Bank/IB Writedowns - Deflationary?

[DemonD]

One thing I've been wondering. Since it seems that a lot of "liquidity" is based upon assets upon assets, leveraging from 100-1000x the principle, wouldn't that liquidity (and therefore, the amount of dollars in the system) decrease when banks write down their assets and increase their loan-loss provisions? And wouldn't this ultimately be deflationary?

Some specific examples:

Ambac marks down $743m
M&T Bank doubles loan-loss provisions
Citi announces $3.3b in writedowns along with warnings earnings
Quote from the last link:

The financial services company said it would record $3.3 billion in writedowns for loans related to buyouts, mortgage-backed securities, and fixed-income trading losses.

I could provide at least a dozen links to homebuilders writing down asset values of property, looking at billions in that arena too...

Here are my questions:
Forgive me if I'm taking this as an oversimplistic view, but isn't that 3.3 billion that is removed from the "global liquidity"? And also wouldn't that mean that that 3.3b would have to be deleveraged - so possibly from 33-330b if it was levered up 10-100x?

And forgive further ignorance - isn't this what would be happening in a "credit crisis?" Shrinking asset base decreases amount they can loan, and indeed they would have to cull back their loans?

[jacobdcoates]

Re: Bank/IB Writedowns - Deflationary?

That would be my take on it, but there are much smarter people than me here to ask.

[GRG55]

Re: Bank/IB Writedowns - Deflationary?

One thing I've been wondering. Since it seems that a lot of "liquidity" is based upon assets upon assets, leveraging from 100-1000x the principle, wouldn't that liquidity (and therefore, the amount of dollars in the system) decrease when banks write down their assets and increase their loan-loss provisions? And wouldn't this ultimately be deflationary?

Some specific examples:

Ambac marks down $743m
M&T Bank doubles loan-loss provisions
Citi announces $3.3b in writedowns along with warnings earnings
Quote from the last link:

I could provide at least a dozen links to homebuilders writing down asset values of property, looking at billions in that arena too...

Here are my questions:
Forgive me if I'm taking this as an oversimplistic view, but isn't that 3.3 billion that is removed from the "global liquidity"? And also wouldn't that mean that that 3.3b would have to be deleveraged - so possibly from 33-330b if it was levered up 10-100x?

And forgive further ignorance - isn't this what would be happening in a "credit crisis?" Shrinking asset base decreases amount they can loan, and indeed they would have to cull back their loans?

What you describe is iTulip's "Bubble Cycle" economy, and the main reason the authorities are seemingly desperate to talk up/prop up asset prices. Have another look at Dr. Hudson's interesting FIRE economy/production economy model - the more this unfolds, the more that model makes sense to me.

In the latter stages of an asset (housing) mania, rising asset prices and the credit system's ability to create liquidity from the increase in fictitious value, keeps fueling the rising asset prices, which keeps increasing the available credit...

Doesn't this late-stage credit derivative fueled asset bubble dynamic far outweigh anything the Fed does with money supply? And isn't it the main reason the Fed became largely irrelevant as anything other than a psychological influencer of the credit markets? And if the authorities can't keep it from going into reverse through psychology (and whatever creative interventions the so called "strong-dollar" "free-marketers" can dream up) doesn't it get rather vicious rather quickly? Frankly, I am amazed at how quickly things calmed down after August 16, and to what degree anyone courageous enough to speculate in the equity markets has been rewarded in the last 60 days.

This has to be the biggest credit bubble in history, and maybe the most pervasive since the 1920's. Back then companies found they could make more money lending their working capital to Wall St (to expand margin credit) than investing in productive capacity. Today we have companies like GM & GE, that for the last 2 decades made more money every year from their Finance subs than manufacturing anything useful.

Back then Wall St "intellectuals" warned about the "scarcity value" in stocks. Earlier this year we heard the same thing from these worthies at the peak of the PE nonsense (the stock market "had" to keep going up as PE firms bought up everything in sight).

Back then the creation of the investment trust pyramids allowed the volume of traded securities to vastly exceed the amount of total corporate assets then in existence. Today we have CDO's, CDO's squared, CDO's cubed...

"All people are most credulous when they are most happy" --Walter Bagehot.

