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Mark's Market Blog

2-14-09: Bad Banks and Cheap Oil on Valentine's Day

By Mark Lawrence

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Markets this week continue to be volatile and more or less flat. The gains of last week were wiped out at a stroke as a couple realities sunk in: 1) Treasury Secretary Geithner does not in fact have a crystal ball, and can't predict exactly how much money he'll need to shore up the banks, how long it will take, or even the details of how he'll do it; and 2) Congress passed a $787B stimulus plan to Obama, but no one knows if it's enough, or the right stuff. Obama immediately called this the first step of several. The market decided it wasn't impressed.

S&P 500, past 90 days

Obama and Geithner have announced they will now work towards the funding and establishment of a "bad bank," a federally owned "bank" that buys bad debt from other banks, allowing them to at least get the uncertainty off their books. This bad bank would then hold the bad paper for a couple years until markets stabilize, then sell it, hopefully at a profit. The problems are that no one knows how much money this bank would have to spend to make a difference, but estimates range from $1T to $6T. Also no one knows how to value the bad paper. If the government buys it at too low a price, the banks aren't really helped; if the government pays too much it's welfare for overpaid stupid bankers. If the government winds up selling the paper a few years from now at a big profit, then the people will claim profiteering; if the government has a big loss, it's the welfare thing again. Overall, a real bed of snakes into which Obama is suggesting Geithner take a hike. Geithner, previously a low-key economist, is learning quickly about presidential level politics, "Heads I win, Tails you hope for a book deal."

Oil continues to trade between about $35 and $50 per barrel as I predicted on 1-9-09, closing Friday at $37.50 per barrel. These days I'm not having a lot of predictive success, so I like to advertise the few times when I call it. The spikes upwards earlier this year to $50 per barrel on news that Opec was taking over the price are now seen for what they always were: a couple little boys with plastic shovels and sand walls announcing that they will hold back the tide. Here's a fundamental law of life in a global economy: in the long run, markets will have their way. No matter how many of the rich and powerful hold hands on the beach and kick at the waves, the water keeps coming in.

Meanwhile, on the west coast gas prices which should be under $2 per gallon stubbornly remain well above $2.20. Nationwide gasoline runs from $1.70 in Wyoming to $2.28 in California, averaging $1.96. Gas prices continue to go up even though oil prices continue to drop. At the right, green is what we pay, pink is what the dealers pay, blue is what the refineries pay. It's not the guys who own the stations that are getting rich. There's a good reason for this, and I'm sure it doesn't involve greedy oil companies. . . Hollywood basically paid for Obama's campaign, and California voters were a big part of him getting into office, so as long as he's handing out goodies some cheaper west coast gas would be appreciated. . .

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Friday the FDIC closed four banks. This brings the total this year up to 13, and the total for the past twelve months to 38. Bank closures are speeding up as housing prices continue to drop and foreclosures continue to increase. It's hard to forecast the bottom on housing prices when there are so many continuing foreclosures, and it's hard to forecast the number of bank failures when we don't know how far the bad mortgage debt will go. Mortgages are classified in three tiers: sub-prime, the loans invented by Clinton and Franks to get minorities and low income people into houses; Alt-A, loans to people who can't easily verify a consistent income stream, like consultants and small businessmen; and conventional, the mortgages made to people who get a regular paycheck and pay their bills on time. To date it's been the sub-prime mortgages that have been the cancer of wall street, however now the problems are spreading to Alt-A and even starting to appear in conventional mortgages as prices drop and layoffs increase. Banks mostly sold off the sub-prime mortgages to Wall Street, but held significant amounts of Alt-A and conventional paper that they considered investment grade. Traditionally foreclosures in these mortgages are around 1%, but now they're climbing up towards 7% with no top in sight. At a 7% foreclosure rate the losses in the loans roughly equals the expected interest, and the loans lose a tremendous amount of value. The banks are now starting to pay for that "sin."

Brett Favre, historically the Superbowl winning quarterback of the Packers but lately the up-and-down quarterback of the Jets, announced his retirement this week. This is, I believe, his fourth such announcement in the last four years, But This Time It's Different. Favre continues to be a big draw to games, so if (when) he changes his mind, he will have no trouble signing with a team that has low attendance and quarterback issues, like Minnesota, Oakland, San Francisco.

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