Economic Rebalancing

The global economy is horribly out of balance, with the United States going deeper into debt each year as a result of a huge trade gap. This blog describes the process of global economic rebalancing. If you have any comments or questions about the posts here, please don't hesitate to use the comments section.

Sunday, March 09, 2008

How to Make Money in a Recession... (If You Are a Big Banker)

So you've just taken over as CEO of SuperMegaMonster Bank. Your predecessor skated off into retirement with a $200 million golden parachute, leaving you to manage $200 billion in bad loans and assorted toxic waste just as the economy is plunging into recession. What are you going to do?

Step 1: Write-Offs
Take huge one-time hits to your earnings and balance sheet and blame it all on the last guy. You'll be able to show a profit sooner if you don't have all these losses trickling in over time. When you do start claiming positive earnings again you'll get all the credit and big bonuses too.

Step 2: Offload Risk
Shift ownership of as much of your toxic waste as possible to the government and retail investors. Scare the crap out of government leaders and the Fed by telling them our entire economic system will come unraveled if they don't save the big banks. They'll enact a wide range of idiotic policies designed to bail you out of the mess your firm created and profited from in the first place. Public pension plans can be suckered into any investment so load them up with the worst of the worst.

Step 3: Credit Crunch
Call in loans to hedge funds, mortgage REITs and other investment schemes. They've served their boom cycle purpose and now they are expendable. Use the money that comes flowing back in to your coffers to purchase the securities that they are forced to unload at a steep discount. The Fed will loan you extra money at ultra cheap rates with your existing securities as collateral so that you can leverage up on even more cheap investments. Don't buy the hopeless stuff, just buy the higher quality stuff that will survive the recession or senior debt that will survive the bankruptcy process.

Step 4: Ride the Carry Trade
With short term rates low and yields high you can play the carry trade for maximum profit. Panicked investors will put their money in low yielding savings accounts and money market accounts and you can invest this in the long-term, high yielding stuff you soaked up in the credit crunch. As short term rates continue to fall, the spread widens and your profit margin increases.

Step 5: Kill Off Struggling Entities
Identify any exposure you have to companies or municipalities that are likely to become insolvent in a recession. Make sure you sell off any equities or long term debt you hold first. Then pull their short term funding to force them into bankruptcy. Layoffs and general panic will help you pick up more securities on the cheap.

Step 6: Eliminate the Competition
Take advantage of the struggling economy to wipe out any competition that grew too quickly in the last boom cycle. Sub-prime lenders? Savings and Loans? Small, local banks? REITs? Fannie Mae? Kill all you can while you can, as you don't want them to compete with you for banking business in the next boom cycle or investing opportunities late in the bust cycle.

Step 7: Debase the Currency
Lobby the Fed for low rates and the Federal Government for deficit spending. Remember that you are now a carry trader, rather than a creditor. It doesn't hurt you if borrowers pay you back in a debased currency because you get to pay back depositors in a debased currency as well. To the extent that you have equities, real estate and other hard assets on your books offset by short term debt, inflation actually works in your favor. Paper gains on these assets will help your case with the compensation committee around bonus time.

No doubt, the big banks are in a very precarious situation right now, but they have their tentacles wrapped around Washington and the Federal Reserve System. There is a clear path to banking profitability and it will come almost entirely at our expense as citizens, investors and taxpayers. All of these steps overlap in the timing of their effectiveness, and I expect we'll see most of the same themes continuing to pop up over the next couple of years as the recession deepens. So far we've seen:

1. A huge "stimulus" package that will help some distressed borrowers make some more mortgage payments. (Step 2)
2. A big increase in FHA, FHLB, Fannie Mae and Freddie Mac backed loans and securities to take up some of the load off of Wall Street with regards to the mortgage mess. (Step 2)
3. The invention of "Term Auction Credit" as a way of helping big banks sustain or increase their investment portfolios. (Step 3)
4. Falling short term rates to lower the borrowing costs for big banks. (Step 4)
5. Widening spreads to increase the profitability of banks that purchase new assets. (Step 4)
6. A large credit crunch that is forcing hedge funds and other investment vehicles to sell into a difficult market, with investors taking the losses. (Step 3)
7. Continuing rapid growth of the money supply. (Step 7)
8. Struggling municipalities. (Step 5)
9. Rising inflation. (Step 7)
10. A declining dollar. (Step 7)
11. A variety of measures designed to help forestall foreclosures and let banks fudge their accounting for bad loans. (Step 2)
12. The VISA IPO. (Step 2)
13. Big banks helping Thornburg Mortgage raise $230 million in stock offerings in January, only to give them big margin calls in March. (Step 5)
14. The collapse of hundreds of smaller banks and lenders. (Step 6)
15. The abandonment of the Auction Rate Securities market. (Step 3)
16. Seizing control of hedge funds to liquidate their assets. (Step 3)

Eventually the economy will hit bottom and the banks can go back to their even more profitable boom cycle business plan, where they make money by extending credit to anyone who wants to take risks and can make the payments in an expanding economy. It might take awhile for the dust to settle this time though, because the big banks sure managed to mess the economy up badly this time.