[jk]

Re: Bank/IB Writedowns - Deflationary?

i've been trying to think more about velocity as well as the "moneyness" of assets. if i buy a million dollars in bonds then i still think of myself as having a million dollars. the seller of the bonds now has the proceeds of his sale, and he indeed has a million dollars. if he buys a million dollars in equities, he still feels like he has a million dollars, and of course the seller of the equities indeed has a million in cash. as asset prices rise all the asset holders think of themselves as wealthier, and indeed sloppy thinkers call this process wealth-creation. [i say "sloppy thinkers" because i asset inflation doesn't create anything real that has value - no factories have been built or even consumables manufactured. the only thing that has been created is more paper value.] all these people feeling wealthier encourages more spending as well as more "investing."

velocity counts here, in that the speedier these transactions the more quickly asset prices will tend to rise.

now get back to the original question raised in this thread: what is the effect on credit creation and availability of the write offs we are seeing in financial assets? the written off values, which go to money heaven and disappear as miraculously as these "values" first appeared out of thin air, will cease to support the credit pyramid which has been built upon them. if the written off assets have been used as collateral, there will be an immediate request for unimpaired replacement collateral. but the general deterioration in credit conditions will also cause a reduction in velocity.

a concrete example comes to mind: we are all aware that credit conditions have tightened in the mortgage markets. various "affordability products" like 110% ltv negative amortization option arms are [i hope] no longer available, and in general higher credit scores are required to obtain loans. thus there is a smaller population of potential home buyers. but another aspect of this change is that it must take more time to vet a potential home purchaser. if now the lender requires documentation when no-doc or low-doc was the prior procedure, that takes time to assemble, and review, and get approval. if appraisals were fudged or faked in the past, now they must be carefully perused. if loan officers are now being laid off as volume contracts, and they face career risk for the quality of the loans they approve, they will take more time in the approval process: all the i's must be dotted and the t's crossed. if the loan is securitized and sold, the individual at the purchasing institution who must authorize the purchase also faces career risk, and will take his time in reviewing the purchase. thus not only is the population of potential purchasers reduced, the time taken for each transaction is lengthened.

as louis gave recalled, pq=mv, where p is the general price level, q the quantity of production, m the money supply, and v velocity. velocity is declining. the money supply must be pumped higher fast enough to offset declines in velocity, or we risk deflation and/or recession.

[GRG55]

Re: Bank/IB Writedowns - Deflationary?

i've been trying to think more about velocity as well as the "moneyness" of assets. if i buy a million dollars in bonds then i still think of myself as having a million dollars. the seller of the bonds now has the proceeds of his sale, and he indeed has a million dollars. if he buys a million dollars in equities, he still feels like he has a million dollars, and of course the seller of the equities indeed has a million in cash. as asset prices rise all the asset holders think of themselves as wealthier, and indeed sloppy thinkers call this process wealth-creation. [i say "sloppy thinkers" because i asset inflation doesn't create anything real that has value - no factories have been built or even consumables manufactured. the only thing that has been created is more paper value.] all these people feeling wealthier encourages more spending as well as more "investing."

velocity counts here, in that the speedier these transactions the more quickly asset prices will tend to rise.

now get back to the original question raised in this thread: what is the effect on credit creation and availability of the write offs we are seeing in financial assets? the written off values, which go to money heaven and disappear as miraculously as these "values" first appeared out of thin air, will cease to support the credit pyramid which has been built upon them. if the written off assets have been used as collateral, there will be an immediate request for unimpaired replacement collateral. but the general deterioration in credit conditions will also cause a reduction in velocity.

a concrete example comes to mind: we are all aware that credit conditions have tightened in the mortgage markets. various "affordability products" like 110% ltv negative amortization option arms are [i hope] no longer available, and in general higher credit scores are required to obtain loans. thus there is a smaller population of potential home buyers. but another aspect of this change is that it must take more time to vet a potential home purchaser. if now the lender requires documentation when no-doc or low-doc was the prior procedure, that takes time to assemble, and review, and get approval. if appraisals were fudged or faked in the past, now they must be carefully perused. if loan officers are now being laid off as volume contracts, and they face career risk for the quality of the loans they approve, they will take more time in the approval process: all the i's must be dotted and the t's crossed. if the loan is securitized and sold, the individual at the purchasing institution who must authorize the purchase also faces career risk, and will take his time in reviewing the purchase. thus not only is the population of potential purchasers reduced, the time taken for each transaction is lengthened.

as louis gave recalled, pq=mv, where p is the general price level, q the quantity of production, m the money supply, and v velocity. velocity is declining. the money supply must be pumped higher fast enough to offset declines in velocity, or we risk deflation and/or recession.

jk: A short excerpt from Robert Prechter that links with what you are describing above:

"A trend of credit expansion has two components: the general willingness to lend and borrow and the general ability of borrowers to pay interest and principal. These components depend respectively upon (1) the trend of people's confidence, i.e., whether both creditors and debtors think that debtors will be able to pay, and (2) the trend of production, which makes it either easier or harder in actuality for debtors to pay. So as long as confidence and productivity increase, the supply of credit tends to expand. The expansion of credit ends when the desire or ability to sustain the trend can no longer be maintained. As confidence and productivity decrease, the supply of credit contracts.

