Reuters
Tougher rules could hurt Wall Street profits-PIMCO
Monday March 31, 11:46 am ET
NEW YORK (Reuters) - Wall Street profits could take a big hit if the government toughens regulations in a proposed overhaul of the U.S. financial system, the manager of the world's biggest bond fund said on Monday.
The White House and some lawmakers have called for a regulatory sweep, not seen since the Great Depression, in the wake of the current turmoil in financial markets and the near-collapse of U.S. investment bank Bear Stearns (NYSE:BSC - News).
On Monday, Treasury Secretary Henry Paulson outlined a plan that permits the Federal Reserve to oversee the books of U.S. investment banks and other large non-bank financial companies which are currently treated differently from commercial banks and savings and loans and thrifts.
Gross, the chief investment officer of Pacific Investment Management Company, or PIMCO, anticipates such a regulatory revamp will result in higher capital standards for investment banks, bringing them closer to their commercial bank counterparts.
"There seems no way that current reserve requirements for banks will not in some nearly uniform way be imposed on investment banks," Gross, who manages the $120 billion PIMCO Total Return Fund, wrote in his latest monthly 'Investment Outlook' published on Monday.
Tougher regulations, with the goal to shore up the safety and soundness of the overall banking system, will likely slash the profits of major investment houses like Goldman Sachs (NYSE:GS - News), Lehman Brothers (NYSE:LEH - News) and Merrill Lynch (NYSE:MER - News), Gross said.
Gross referred to these Wall Street firms as "shadow banks" because they have raised billions in the capital markets, rather from savings and traditional lending. Less stringent regulations had allowed Wall Street to make riskier and more profitable bets than commercial banks.
This "shadow banking system," which consists of all the levered investment conduits, vehicles and structures created by Wall Street, is now facing liquidity constraints.
"Shadow banks will likely be forced to raise expensive capital and/or reduce the bottom line footings of their balance sheets," he said.
This would mean lower stock prices on higher borrowing costs for investment banks, he said.
Meanwhile, more stringent regulations would mean investors would demand wider risk spreads or higher return premiums, which could be a drag on the economy, according to Gross.
"Risk spreads - from corporate bonds to equities to commercial and residential real estate - will settle at permanently higher levels. The U.S. asset-based economy will morph into a more expensive hybrid that will reign supreme for years to come," he said.
I’ve become moderately obsessed with the “Lost Decade” in Japan. I am a firm believer that there truly is nothing new under the sun and if one examines history correctly one can find pointers and perhaps a true north if one works particularly hard at it.
August 19, 2005 Moneyweek Japan’s New Dawn:
Several times in the last decade and a half, this is exactly what has happened. Investors have got very excited as a global cyclical upswing has driven the market up 40% to 50% in the space of a year. But then, as in 1997-1998 and 2001, the cycle turned, taking the Nikkei down with it. The upswing has never yet turned out to be self-sustaining and there has been no end to the debilitating run of deflation in goods and land prices
From the Wikipedia Entry on Japanese asset price bubble:
The easily obtainable credit that had helped create and engorge the real estate bubble continued to be a problem for several years to come, and as late as 1997, banks were still making loans that had a low guarantee of being repaid. Correcting the credit problem became even more difficult as the government began to subsidize failing banks and businesses, creating many “zombie businesses”.
and finally, more clues to what I was looking for in this Financial Times article from February of 2007 (while it talks about China the history lesson is the road map):
The definitive history of Japan’s dismal decade has yet to be written. But almost all knowledgable observers would agree that significant elements included the bursting of the stock market and land bubbles, the resulting problems in the financial system, the collapse of aggregate demand as banks stopped extending credit
or here:
In retrospect, Japanese officials made several important policy errors. In order to avoid further yen appreciation after the 1987 Louvre agreement, they followed easy monetary and financial policies that gave rise to huge asset price bubbles and expansions in credit that set the stage for the subsequent downturn.
What’s Different
Well, there’s a whole wack of things different between the US and the Japanese markets of their respective time periods. While there are great similarities the differences boil down to two things that I’d like to point out:
The Japanese culture of the time was less individual oriented and more geared towards making sure that the country, the corporation, or the family prospered at the expense of the individual. The North American model could be almost a perfect inverse of that priority structure. At the time of the bank failures, the “zombie businesses” there were not the same levels of individual debt that is carried now by the American consumer.
The Japanese economy at the time was an exporter. The main problem that the central bank had, which took a full decade to solve, was to get the individual consumer to spend domestically. Again, the American situation is a stark contrast as the US seems to export little and certainly, if left to it’s own devices, would have a long rough row to hoe if it were to forced to look inwardly to stimulate growth.
