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Five Things for Monday, May 11, 2009


Government Math: 2+2 = Negotiable, Relief Spelled E-X-H-A-U-S-T-I-O-N, News and Weirdness for Monday

1) Government Math: 2+2 = Negotiable

Since when did math become negotiable? The answer is 1931, when mathematician Kurt Gödel proved the limitations of mathematical logic. But that's not the kind of answer we're looking for when discussing how much capital banks need. Under those circumstances the only right answer is "enough." Of course, where banking is concerned, as has been cruelly demonstrated for the better part of 10 years now, "enough" is always negotiable.

The Wall Street Journal this morning reveals - with well-performed innocence and horror ("I'm shocked, shocked to find that gambling is going on here!") - that there may have been bargaining between the banks and the Federal Reserve regarding the amount of capital that needed to be raised in the wake of the government-performed "stress tests".

According to the Journal, Bank of America's (BAC) initial estimate for needed capital exceeded $50 billion and Citigroup's (C) initial estimate exceeded $35 billion. So what happened to those estimates? Apparently the banks successfully argues with the government that one) the Fed underestimated their ability to cover the capital gap with revenue growth and aggressive cost-cutting, and two) they should get more "credit" (Wall Street Journal's inadvertent pun) for pending transactions that "would thicken their capital cushions."

2) More Negotiable Math

Speaking of stress test results, do we really need yet another lesson why you can't ask the people who never saw debt crisis horror show coming in the first place when it is going to end?

Buried among the results of the bank stress tests last week was $82.4 billion in potential credit card losses under regulators' "worst case" scenario... which we know is not really a "worst case" at all, but what normal people would consider a "best case" outcome. But I digress.

The results show that, worst case, regulators expect that nearly a quarter of credit card loans at Bank of America, Citigroup and JPMorgan Chase (JPM) could go bad. American Express (AXP) and Capital One (COF) are slightly better off... only about 20 percent of their credit card loan portfolios are expected to go bad over the next two years.

Ok, let's take a closer look at Capital One for a moment because I've provided a running documentation of their rose-colored vision over the past two years...

In the fourth quarter of 2007, here's what Chief Risk Officer, Peter Schnall, provided as an update to the Company's 2008 credit outlook.

"In the third quarter earnings call, we provided a view of fourth quarter 2007 and full year 2008 credit losses based on the delinquency trends we saw in our portfolio at the time. We said we'd see $1.2 billion in charge-offs in the fourth quarter and $4.9 billion in 2008 including an "extra" $175 million in the first quarter of 2008.

COF at the time updated its view of 2008 charge-offs to a range of $4.9 billion on the bottom and up to mid-$5 billion.

Schnall added: "Fourth quarter delinquencies are unlikely to decline the way we had assumed, and consequently, the $175 million of "extra" charge-offs we anticipated in the first quarter are likely to continue into the beginning of the second quarter and possibly longer."

Eh, that's not so bad. At least they got the extra charge-offs are going to last longer than we expected part right. The dollar amount... well, the government's "worst case" scenario is calling for $13.4 billion in estimated losses before purchase accounting adjustments.

3) What Does It All Mean?

The real question is what does the results of these stress tests mean for the market? In order to understand that, we have to pretty much ignore what the government said and look a bit closer at what "stress" was actually "tested."

The government's stress tests were supposed to measure these banks' potential losses on everything from mortgages, commercial loans and securities to other assets on their balance sheets. But the main variable in the stress analysis was bank earnings.

As you know, earnings increase capital while losses reduce capital. The higher the base case for earnings, the better under any scenario of stress the banks will do. So while the government took great pains to note that it's "most adverse" expectations for two-year cumulative losses on total bank loan portfolios was 9.1% - "Worse than the Great Depression!" – the reality is that the stress tests used first-quarter earnings as its base case.

Why is that a problem? Well, two reasons. First, earnings in Q1 were greatly increased through the use of the massive Troubled Asset Relief Program (TARP) funds. The banks naturally used these funds to profit via carry trades. Second, Q1 earnings were also greatly improved as accounting rules were "loosened" to allow banks to avoid marking to market many toxic assets.

4) Relief Spelled E-X-H-A-U-S-T-I-O-N

The Nasdaq OMX Government Relief Index as it is described on Bloomberg is an equal-weighted index designed to track the performance of US listed firms participating in the TARP or other direct government investment programs. The base value is 1000 as of 1/5/2009.

The 21 members are:


I bring this up because of some interesting DeMark relationships worth checking out.

Below the chart shows a TD Sequential 13 Sell Signal registering Thursday. Even with the sell signal, note the solid green line is a qualified break of TDST resistance. So what can we use to determine a potential upside target for this thing? TD Absolute Retracement, as described by Tom DeMark's associate and resident genius Rod Bentley, is designed for IPO's and all time highs/lows. Based upon these points, TD Absolute Retracement Up projects resistance as specific levels for upside retracement. These levels are 138.2%, 161.8%, 2.618% and 3.618%. The chart shows where the 2.618% up level is, very close.


5) News and Weirdness for Monday

World Regains Taste for Risk - ($) WSJ (Tastes like chicken, but slightly gamier.)

Banks to Sell Stocks to Repay TARP - ($) WSJ (Includes Capital One (COF), US Bancorp (USB) and BB&T (BBT).)

Analysts Turning Bearish on S&P 500 in Biggest Earnings Rally Since 2002 - Bloomberg

Obama Administration to Strengthen Antitrust Rules - NYT

Mortgages Exceeding 5% Mean Quantitative Easing Amid Treasury Market Slump - Bloomberg

More Companies Freeze Pensions - USA Today (Cities likely to be next. Prediction: More grumpy, transit workers, police and firefighters.)

General Motors (GM) Bankruptcy Almost Ineivtable, Experts Say - USA Today (As predicted in Minyanville long, long ago.)

Food Brands Compete to Stretch a Dollar - NYT (Kraft (KFT) and others competing in private label branding for consumers trading down.)

Target (TGT) Tests Price Matching Program - Minneapolis/St. Paul Business Journal

Starbucks (SBUX) Word Cloud Comparison (2007 vs. 2009) - Seattle Post Intelligencer
Intel (INTC) May Face Record $1.4 Billion Fine - Bloomberg

Swine Flu's Ancestral Viruses Gave Immunity to Older People - Bloomberg (Young man, In my day we washed our hands with bacterial soap, dried them with staph infection and drank Hepatitis out of dirty socks.)

Rachel Alexandra Might Be Shut Out of Preakness Stakes After Winning Oaks - Bloomberg

More Than 1 in 10 Caucasians Have "Churchill Gene"; Lets Them Turn Booze Into Great Works
- Prospect Magazine UK (Hand raised.)
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