The psychological aspect of deflation and depression cannot be overstated. When the social mood trend changes from optimism to pessimism, creditors, debtors, producers and consumers change their primary orientation from expansion to conservation. As creditors become more conservative, they slow their lending. As debtors and potential debtors become more conservative, they borrow less or not at all. As producers become more conservative, they reduce expansion plans. As consumers become more conservative, they save more and spend less.

These behaviors reduce the "velocity" of money, i.e., the speed with which it circulates to make purchases, thus putting downside pressure on prices. These forces reverse the former trend."

[c1ue]

Re: Bank/IB Writedowns - Deflationary?

This thread has some good thoughts in it.

I would add that it is also important to consider the outside money: i.e. the money that the world has been lending to the USA.

All of the activities within the US have much less power to influence whether the foreigners and foreign governments are willing to continue lending when both US consumption and US ability to repay - as well as the value of the debt itself - is increasingly at risk.

Even should the US itself jack up the money supply, ultimately that only serves to reduce existing debt. In the meantime interest payments on this debt are a constant need and payments are these days more CASH than CREDIT due to the disarray of the credit markets (would YOU accept an MBS or CDO for interest payments?)

At present it seems to me that the real risk is that external financing will significantly reduce at which point the whole house of cards collapses.

Should the US be unable to borrow enough to pay its interest debts and have to resort to the actual printing of CASH (NOT credit), then we could very much have GDII.

The current account deficit being 5.5% of the economy makes this seem to me more possible than ever. If the USA cannot borrow enough 'hard' foreign currencies to pay interest payments...

[olivegreen]

Re: Bank/IB Writedowns - Deflationary?

I'm new here and know absolutely nothing about finances and the economy but I'm reading here and learning. I have a very stupid question to ask... this $100 billion fund the banks are creating to "save the situation"... where does that money come from?

olivegreen

[c1ue]

Re: Bank/IB Writedowns - Deflationary?

OG,

The original bailout money will ostensibly come from the sponsoring banks.

However, in reality it will come from the Fed, and via the Fed and money supply inflation/$ depreciation, from you and me

[olivegreen]

Re: Bank/IB Writedowns - Deflationary?

Well... here I am again... the one who knows very little about all this stuff... I think I picked a terrible time to try and understand economics. Seems to me people are all saying things aren't "normal" which means I haven't a hope in hell of understanding anything.... However, I was reading this thing below and given what's happening with the thing in Florida... can anyone tell me how this situation below is any different than what is starting to happen now?

"During the Great Depression, banks throughout the United States faced a financial crisis. During the 1920s, many banks had made ill-advised investments, including placing depositors' funds in the stock market. Bankers also provided mortgages to people who, during the Great Depression, did not have the means to pay back their debts. As a result of these investments and mortgages, many financial institutions faced bankruptcy. Many Americans withdrew their money from banks, believing that their funds were no longer safe. These runs on banks, as they were known, worsened in the first two months of 1933, as numerous financial institutions went bankrupt.
To try and restore confidence in the banking system, on March 6, 1933, President Franklin Delano Roosevelt declared that all banks in the United States were closed and would remain so until he proclaimed otherwise. In essence, Roosevelt had declared a holiday for all banks in the United States. Roosevelt decided that government auditors would determine which banks were financially sound. The auditors would then allow these banks to reopen, but the financial institutions had to follow strict regulations to guarantee their solvency.
State governments also implemented regulations to help keep banks open. In Ohio, in late February 1933, the state legislature limited the amount of money that a depositor could withdraw from the banks...."

[Tulpen]

Re: Bank/IB Writedowns - Deflationary?

Since it seems that a lot of "liquidity" is based upon assets upon assets, leveraging from 100-1000x the principle, wouldn't that liquidity (and therefore, the amount of dollars in the system) decrease when banks write down their assets and increase their loan-loss provisions? And wouldn't this ultimately be deflationary?

