Okay. Let us assume the world is normal for a day. Obviously it’s not. Investors are in wholesale denial about valuations. Governments are in wholesale denial about the consequences of money printing. And no one seems to be too terribly concerned that the continued financialisation of the economy in the Western world is slowly but surely destroying our standard of living.
Well, a few people are concerned. Hedge fund manager Peter Thiel told the Wall Street Journal, “The recovery is not real…Deep structural problems haven’t been solved and it’s unclear how we will create jobs and get the economy growing again — that’s long been my thesis and it still is.”
That sounds about right. But is Mr. Thiel’s sentiment just sour grapes? Are the bears (your editor included) just cranky because they’ve missed a powerful six month rally? That’s possible, but unlikely.
The real worry is that despite the pages of the calendar flipping over, not much has changed in the last year. The financial system remains fragile. The economy remains addicted to finance. And investors are valuing earnings as if everything was pre-Lehman.
I have rarely been so convinced that the next broader market move is down,” says Benjamin Bornstein of Prospero Capital Management in Chicago. “The problem is that governments do not create income or wealth, and current stimulus equates to a future tax liability. That will become a major concern in mid-2010 when the stimulus is done.”
By the way, on that subject, the International Monetary Fund agrees. Are you listening Kevin Rudd? The IMF reckons that less than half of the nearly $4 trillion in losses since 2007 have been realised by financial institutions. It says those institutions have to worry about rebuilding capital, stabilising earnings, and borrowing money without a government guarantee.
The Fund also warned that government stimulus programs make life harder for banks because government borrowing sucks away capital from the private sector. “Since all credit providers can buy sovereign debt, sovereign issuance will effectively compete with – and possibly crowd out – private sector credit needs.”
Just to recap, government borrowing draws away capital from businesses that might use it to invest in productive projects that generate a real return. What you get in return is higher debt, probably higher interest rates, and people who’ve never really had to earn a paycheck or meet a payroll deciding how to allocate capital. And you still think it’s a good idea?
But let’s pretend that government monetary and fiscal policy is not actually making the recession worse and a profitable recovery less likely. For today, let’s take up the subject of Aussie banks and the outlook for their earnings. We said that bank capital cushions may still not be large enough to protect them from falling asset values. So having literally rolled up our sleeves, let’s get to it.
You might have seen the headline in yesterday’s Australian Financial Review, “Cash rich banks ready for growth opportunities.” The article claims that Aussie banks are carrying about $6 billion in “surplus capital” which gives them scope, “for expansion and putting them on track to return to record profits in 2010.”
Is that so?
It’s true that Aussie banks have raised nearly $24 billion in new capital through the equity and debt markets in the last year. And it’s true that the big four banks held aside $12.6 billion in provisions for loan losses as of June 30th. But no one knows if that’s enough to cushion the banks from another wave of losses.
The consensus view is that since the unemployment rate has (officially) stayed around 6%, loan losses will be less than expected. But we have yet to see any correlation between the Aussie unemployment rate and bank losses. It sounds a bit like saying that because the sky is blue, peanut butter sandwiches taste better.
Aussie banks have booked most of their losses so far on overseas investments related to the implosion in U.S. housing and housing related debt securities. But the future solvency of the banks is dependent on the value of their local loan portfolios. And that brings it down to whether commercial real estate prices and residential housing prices in Australia are really going to escape global deleveraging without declines of at least 20%.
Our view, as you know, is that they can’t. If the commercial real estate and housing markets experience large falls, the Aussie banks will be in big trouble, just like banks in Europe and America were when faced with assets that suddenly plummeted in value. In fact, these falling asset values are still taking a hacksaw to the equity of smaller regional banks in the States.
Of course the big banks are not allowed to fail in America. And maybe the very big banks will never be allowed to fail in Australia. But that does not make them a good investment. If you think that other people’s mortgages (what the bank calls its assets) are stable and not vulnerable to deleveraging, then we’ve wasted your time today.
We promise to make up for it tomorrow by telling you why gold stocks are horrible investments but world-class speculations. It’s the antidote to Ponzi finance.
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