Mohamed Ei-Erian, chief executive and co-chief investment officer of Pimco, wrote in his latest blog carried in the Financial Times, noting that careful reading of the minutes just released by the US Federal Reserve Board suggests, the Fed is already considering additional measures of monetary policy to boost the US economy – in other words more quantitative easing is coming. I and other financial participants are questioning the effectiveness of these additional measures based on the non-responsiveness of the financial markets to recent measures already performed by the Federal Reserve Board. Whatever one believes in the current debate about the “Fiscal Cliff” there is no question that US fiscal policy going into 2013 will be tighter, more restrictive, then anything we have seen since 2008. So starting 2013, government fiscal policy will be contracting the economy while monetary policy will be extremely accommodative. If fiscal policy is too restrictive this would be like sitting in your car, with one foot on the brake and one the accelerator both pushed to the floor – we all know the car (economy) will not move. Europe is currently deploying this dangerous cocktail of policy – austerity with loose monetary policy – as the financial press this week announced Europe has officially entered another recession.
One the keys in the puzzle in increased future economic growth lay in what our model price charts are telling us about the US financials. The TBTF – To Big To Fail – institutions primarily Citigroup, Bank of America, JP Morgan and Goldman Sachs are trading under EBV-3 and are having a difficult time transiting up through this level. These four financial institutions have a total of $7.4 trillion of combined assets and because of our work we know the market has questions about their stated asset value.
I will subdivide the four banks in two groups. The first group of Citigroup and Bank of America has combined assets of $4.1 trillion and trade deep into EBV-3 territory.
Here are the long-term model price charts of each.
Bank of America with monthly price bars, EBV Lines (colored lines) and model price (dashed line)
Citigroup with monthly price bars, EBV Lines (colored lines) and model price (dashed line)
Both financial institutions trade below our last EBV line or EBV-3. When companies trade under EBV-3 this indicates the market doesn’t believe the stated asset value as recorded on the company’s balance sheet. Certainly under normal circumstances this would be a precursor for future asset write-offs. However market participants all realize that asset write-offs will not be occurring in any of the TBTF financial institutions for the foreseeable future. Even though regulators and the SEC are pretending these asset values are what they are recorded to be, “the market” doesn’t pretend and is signaling the impairment of these stated values. Without restructuring, these financial institutions cannot transmit excess reserves – credit – to the real economy. They become pejoratively known as zombie banks.
Sheila Bair, the former head of the FDIC, did an interview with Charlie Rose recommending that Citigroup in particular, during her tenure as FDIC head, either be separated into two banks; a good bank with good assets, and a bad bank with toxic assets in hopes that values emerge down the road, or Citi be placed in receivership and reorganized. Tim Geithner, the current and outgoing Treasury Secretary, was (and probably still is) opposed to such action according to her. Her interpretation of Geithner’s position was to keep giving these TBTF institutions money and they will work themselves out of their current position.
The other two financial players, JP Morgan and Goldman Sachs with combined assets of $3.3 trillion are acting according to model price very curiously indeed. Here are our model price charts for both of these financial institutions.
JP Morgan Model Price chart
JP Morgan with weekly price bars, EBV Lines (colored lines) and model price (dashed line)
Goldman Sachs Model Price chart
Goldman Sachs with weekly price bars, EBV Lines (colored lines) and model price (dashed line)
Both financial institutions succeeded in transiting up through EBV-3 in March of this year. After transiting up, both these financial institutions transited back down past EBV-3 in April and traded deeply past EBV-3 into the summer. Starting in July and August these two financials rallied hard up to EBV-3 and is currently having a hard time transiting up through EBV-3. What does all this mean? Not sure. Sometimes I think it best not to over think what is going on in the real world and what is going on with our model price charts. “The market” is waiting for something – not sure what – before there is a positive transit if one occurs at all. Again, you don’t have to over think this. The balance sheets of all of these financials are so opaque and complex the outside world will probably never know what is recorded as assets on their balance sheets.
Tying this all together
The US people and the world economy needs the US economy to get back to moderate sustained growth. According to Mr. El-Erian more Quantitative Easing (QE) is coming shortly and I, for one, question any additional effectiveness in assets prices. The “Fiscal Cliff” resolution will certainly be a drag on economic recovery however necessary to stop the trillion dollar deficits the United States has been occurring and projected in the future. According to our model price work another piece of the future growth puzzle are the TBTF financial institutions that have been left alone since the crash of 2008. Certainly Citi and the Bank of America should be reorganized or restructured. With a new Treasury Secretary being appointed, fresh eyes should take a look at these financial institutions. Goldman and JP Morgan are on the cusp of transiting up through EBV-3, however they are being held back by something. Again the new Treasury Secretary can review these financial institutions and remedy what the market doesn’t like or what management has failed to do.
Certainly the US is further down the road in reforming their financial system then Europe, however our model price work suggests further restructuring needs to be done with these TBTF financial institutions so the US can put this financial crisis in its rear view mirror and become the economic engine of world growth.
P.S. I have highlighted twice this year JP Morgan and Goldman Sachs “Coming out of the Blue” or transiting up through EBV-3. Each time these two had a positive transit they have transited down through EBV-3. Frustrating yes. However experience tells me that when these two financials finally transit up through EBV-3 for good, they will quickly trade up to at least EBV, giving investors and traders relatively quick and substantial gains.
P.P.S. Everyone seemed to be surprised at the sudden resignation of Mr. Vikram Pandit, CEO of Citigroup, back in October. Whether Mr. Pandit resigned or he was pushed is immaterial. Managements can come and go with Citi and Bank of America and won’t make a bit of difference to the math these organizations face in terms of their balance sheets. These organizations need radical surgery according to model price math, and caretaker boards and management will find it hard to perform taking baby steps – selling non core assets – and hoping time bails them out.