Kitchen sink quarter
I was reading a story on Marketwatch.com tonight regarding the quarterly results from some of the big banks. Several times in the story the author mentioned “kitchen sink”, which refers to the hope that the banks have finally written down all the losses, that they’ve included everything - including the kitchen sink.
I think they are wildly optimistic. One reason I think so is a statement like this: Analysts say that after this report, Merrill has less than $20 billion in risky securities left on the balance sheet.
The problem is that they included the caveat “on the balance sheet”. There are exceptions, but almost all of these banks’ really risky “investments” are in hedge funds and derivatives that are off the balance sheet. Very few are actually on the books, so the losses (so far) have been hidden. Eventually those losses will need to be accounted for.
Anyway, I posted this as a comment on the Marketwatch site in response to the story, and decided I might as well post it on my own blog as well.
When a stock rises because they LOST less money than was expected, it’s still just speculation. Try running a PE on a stock that isn’t making money - and doesn’t expect to make money in the near future. Does that remind you of the dot com days?
Stock prices eventually reflect real earnings. There are lots of chances to make money on stock price movements no matter what the earnings are, but long term the price will revert to the mean. And that means (no pun intended) that artificial high prices will eventually reflect reality.
The reality is that these banks have not even started to write down the multi-trillion dollar derivatives market, which is almost all based on mortgages. One dollar that’s been leveraged 20 and 30 times becomes $20 to $30 in losses for every mortgage that goes bad. Foreclosures are running at about 1.5% to 2% right now, and expected to increase.
Do the math. $500 billion in mortgage related writedowns (which I think will prove to be a conservative estimate) will erase $10 to $15 trillion of derivative “assets”. Let’s see what these losses are next year - assuming that the companies “invested” in the financial derivatives are still around.
That’s why I’m not buying into this weeks’ rally.
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July 25th, 2008 at 2:32 pm
Hi,
Excellent article. I agree completely. I have one question. You wrote
“Do the math. $500 billion in mortgage related writedowns (which I think will prove to be a conservative estimate) will erase $10 to $15 trillion of derivative “assets”. Let’s see what these losses are next year - assuming that the companies “invested” in the financial derivatives are still around.”
My question is how did you come up with your $500 billion estimate? I came up with a similar estimate a while ago.
http://seekingalpha.com/article/60093-estimating-the-risk-in-citigroup-stock-and-bonds
I now think it was too low.
The leverage factor is an unknown. Are actual leverage figures for these banks published anywhere?
I am surprised to read that foreclosures are only 1.5 to 2%. Could that be because banks are now not declaring loans delinquent until six months of no payments? That’s just delaying the inevitable write offs of principal.
Chic B.
July 25th, 2008 at 8:10 pm
The $500 billion number is simply my estimate, based on a variety of sources. Starting last year we saw numbers such as $100 billion, then $200, then $250, $300, etc. The actual amount is still unknown, but the estimates keep rising as banks continue to de-leverage.
I used $500 billion as a mid-range type number based on what the estimates were when I wrote the article. I see that Bill Gross is now saying $1 trillion…. These numbers will continue to rise as long as housing keeps falling - and there’s no end in sight for home prices at this point.
Nationwide, the foreclosure rate in the 2nd quarter was 1 out of every 171 homes, which is about .6%, but that’s total homes — including those which are paid for. I did a quick search, but I didn’t find the actual percentage of mortgages which were in foreclosure currently. I may do some more research and post on this later.
gk