to act like a market searching for a bottom.

Well, sort of.

In former boom states like California, Arizona and Florida, distressed sales are driving the local real-estate markets. After a near-complete evaporation of buying activity last year, buyers have been brought off the sidelines by continued price declines, a glut of homes for sale, and low interest rates. Comparisons with last year are easy: Some areas are seeing activity up more than 300% year-over-year.

Many contend this is a healthy development, as prices return to more affordable levels and latent demand sops up overhanging supply. The bottom, they argue, is nigh.

However, even in areas seeing strong buying activity, median home prices continue to tumble. Banks and private sellers alike are finding the only way to guarantee a sale is to list the house below the market. This constant undercutting is pushing prices down, sometimes well below affordability levels derived from median income data.

This trend is not indicative of the capitulation most market watchers believe must happen before prices can truly bottom.

Capitulation is a concept more often reserved for equity-market analysis than for housing. Since real estate is vastly more fragmented and localized than stocks, housing trends take months, even years to develop, while equities can reverse course in a manner of days, if not hours.

Still, drilling down into individual transactions, evidence of capitulation in certain markets is becoming evident. Sellers, after 4 years of price declines, are finally throwing in the towel.

Homebuilders are becoming desperate: Toll Brothers (TOL) is trying to lure in buyers with 3.99% interest rates through a partnership with Wells Fargo (WFC). Centex (CTX) did them one better by offering rates as low as 3.25% (that rise to 4.50% after 2 years) and Pulte Homes (PHM) also offers a 3.99% fixed rate option for qualified buyers.

Banks like JPMorgan (JPM), Bank of America (BAC) and Citigroup (C), desperate to shed their growing inventory of foreclosed homes, are beginning to accept bids 10, 15 or even 20% below their asking prices.

And its not just banks. Just in the past few weeks, private sellers have started to jump at low-ball offers. Better to take less cash now than be constantly priced out of the market, chasing it all the way down.

Although this type of sale is still very much the exception rather than the rule, it’s an indication that sellers are becoming despondent, willing to accept any reasonable price to rid themselves of what could be months of headaches, upkeep expenses and deteriorating market conditions.

To be clear: This analysis is by no means a call that housing has bottomed, or is even remotely close to a bottom. It’s merely evidence that certain areas are closer to stabilization that others, and these signs -- which may look like capitulation -- should be viewed as a positive development in a market deeply in need of hope.

Main Street Out for Wall Street's Blood

This post first appeared on Minyanville.

Why do you look at me when you hate me?
Why do I look at your when you make me hate you too?
I sense a smell of retribution in the air.
- Guns N' Roses, "Get in the Ring"

Man, but it's a lousy time to be a banker.

Are We At Risk?
Protesters Mass Outside Bear Stearns
Not the Financial End of the World as We Know It
Outbreak! The Other Side of Anxiety
Toddo on TV: Capturing Crude

Fed Jumps on Loan Modification Bandwagon
Bank CEOs Beg For Bailout, Their Jobs
Central Banks Fight For Survival
Taxpayer Dollars Don't Return to Main Street
Wal-Mart Goes Green, Makes Green

Not only are financial professionals facing the most hostile market environment in a generation, but backlash -- thanks to their role in the current crisis and the size of their paychecks during the run-up -- has politicians and the public alike out for blood.

After last week's World Economic Forum in Davos, Switzerland, which attendees were calling "the grimmest ever," the witch hunt for those responsible continues . And increasingly, finger-pointing and blame are being directed at the world's financial professions.

According to Bloomberg, Wall Street was virtually unrepresented in Davos, with JPMorgan's (JPM) Jamie Dimon the lone banking CEO in attendance to defend his ilk. To his credit, Dimon owned up to past mistakes, but openly wondered whether blame should also be directed towards regulators: "God knows, some really stupid things were done by American banks and by American investment banks. To policy makers, I say: Where were they?"

The mood of the gathering, typically a highbrow affair where the ultra-rich and ultra-influential flaunt their good fortune for the rest of the world to admire, was humble, even depressed. And rightly so.

Opinion on Main Street has been turning against Wall Street for months. But as details of just how much bankers and traders are paid -- even as their firms receive billions in taxpayer support -- continue to emerge, things are turning hostile. Last night, at an otherwise good-natured Super Bowl party, one guest muttered aloud, "Can you believe how much these banking [expletive]s got paid? People are losing their jobs, and they're still taking home million-dollar bonuses." The crowd agreed; it was a "shameful" display of unadulterated greed.

The irony -- and evidence the changing social mood isn't just the usual negativity that accompanies economic downturns -- is that this didn't just start last year: Bankers have always taken home outrageous sums. Year-end bonuses weren't paid out for the first time in 2008; greed didn't suddenly rear its ugly head in the bowels of Manhattan. Nevertheless, people who couldn't have cared less that investment bankers and traders earn massive salaries -- even as their firms cut staff -- are suddenly up in arms.

And while many argue this time is different -- since the likes of Goldman Sachs (GS), Morgan Stanley (MS) and Bank of America (BAC) are now on the government dole, that's simply canon-fodder for political posturing.

What's really changed is the mentality on Main Street – we no longer look fondly upon the pin-stripe suited banker or dapper real estate mogul. Flashy cars get sneers as they roar past, Louis Vuitton bags are carried by only the most egregious snobs. Our envy has turned to disdain.

The sentiment of millions, however, doesn't change overnight. Just as it took years to arrive at the apex of bling, so too will it take time for the revulsion at unnecessary excess to fully take hold.

But take hold it will.