4.6.08
The bunny is having one of those existential moments we've all had, when you wonder if you are insane, or if the rest of the world is.
He cannot fathom the relentless optimism surfing the tsunami of bad news. Talk about "irrational exuberance"--and the former Fed chief who coined that phrase himself went on the record stating there's better than a 50/50 chance the country could be in a recession, though of course that hasn't happened yet despite rising unemployment (from 4.8% to 5.1%), the dollar falling to a 12.5-year low, declining factory orders (1.3% in February, after 2.3% in January), a record national housing slump (too much source coverage to list), continuing acute credit-market constipation (ditto), a 30% jump in bankruptcy filings in March alone,and a financial industry so full of holes its notorious opacity has been thinned to a gossamer translucence.
Take, for example, the Dow's spike this past week on the news that UBS would take an additional $19 billion in writedowns (for a titillating total of $37 billion in losses), or that Lehman Brothers--which Wall Street sharpies have been betting is the next investment banking horse to lose, be shot and processed into dog food--will have to raise an additional $4 billion in capital because, y'know, just in case. This was interpreted as Good News because (so the rationale goes) these writedowns take us past the halfway point of the estimated $1.2 trillion global credit loss, roughly $460 billion of which will be sustained by "leveraged" US financial institutions (so sayeth the anonymous economists of Goldman Sachs, according to equally anonymous journalists at Reuters), and therefore, there's nowhere to go but Up.
This is about the time the bunny puts his head in his paws and emits a world-weary sigh through his fuzzy black nostrils. (As with all members of the Checkered Giant breed, the bunny's face bears the singular mask of black over the snout, eyes and ears. Closer inspection reveals natural brindle highlights--no Sun-In for this bunny.)
Such financial psychosis, the bunny concedes, may be in part a reflex reaction to the torrent of terror following the Bear Stearns debacle, arguably the industry's worst trauma since 9/11 (or, even more arguably, the industry's very own 9/11). But it seems to carry the seeds of its own perpetuation by policy. The bunny cites Andrew Bary's excellent article in yesterday's Barron's ("Wall Street's Latest Illusion", p.40), which illustrates the alchemy by which tottering financial firms turn their losses into profits on their books. Abracadabra:
"Here's how the accounting works: When a company's credit weakens and the yield on its debt rises relative to risk-free Treasuries, the debt becomes worth less to the holder. The financial company, which is the debt issuer, then takes a gain, because theoretically it could buy back its debt below face value."
Got that? If not, here's the bunny's breakdown. Let's say you're an investment bank. You issue a ten-year bond with a maturity value of one thousand smackeroos. Two years on, the bond's market value drops to $800 due to reduced demand. You know you're still getting the full grand eight years out, so you book the loss as anticipated profit. This is not only legal, it's common practice, or, as one of Bary's sources sums up, "a natural consequence of fair-value accounting." As Bary himself notes:
"Lehman, for instance, reported earnings in its most recent quarter of 81 cents a share, above the consensus estimate of 70 cents. However, the $600 million gain from the reduced value of its liabilities essentially added about $400 million, or about 70 cents a share after taxes. Excluding that gain, Lehman's profits would have been below the consensus."
If that sort of financial wizardry sends a distinct shiver of discomfort up your spine, you're not alone. The bunny thinks this practice is but one of a whole spread of torpedoes fast closing on the carrier which has slowed to recover planes. Get clear, greedy bipeds, he warns. Get airborne and get clear before it's too late.
Bunny ballast:
"Wall Street's Latest Illusion" by Andrew Bary, Barron's, 4/7/08
"The Dollar and the Credit Crunch" by Ronald McKinnon, Wall Street Journal, 3/31/08
"Soros Sees Additional Market Declines After Reprieve" (update 1) by Katherine Burton, Bloomberg.com, 4/3/08
"After Meltdown, Dollar May See Some Relief" by Gertrude Chavez-Dreyfus, Reuters, 3/14/08
"Muni Losses May Put Taxpayers on Hook for $7 Billion" (update 2) by Martin Z. Braun and Jeremy R. Cooke, Bloomberg.com, 4/3/08
"US Sees Biggest Jobs Drop in 5 Years as Downturn Spreads" by Kelly Evans, Kris Maher and Timothy Aeppel, Wall Street Journal, 4/5/08
"Bankruptcies Jump 30% in March, Led by Housing-Bust States" by Bill Rochelle and Bob Willis, Bloomberg.com, 4/5/08
"Pushovers at the Fed", editorial, Wall Street Journal, 3/25/08
"To See a Stock Market Bubble Bursting, Look at Shanghai" by David Barboza, nytimes.com, 4/2/08
"Goldman sees $1.2 trillion global credit loss", Reuters, 3/25/08
"Factory Orders in US Decline More Than Forecast" by Bob Willis, Bloomberg.com, 4/2/08