The comparison is valid and has been made by a number of people. Both stockmarket busts were led by banks and real estate.
The Japanese market, almost 20yrs later is still in the doldrums, is this what is in store for the American market? I think not, due to some very important differences. The crucial difference is contained within the accounting standards utilised.
Japanese banks record assets at "Historical purchase value" thus, the assets are not marked-to-market and written down if they become impaired. Obviously in the real estate bust, poor real estate loans were impaired, but never written down. The result being that the capital of the bank and it's ability to lend were impaired, while concurrently scaring off sources of new capital as they did not know the true extent of the damage.
In the US, banks are forced to mark-to-market, thus faulty loans are written down aggressively, so aggressively that many lending institutions are boderline insolvent if not outright bankrupt. That so many within the financial system are insolvent has led to a government bailout to protect the financial system from total collapse. This has happened numerous times, each time, it has been successful.
The huge advantage is by writing down impaired loans and reserving against future losses is that should the banks overestimate the losses, via a total writedown, any surprises must be to the upside.
Prior to the 1935 post depression, banks had never lent against real estate, it being deemed too illiquid. Business was exclusively in self-liquidating loans. This business is still viable, and will most likely be the source of banking profits again, whether legislation forces it upon them or not.
That the banks are now probably through the worst of their writedowns, that the Fed has taken upon itself to fund any bank in serious trouble, the financials will cease to be a drag on the index.
That is not to say that the economy is not without problems, just that banks and bank earnings will start to surprise to the upside, rather than being a source of continued woe.
Japanese banks by contrast, not only did not write down their losses, thus depriving themselves of gaining meaningful new capital, they further compounded their error by continued lending to already failed loans, digging themselves ever deeper into insolvency.
The destruction currently being endured by American banks is creative in that it sows the seeds for the next expansion.
It is interesting in that the American consumer is also engaged in writing down his debt, via walking away from underwater mortgage contracts. Personal bankruptcy, as corporate bankruptcy, has become a viable and acceptable business decision. Thus again we have a creative destruction underway, paving the way for future prosperity.
Obviously this will not resolve overnight, however, the seeds of the next expansion are being sowed while all eyes are still focused on the doomsday scenario.
The key will be on productivity going into the future. High productivity will allow America to earn it's way out of the hole that it has dug for itself.
~ the stock market is in turmoil and their portfolio is losing value
~ the housing market is roiling like a turbulent sea during a hurricane just when they are planning to move to a smaller place
~ the dollar is depreciating and their income is not increasing - at least not as rapidly
~ fuel prices are rising - the $15 fill-up of three years ago is now $45
~ the cost of almost everything they buy that depends on fuel for manufacture and delivery is rising too - food, clothing, automobiles, electricity for lighting and air conditioning, and gas for heat, and more.
Those who have wealth great enough to make them celebrities can weather the financial storms that are raging just because they have so much. The pundits that pander to every fashionable financial fad can talk to no end about how their latest strategy will solve your problem, and perhaps that's what some folks need. Those who follow the practices of Money for Life...in good times and bad are also secure during financial upheavals such as these.
But we Americans have a problem that is systemic. Our financial Apollo 13 has been hit by some economic debris that was engineered by Wall Street's merchants of misinformation and their financial snake oil sales reps who chant the shibboleths they rely on to keep America dazed and confused. We can, of course, keep on keepin' on, cobble together a solution to today's problem, await the next disaster and continue to rely on a personal economy that is engineered by others for others.
The Apllo 13 crew and the NASA engineers had no choice and performed astonishingly well when the Apollo space vehicle was damaged. They also dealt with the issues surrounding the problem to assure it didn't happen again. Wall Street won't do that for you. Individuals do not have a NASA to look into the future on their behalf. While NASA is committed to the safety and success of its astronauts, Wall Street is committed to its own success and no other. Noone on Wall Street is going to devise a solution for you.
At the cost of being boringly repetitive, if you manage just four aspects of your finances properly, you will be able to handle almost any money challenge the you face. The foundation of every successful personal economy is money that you control - money that is in your "banks" not Wall Street's. That means the money cannot be in an investment that Wall Street wants you to buy; and remember, when you buy anything - they call it investing - someone else gets some of the money you spend. They are not paid in kind.