Solvency decreases.

Solvency is the amount of available money, while liquidity is how much money is flowing.

The bad credit problem is a solvency problem, as a result it could also be a liquidity problem but the fed can solve that if necessary.

[Spartacus]

Re: Bank/IB Writedowns - Deflationary?

These are just bookkeeping entries at the moment.

No money has "disappeared" yet.

IOW no one is YET demanding the dollars in your pocket (raising their value) because of these write-offs/downs (W.O.D.s?)

But this is just the beginning - not all the WODs are blown yet ; )

(a Stan Lee no-prize for those who saw it coming)

One thing I've been wondering. Since it seems that a lot of "liquidity" is based upon assets upon assets, leveraging from 100-1000x the principle, wouldn't that liquidity (and therefore, the amount of dollars in the system) decrease when banks write down their assets and increase their loan-loss provisions? And wouldn't this ultimately be deflationary?

Some specific examples:

Ambac marks down $743m
M&T Bank doubles loan-loss provisions
Citi announces $3.3b in writedowns along with warnings earnings
Quote from the last link:

I could provide at least a dozen links to homebuilders writing down asset values of property, looking at billions in that arena too...

Here are my questions:
Forgive me if I'm taking this as an oversimplistic view, but isn't that 3.3 billion that is removed from the "global liquidity"? And also wouldn't that mean that that 3.3b would have to be deleveraged - so possibly from 33-330b if it was levered up 10-100x?

And forgive further ignorance - isn't this what would be happening in a "credit crisis?" Shrinking asset base decreases amount they can loan, and indeed they would have to cull back their loans?

Just recall the Internet bust - more than $5 trillion in fictitious wealth evaporated, much of which had been used to write loans against. IN fact, I knew tons of people who had gotten loans using Internet company OPTIONS (not shares) - one person I personally know got a house mortgage in part based on pre-IPO options.

Yet we never had general deflation.

[santafe2]

Re: Bank/IB Writedowns - Deflationary?

All of the activities within the US have much less power to influence whether the foreigners and foreign governments are willing to continue lending when both US consumption and US ability to repay - as well as the value of the debt itself - is increasingly at risk.

C1ue - It's probable they'll begin turning more of their bonds into purchases of other US assets. Like 1988 all over again. Do you think anyone will want Pebble Beach?

In case you're worried about foreign investment, you don't need to, your boys and girls, both elected and appointed to Federal posts, have got us covered so it should be smooth sailing from now on.

All joking aside, I'm always a little concerned when a high ranking member of the Treasury is telling us there's "no cause for alarm" regarding foreign investment when they're not also talking about metrics by which we can measure just when there may be cause for alarm. The following article is from Deputy Treasury Secretary Robert Kimmitt's statements earlier today regarding SWF investments.

http://www.forbes.com/markets/feeds/...fx4403204.html

The Foreign Investment and National Security Act, (FINSA), became effective a little over a month ago. Less than a month later, a sovereign nation bought the rights to up to 4.9% of Citibank. It's more like a $7.5B bailout for them because their own investment groups had done such a poor job of investing, they appeared at risk of going under.

To give some sense of how desperate Citi was for a large investor, they're paying 11% for the money. My brother-in-law, who I wouldn't lend money to, doesn't pay 11%. Then again, he doesn't need $7.5B.

This SWF keeps it's investments below 5% so they don't have to disclose their investment portfolio. That's a trust builder.

To keep this post from truly going off-topic, I should point out that this investment in Citi will go a long way toward off-setting their write-downs, re-create the liquidity they drop-kicked and help get them back on their feet so they can begin creating the next bubble.

[c1ue]

Re: Bank/IB Writedowns - Deflationary?

To keep this post from truly going off-topic, I should point out that this investment in Citi will go a long way toward off-setting their write-downs, re-create the liquidity they drop-kicked and help get them back on their feet so they can begin creating the next bubble.

Well, Citibank lost somewhere above 30% of its loans to South America in the late 80's/early 90's, the total loan amount being somewhere above $10B.

http://www.defaultrisk.com/pp_recov_21.htm

This was enough to put Citibank in jeapordy the last time - such at Al-Waleed jumped in with his historic investment of $550M.

This time around Abu Dhabi has thrown in $7.5B, but Citibank has something like $130B in various SIVs plus its own loan portfolio.

I'm not so sanguine that it will be enough.

A similar loss ratio (30%) just on the SIVs and Citi is history.