Words after 9/21/2011 FED - (1)

I discussed my expectation of FED's 9/21/2011 meeting HERE. They didn't do much except the widely expected Yield Curve Twist approach. You know, Ben is a famous "meet-expectation" guy. Market got disappointed on the underwhelming reaction. A sell-off was followed, which made last week one of the worst in recent months. Before I jump onto the analysis of the twist, let’s start with the reality check (outline).

1.       Recovery from the Abyss: This is the most severe economic upheaval since the great depression 1929, with Epicenter in the severe housing downturn. The unprecedented damage spread to largest asset/credit class:

• Highest employment loss percentage since 1940s
• Deleveraging on a global scale
• Collapse of some of the largest financial institutions in the world
• Unprecedented government intervention in an attempt to provide stability

2.       U.S. Banking Industry Stabilized but Still Fragile ….

• a)      Credit metrics appear to have peaked but remain an industry burden
• Credit loss cycle may have a second leg
• b)      Capital has been raised to stabilize balance sheets
• Incomplete at regional and community level
• 90% of TARP has been repaid but 491 banks still hold TARP ¹
• c)       Bank loan demand in place but sluggish
• Lack of “shadow banking” industry may spawn re-intermediation
• d)      392 banks have been closed by 865 remains on the FDIC’s problem list

(Source: FDIC September 2011)

3.       Regulatory Reform and Pace of Economic Recovery Remain Big Variables ….

•       Significant economic hurdles ahead

a.       Structural problems remain: Leverage and unemployment

b.      Housing unresponsive

c.       Inflation taking root

d.      Significant long-term interest rate risk

•          Regulatory reform just beginning to unfold

a.       Increase in required capital levels and renewed emphasis on common stock as dominant form of capital

b.      Reduced fee income and rising regulatory and compliance costs disadvantage those without sufficient scale

4.       Summary of FDIC’s Quarterly Banking Profile (2Q11)

Industry posted net income of $28.8 billion, eighth consecutive quarter of year-over-year improvement. Wait, you think I am an angle delivering great news? The ugly truth is:

• Lower loan loss provisions were principal source of increase; net operating revenues declined for the second consecutive quarter (cooking the book)
• Half of all institutions reported declines in non-interest income, while non-interest expenses were 6.1% higher than a year ago (spend more, make less. Sounds familiar.)
• Average ROA was 0.85% for all institutions, 0.57% for community banks (I can do better than that)
• 15% of insured institutions reported a loss for the quarter (My tax money will go there soon)
• Non-current loans declined for 5th straight quarter to $320 billion (they are not lending)

“Problem List” saw first decline since 2006, now 865 institutions with total assets of $372 billion

Source: FDIC

Now comes with the Recession/Recovery question: Slow Climb Out or Double Dip?

I believe the Key Elements of Recovery is still Job growth. Only if people get a fairly paid job and don’t worry about next month’s paycheck, they will become consumers again. At this moment, they are still looking to de-lever, which will curtail spending. Only if people have job, they will think of housing. 

But it is still not enough for the housing market. I spoke with a fellow from FDIC last week. He told me he covers south east region. Atlanta, GA, for example, has 20 years worth of house inventory. This is the reality. Do you think it will go away or recover on its own? When I was in school studying Macro Economics, it said in the Great Depression, farmers pour milk into the sea because they cannot find a way to sell them and they cannot afford the storage costs. Now what? It’s not milk, but houses. Demolish them? Low interest rate will help the builders haunting around for a little bit longer, but they are not anywhere near recover. Ben of the FED, Tim of Treasury, Whitehouse (no name), whoever, whatever, they need to provide a basket of “creative” solutions to housing debacle.