This was reported on CNN yesterday, but it’s worth mentioning here. There has been a recent trend of Wall Street firms increasing their exposure to hard-to-value assets, such as those backed by mortgages, which raises concerns about the accuracy of their balance sheets.

It might sound like an increase in assets is a positive thing for a bank. But no financial institution wants to record a big increase in illiquid assets, because pricing and selling them is difficult and, if the credit crunch persists, many of them could be a source of large losses in coming quarters.

To get a better grip on how level three assets might affect a bank, it makes sense to look at what exactly makes up level three assets, though this can be hard because of banks’ limited disclosure. In the case of Merrill, for example, we know that a sizable share of level three assets are distressed mortgages and CDOs, which are likely to be subject to further losses in the fourth quarter.

In defense of the banks, not all of these assets are backed by CDOs and subprime mortgages. Some of them are invested heavily in leveraged loans.

But even a well-resourced auditor can’t be expected to properly scrutinize the huge amount of level two and three assets sitting on banks’ balance sheets. For the seven banks Fortune surveyed, level three assets totaled over $430 billion, equivalent to 110% of the banks’ combined equity. That number will likely increase in the fourth quarter, making bank balance sheets even harder to read. Yes, that’s right: Wall Street’s black hole is getting bigger.

Financial Market, Kool-Aid, Stock Market | No Comments »

Marketwatch has an article that highlights some things going on with California’s economy that suggest the state may be in recession.

“California seems to be sliding into recession,” wrote Jan Hatzius, chief economist for Goldman Sachs, in a research note earlier this week. Hatzius based his appraisal on the sharp increase in the unemployment rate in the state from 4.7% in November 2006 to 5.6% in September 2007.

How many of those newly unemployed recently lost jobs that were related to housing? That includes mortgage lending, real estate appraisal, real estate agents, and construction. Of those newly unemployed, how many have massive mortgages themselves and instead of saving any profit they earned over the past few years spent it on shiny toys and lavish vacations?

“California is in for at least another year of economic doldrums,” said UCLA economist Ryan Ratcliff in his latest forecast published in September. But California will not sink into a recession unless a second source of weakness develops, or the housing market worsens more than expected, Ratcliff said.

Ah, here we have another economic expert predicting that things will turn around in a year. Pay attention to the last part of what he said - the part about everything being OK as long as the housing market doesn’t worsen more than expected. How much more of a downturn is expected? With mortgage lending standards tightening every day, major banks writing off massive amounts in losses, and home [asking] prices still astronomically higher than what typical buyers can support, it’s difficult to see how things can get get better any time soon.

The state of California isn’t taking any chances. Gov. Arnold Schwarzenegger has ordered state agencies to plan for a 10% cutback in their budgets for next year, figuring that tax receipts could fall significantly along with home prices.

Again, real estate seems to be the problem again. With lower transaction prices, and current owners likely to argue for lower value assessments, the state is expecting lower tax revenue and is acting to reduce budgets to avoid problems. Is 10% enough to be safe?

A few years ago and up until a few months ago, this was predicted by many bloggers and independent authors, yet they were dismissed by the experts as being overly negative doom-and-gloomers. Did they know something the experts did not? Key fundamentals were ignored and instead the Kool-Aid was going around.

Kool-Aid, Economy, Real Estate | 1 Comment »

According to Yahoo News, Federal Reserve Chairman Ben Bernanke said economic problems, including the severe housing slump, will cause business growth to slow in the months ahead.

Bernanke said he and his colleagues believe economic activity will “slow noticeably in the fourth quarter” compared to the 3.9 percent pace of the third quarter.

“Growth was seen as remaining sluggish during the first part of next year, then strengthening as the effects of tighter credit and the housing correction begin to wane,” Bernanke told the JEC.

Many economists believe the economy’s maximum point of danger of falling into a recession will occur in the early part of next year. A variety of problems from the steepest housing downturn in more than two decades to a severe credit crunch, surging oil prices and a falling dollar have roiled Wall Street in recent days, triggering big plunges in stock prices.

I guess the first step is to acknowledge that there is a problem.

Bernanke said the Fed plans to issue a proposal by the end of the year that would create new standards and rules for all lenders that issue subprime loans, mortgages offered to borrowers with weak credit histories.

What will these new standards and rules do the housing market? Is a set of rules really necessary? The free market will determine the rules for lending, as we’re seeing now.

Economy, Real Estate | No Comments »

Bloomberg is reporting that China’s Vice Chairman of National People’s Congress Cheng Siwei made a statement that China is shifting foreign-exchange reserves to stronger currencies.

“We will favor stronger currencies over weaker ones, and will readjust accordingly,” Cheng said in a speech before a conference in Beijing today. The dollar is “losing its status as the world currency,” Xu Jian, a central bank vice director, said at the same meeting.

Chinese investors reduced holdings of U.S. Treasuries by 5 percent to $400 billion in the five months to the end of August and the government set up an agency in September to seek higher returns on currency reserves. The U.S. dollar has weakened 4.7 percent against the yuan this year, while the euro has advanced 5.7 percent.

It will be interesting to see if this has any effect on the US economy. There have been rumors going around as far back as a year or two ago that China could cripple the US Economy by unloading their currency reserves in USD. Let’s not forget that American consumerism is the primary driving force behind China’s economic growth. Without American consumers buying goods, Chinese factories may be forced to slow down.

According to Marketwatch, this announcement by China has caused the prices of crude oil and gold to surge.

Economy | No Comments »