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Five Things You Need to Know: Bernanke and the Name Which Must Not Be Spoken; November 15; Bankruptcy Laws Backfire; Consumer Credit; What We Need Are More Fake Plastic Trees

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What you need to know (and what it means)!

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Minyanville's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Bernanke and the Name Which Must Not Be Spoken

Federal Reserve Chairman Ben Bernanke this morning said the U.S. economy is likely to "slow noticeably'' this quarter while high commodity prices and a weaker dollar will probably stoke inflation.

  • Like us, you may have read Bernanke's comments looking for the word "Stagflation."
  • Well, good luck with that, because it's not there.
  • It's the name which must not be spoken.
  • Meanwhile, among other things, Bernanke said the market for nonconforming mortgages remained "significantly impaired" and the contraction in housing-related activity "seemed likely to intensify."
  • Nonetheless, he's optimistic!
  • Growth will probably improve in the second half of next year as the credit and housing issues begin to wane, he said.
  • What might cause growth to not improve?
  • Simple, he said, "Financial market conditions could fail to improve or even worsen, causing credit conditions to become even more restrictive than expected."
  • Wait there's more.
  • Also, "house prices might weaken more than expected, which could further reduce consumers' willingness to spend and increase investors concerns about mortgage credit."
  • So the bottom line is that the Fed expects housing and credit issues to wane next year unless they get worse.


2. November 15

We continue to read more and more about this November 15 "deadline" for implementation of U.S. Financial Accounting Standards Board Rule 157 (FASB 157 for short) that make it harder for banks to avoid "mark-to-market pricing" of securities. (See this Special Five Things You Need to Know About Mark-to-Model for more.)

  • CFO Magazine has an article titled, "FASB 157 Could Cause Huge Write-Offs."
  • Why? Because under the new provisions firms are forced to whenever possible use "observable inputs" in pricing their Level Three assets.
  • In somewhat overly simplified terms, Level Three assets are those that may rely on mark-to-model inputs since they so rarely trade.
  • In may cases there is no way to price the securities. This gives the firms a lot of leeway in determining their value.
  • But when something does trade, under the new rules it forces that asset out of Level Three based on the pricing data that becomes an "observable input."
  • "It you think banks are writing off large amounts of assets now, wait until new accounting rules take effect this month," the CFO article says.
  • But Goldman Sachs (GS), Merrill Lynch (MER), JP Morgan (JPM), Morgan Stanley (MS) and Citigroup (C) already adopted early implementation of FASB 157 beginning in the first quarter of 2007.
  • Still, we keep reading vaguely grim predictions of looming disaster beginning on November 15.
  • What gives?
  • We think there may be confused causality here.
  • Firms such as American International (AIG) in their 10Q said they are "currently addressing the effect of implementing this guidance."
  • A lot of firms out there are in this boat.
  • Meanwhile, Wall Street's major firms are about the only firms that have already adopted the FASB 157 provisions.
  • The issue is not increased writedowns based on this FASB 157 "implementation date."
  • The issues remains the fear of forced sales creating "observable inputs" at distressed prices that will force assets to be valued at starkly lower levels.


3. Bankruptcy Laws Backfire

It seemed like such a good plan. According to the Center for Responsive Politics, Washington Mutual (WM), Bank of America (BAC), JP Morgan Chase (JPM) and Citigroup (C) forked out $25 million in 2004 and 2005 lobbying for changes in bankruptcy laws they hoped would protect their credit card profits.

  • The result was exactly what they wanted, a Bloomberg story noted this morning.
  • Less forgiving bankruptcy laws are making sure people can no longer walk away from their credit cards.
  • The new bankruptcy code makes it harder to qualify for Chapter 7, the type of bankruptcy filing that wipes out non-mortgage debt like credit cards.
  • Unfortunately, an unintended consequence of the law is that people are struggling to make their mortgage payments as a result.
  • According to Capital One (COF), of those who are at least three months behind on their mortgage payments, an astonishing 70% are current on their credit card payments.
  • "What we conclude is that people are saying, `Honey, let the house go,''' but keep the cards, COF CEO Richard Fairbank said according to Bloomberg.
  • The problem is still in the early innings thanks to ongoing and still upcoming mortgage payment resets.
  • Four million subprime borrowers will see their mortgage bills increase by an average 40% in the next 18 months, according to the National Association of Consumer Advocates in Washington, Bloomberg said.
  • The attitude these numbers bear out seems contradictory and nonsensical: people are choosing to hold onto their credit cards over their houses.
  • How could that possibly be?
  • The reality underlying this bizarre choice is that consumer balance sheet stress is so severe that credit cards which allow one to purchase basic necessities are valued over shelter.
  • That doesn't bode well for the Bernanke Fed home price deflation thesis: that it will end mid-2008.


4. Consumer Credit

Consumer credit in September expanded by a lower than expected $3.7 billion, much less than the $9 billion that was expected.

  • The Federal Reserve reported yesterday afternoon that consumer credit rose at an annual rate of 1.8% in September, the slowest since April's 1.6% increase.
  • Virtually all of the increase was in revolving credit, credit cards, which expanded by $3.4 billion.
  • Nonrevolving loans, which includes auto loans, rose at a 0.3% rate in September, compared with 6.4% in August.
  • It was the weakest showing for auto loans since October 2006.
  • Overall, total consumer debt rose by $3.75 billion in September, a sharp decrease from a gain of $15.41 billion in August.
  • What does it all mean? As housing values continue to decline, and with mortgages resetting at higher rates while basic cost of living expenditures (food, etc.) rise, consumers have no choice to turn to credit cards to get by... and this leads us to today's Fifth Thing.


5. What We Need Are More Fake Plastic Trees

The New York Times this morning spells out what all this means pretty clearly: "[I]n an ominous portent for the national economy, Mr. Whittey has grown tight with his money. His home is worth far less than it was a year ago, and his equity has evaporated. And like many other involuntary adopters of a newly economical lifestyle, he can borrow no more."

  • Putting numbers to the situation, the Times notes: "From 2004 through 2006, Americans pulled about $840 billion a year out of residential real estate, via sales, home equity lines of credit and refinanced mortgages, according to data presented in an updated working paper by James Kennedy, an economist, and Alan Greenspan, the former Federal Reserve chairman."
  • In the first half of this year, however, home equity withdrawls were down 15%.
  • And lately it's gotten worse.
  • To summarize, this is how a deflationary credit contraction begins.
  • The joke is that while everyone has been focusing on the consumer to lead the first wave of the contraction, no one expected it would actually be the banks that would kick it off.
  • The Federal Reserve is confident it can re-create the demand for credit that has enabled the economic "boom."
  • What they will discover is that they can only re-create the technical foundation.
  • The psychological aspects of risk aversion are continuing to expand, and each day becoming more and more entrenched, and over that the Fed is powerless.
No positions in stocks mentioned.

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