WILL HISTORY REPEAT ITSELF?
The Resolution Trust Corporation (RTC) was the organization created to clean up and liquidate insolvent savings and loans during the last major U.S. real estate crisis in the late 1980’s and early 1990’s. We predicted the coming of a new RTC-like organization over a year ago. That prediction has materialized, as the Federal Deposit Insurance Corporation (FDIC) is now undertaking the same role played by the RTC twenty years ago.
Let us examine the parallels to today. In the late 1970’s and 1980’s, the real estate finance industry was a big donor to politicians in the U.S. Congress and to the executive branches at both state and federal levels. After a decade or two of influencing legislation in their favor, too much power was in the hands of the savings and loan industry. This led to abuses in banking and real estate finance that created the savings and loan crisis, and the failure of over 700 institutions. The government’s plan to resolve the crisis called for the formation of the RTC to manage the liquidation of bad saving and loans portfolios, and the taxpayer picked up the bill for the losses.
Today, the banking industry, especially the Wall Street branch of the banking industry, is the big donor to the legislative and executive branches in state and federal governments. Will history repeat itself with a few variations?
Already the taxpayer has been asked to contribute hundreds of billions of dollars. The derivatives crisis still continues. The underlying culprit behind the banking crisis, unregulated derivative transactions, continues unchecked. It remains to be seen if the power that the banking industry currently holds will result in further problems for the economy, financial markets, and the taxpayer. Many experienced observers believe that there is a strong possibility that another and much bigger crisis will develop.
FDIC HAS TAKEN THE JOB
Sure enough, the FDIC, a federal agency, has taken on the role of bailing out and selling
bad banks. About 140 banks were shut down in 2009 by the FDIC, and about the same amount were shut down in 2008. The banks that have been taken over represent about 4% of total deposits. This is an immense sum, and there remain many banks on the watch list. In the last two years, we have pointed out twice that the Federal Reserve believes that there are about 3,000 banks on their solvency watch list. Approximately 300 have thus far been liquidated, there is a long way to go until the remaining problem banks have either raised enough capital to create stronger balance sheets, or are liquidated by the FDIC.
If we assume that 50% of the troubled banks identified by the Federal Reserve (or about another 1,300) must be liquidated, we have several more years of liquidation before the banking system will be healthy in the U.S.
THE EXTEND AND PRETEND SYNDROME
According to contacts of ours in the banking industry, federal bank inspectors and legislators pressured the Financial Accounting Standards Board (FASB) to suspend fair value accounting requirements. This allows the banking industry to overvalue and consider ‘current’ a large number of questionable commercial real estate loans on bank balance sheets. This positively overstates the financial condition of many weak banks. Professionals in the banking and real estate industries refer to this game by the name of “Extend and Pretend”.
Loans which are not making principal and sometimes even interest payments are considered good enough to continue to be held on the lending bank’s books at cost. This game of extend and pretend is intended to work until the value of real estate assets begins to stabilize. The hope is that the price of commercial real estate will stabilize and slowly begin to rise so that banks will actually be repaid these loans.
An excellent article appeared in the January 11, 2010 issue of Business Week entitled “Not So Radical Reform”. It is about financial regulation and how it is being watered down in the U.S. Congress. Needless to say, this is a very negative prospect and one which, in our opinion, will probably lead to future declines in the standard of living of most Americans.
Below is a link to the article:
OUR OUTLOOK FOR ECONOMIC GROWTH AROUND THE WORLD
In our opinion, stock market appreciation is a function of corporate profit growth. Corporate profit growth depends upon the industry or industries in which the company operates and the growth rate of the countries in which the company operates. A summary of the markets which we believe are attractive for investment in 2010 and their estimated growth rates.
Asia Pacific (faster growing countries)
Another category is slowly growing countries where investments in exporters may be successful.
Japanese currency declines are good for exports. Even though the Japanese economy is slow growing.
The following countries produce commodities. Corporate profits in export and commodity related industries may exceed national economic growth.
Opportunity to enjoy stock market appreciation can be found in many sectors of the investment world in 2010. Stocks in fast growing counties such as those mentioned above. Stocks located anywhere in the world which are strong exporters. Companies which are producers of food, copper, gold, and oil. Manufacturers of machinery which are used to produce commodities (mining, farming, and oil drilling equipment and services), or machines that are used to build manufacturing facilities (machine tools) should also do well. Transportation equipment will benefit as global trade begins to gradually resurge in 2010.
In the last half of 2010 we expect to see rising inflation in many parts of the world. This will increase demand for commodities, especially precious metals.
The outlook for currencies depends on many variables, including relative economic growth rates, financial decision making, and interest rate trends. Unless the U.S. changes their current financial strategy, the U.S. dollar will continue to decline over the long term. This decline will be punctuated by periodic dollar rallies, such as the one currently taking place.
Please accept our best wishes for a happy, healthy and successful New Year.
Thanks for listening.
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