It took only 48 hours for Citi’s new CEO, Vikram Pandit, to make his first major move since taking the helm at the bank. In one fell swoop, he transferred $49B in shaky mortgage assets held by seven SIVs controlled by Citi onto its balance sheet. (See our Oct. 22 posting for additional details.) Moody’s wasted no time in lowering Citi’s credit rating from A2 to A3 as its stock continued its 40% decline.The move by Citi signals that the bank is no longer serious about postponing the valuation of its off-balance-sheet assets. Prior to this development it was known that Secretary Paulson’s creation, the SIV “superfund”, or M-LEC, was having trouble raising $80B with which to fund the proposed conduit. Now it appears highly unlikely that the M-LEC will act as an escape hatch for the B of A, J.P. Morgan-Chase, Lehman and other major banks to avoid pricing to market their subprime assets. In fact, Citi’s action will likely accelerate the recognition of a market value for subprimes.Which is a good thing.
At the bottom of the “liquidity” problem is a lack of financial transparency: the fact is that no one yet has a reliable estimate of the market value of these financial derivatives. So it is little wonder that banks are reluctant to lend each other when the true condition of their balance sheets remains unqualified and unquantified.
Nonetheless, Chairman Bernanke remains determined to solve the underlying problem by injecting still more and more liquidity into the system. In an action coordinated with European banks (
England, ECB, Swiss National) and the Bank of Canada, a newly created entity, Term Auction Facility (TAF), will auction off at least $40B in four separate auctions starting the week of Dec. 17. Additional auctions are scheduled for Dec. 27, Jan. 14 and Jan. 28. The Fed will also make up to $20B available to the ECB and up to $4B to the Swiss National Bank.Under this plan, the central banks will auction loan funds directly to commercial banks who are adjudged to be in sound financial condition. In the
United States, banks would be approved for participation in the auction by their local Regional Federal Bank.
Banks accepted for a loan from the TAF will be able to furnish a wide variety of collateral and to borrow at rates somewhat below the federal discount rate.
The goal is to make funds available to qualified lenders who otherwise may not be able to secure a loan, thereby providing additional liquidity to the system. The plan is, in effect, an attempt to jump-start lending and thereby provide credit where credit is scarce.
All of which is to say that the shutdown in lending is attributed by the Fed to a lack of liquidity rather than a question of credit worthiness. But the problem of the subprimes is a problem resulting from lending money to individuals with poor credit and diminished ability to repay the loans. It is not the result of a scarcity of cash. The low-credit loans which were created have been disseminated throughout the world and have thus become a global financial problem rather than just a local one.Many will recall the experience of
Japan whose banks were profligate in issuing loans during the ’90s to companies that could not repay them. Rather than acknowledge these non-performing loans, Japanese banks kept them on the books for 15 years.
Japan is just now beginning to emerge from the economic consequences which resulted when bad loans on the books displaced available credit.Perhaps Vikram Pandit’s action to recognize a bad loan when he sees one will be the first painful step along a path for all major banks to clean up the subprime mess. Until that happens credit will remain difficult and expensive to come by, no matter how many dollars Mr. Bernanke injects into the system.
Meanwhile, the cost of commercial real estate loans is increasing and the number of transactions decreasing. For investors higher debt costs resulting from higher risk premiums will lower property prices despite lower short-term rates. In Southern California, capitalization rates are still below the cost of funds, resulting in negative leverage. It would be optimistic to say that rents will continue to increase in order to justify higher prices. But this does not appear to be in the offing.