With your "banks" as a foundation, you have to pay attention to only four goals - I call them the Four Pillars of your personal economy:
Freedom from debt-to-others
Income you don't have to work for and you can't outlive
Ready money to deal with the surprisingly unsurprising surprises life deals out every day
A legacy of your wisdom and wealth to pay forward to those you care about
Wouldn't you feel better if those four goals were in reach? They are and you can learn how to achieve them with the guidance found in Money for Life -->
Following on from the rabbit hole adventure. Today I switched on the TV and found myself looking at a speech by Treasury Secretary Hank Paulson making a speech about the Bush government's new plan to restore order in the financial system chaos brought on by current events in the housing sector.
Well, Big Brother is upon us, I thought.
The broadcast was cut off a few minutes because the rather inept interpreters more or less collapsed and apparently couldn't go on. So I went to the Net for more info and found the following article at MediaChannel.org:
Dark forces in action? More interesting events in the 3rd dimension.
Do you agree with Treasury Secretary Henry Paulson's plan to regulate Wall Street and the mortgage industry more closely? Will it help prevent another financial crisis? ()
Just been to local bank i have been with for over 30 years. I thought their was a mistake on my bank statement because they charged me £50 for being £25 overdrawn for 1 day.
They said "no, it was right"
so i said "even loan sharks and the mafia do not charge that much intrest on their money"
Do not get me wrong i expected some bank charges even for 1 day something like £5 or even £10 but £50 that is absoloutely ridiculous. my parting comment was "you are out of order and i am changing my bank account, even loan sharks do not charge that much"
Does anybody else think 73,000% intrest charges on £25 for 1 day are a bit steep????
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.. ..the bank doesn't want you to default on your loan, and them have to repo your house.. ..a bank who holds the loans would have just the opposite incentive.. ..if bosses are encouraging such things then they too are wrong.. ..mortgage brokers and agents shouldn't game the system.. ..there are some banks who don't hold the mortgages so their incentives might be closer to that of the mortgage broker.. ..a mortgage broker might have alot of reasons to sell loans to crappy customers.. ..I don't want to lose my home...so I probably should only mortgage what I can pay.. ..the concept that an automated system gives you a go or no is just crappy.. ..if your rating comes back way in the NO category, obviously you have little to no chance.. ..
The will have severe consequenses on the local banking sector. To recap the following steps were taken by the CBK:
Consumer loans cap will be 40% of salary, from 50%
Pensioners loans' cap to 30% of income
A new limit on interest rates of 3% over discount rate, from 4%
The banking sector in general relies heavily on lending funds to consumers at high rates at long term intervals. The loan cap on potential customers will decrease the amounts banks can lend and along with the limits on the interest rate charged will lower returns on the already decreased amounts taken. This step in itself will lower the revenues' for the banking sector which will be evident in the 2009 statements. My prediction is that, based on the new regulations, banks' revenues will be between 20 -25% lower than last year.
The U.S. housing secretary will resign Monday morning under pressure after accusations of improper allocation of federal contracts, the Wall Street Journal reported in its Monday edition. Housing and Urban Development Secretary Alphonso Jackson will step down on Monday morning, the paper reported. The department announced late Sunday that Jackson will make a statement to the press on Monday morning. Jackson has faced calls for his resignation after lawmakers have said he behaved improperly in awarding federal contracts. The Federal Housing Administration, overseen by HUD, runs the largest government program to aid home buyers and is seen by many lawmakers as the key to a federal effort to stem foreclosures.
who have left millions of Americans scrambling to keep their homes but all the while her campaign manager, Margaret “Maggie” Williams, has sat on the board of one of the nation’s once-largest and now-bankrupt sub-prime mortgage lenders.
Clinton Communications Director Howard Wolfson told FOXNews.com late Sunday that Williams, a longtime Clinton ally, didn’t join Clinton’s Democratic presidential campaign as a volunteer until after Delta Financial Corporation — for which Williams is a director — went bankrupt in December 2007.
That’s more than seven years after Williams joined New York-based Delta Financial in 2000. She became a director one month after a federal settlement was reached with the lender over discriminatory lending practices. More recently, Delta has been accused by consumer advocates of pursuing predatory practices throughout the housing boom and bust.
As of September 2007, Williams owned 12,500 shares of Delta’s common stock, and by 2007 had earned at least $175,000 for her board obligations, according to company filings available in the Securities & Exchange Commission online database.
...
Intently focused on the nation’s housing crisis in recent appearances, Clinton has been clear that sub-prime mortgage lenders, particularly in poor, working class urban neighborhoods shoulder much of the blame for the credit crunch.
...
But as it turns out, Clinton’s top aide is on the board of what had been — until its bankruptcy — the ninth-leading sub-prime lender in the nation, handling almost $800 million worth of sub-prime lending in the third quarter of 2007 alone, according to National Mortgage News.