Bankrupt Banks


At a congressional oversight panel on the government’s financial rescue program the tax evading Treasury Secretary Timothy Geithner testified, “Currently, the vast majority of banks have more capital than they need to be considered well capitalized by their regulators.”  With the recent fair-value lying accounting changes banks have reported surging quarterly profits.  Even the single digit midget Bank of America booked a first quarter net income of $4.247 billion – 6% more than it made in all of 2008.

Olivier Garret, CEO of Casey Research, asks a couple penetrating questions and gives a couple answers.

“For starters, just where did all this income come from?  And has credit quality really improved.

The answers to both can be found buried in a company press release bearing the encouraging title “Bank of America Earns $4.2 Billion in First Quarter.”

I’d like to draw your attention to the four most telling excerpts from this release.

  1. Equity investment income includes a $1.9 billion pretax gain on the sale of China Construction Bank (CCB) shares.”
  2. Noninterest income included $2.2 billion in gains related to mark-to-market adjustments on certain Merrill Lynch structured notes as a result of credit spreads widening.”
  3. Credit quality deteriorated further across all lines of business as housing prices continued to fall and the economic environment weakened.”
  4. Nonperforming assets were $25.7 billion compared with $18.2 billion at December 31, 2008 and $7.8 billion at March 31, 2008, reflecting the continued deterioration in portfolios tied to housing.”


Bank of America makes $4.2B almost completely from a one time sale of a Chinese bank and some accounting sorcery on Merrill’s failing mortgages.  Looking at the cash position of Bank of America if those two extraordinary events were backed out and preferred dividends were included then Bank of America actually bled about $1.3B.

The head of the sorcery order, Goldman Sachs, was very creative by changing its reporting calendar which effectively erased the impact of $1.5B loss in December from showing up in its earning statements although it still flowed through to the balance sheet.  Bank of America is not the only bank with these shenanigans.

The FDIC poltergeist possessed another four banks on Friday bringing the total for the year to 29.  The evaporated banks that went poof were dotted across the nation holding about $1.6B in deposits including American Southern Bank of Kennesaw, GA with $104M in deposits, Heritage Bank of Farmington Hills, MI with $152M in deposits, First Bank of Beverly Hills in Calabasas, CA with $1B in deposits and the First Bank of Idaho in Ketchum, ID with $374M in deposits.


It is clear that credit quality continues to deteriorate at the banks and almost all banks are engaged in fraudulent accounting sorcery.  On the bright side for these vampires, the steep yield curve helps generate tremendous real income for the banks as they are able to suck the life out of the remaining wealth generating companies in the economy.

JP Morgan reported a stunning profit because the value of their bonds declined in the market and Citigroup had a similar $2.5B gain.


A few days ago I attended an art walk with some colleagues.  While the funnel cakes, BBQ, smoothies and live music were fun we began to chatter about business.

One of them happened to be a commercial property appraiser.  He was telling me about the difficulty of appraising buildings because the market is failing to clear and data points are getting extremely scarce.  For example, quarterly he appraises a beautiful 100,000+ square foot high-quality office building that overlooking the Pacific in Oceanside, CA.

Usually this premium building is never vacant but starting November 2008 its vacancy rate climbed to about 20%.  He avoided a write down in Q4 2008 turning in a $64M appraisal.  But because the vacancy rate, lack of comps, etc. is now typical for the market in Q1 2009 he had to evaporate $8M from the building turning in an appraisal of $56M and did not receive any complaint from the client.  He told me he is currently working on the Q2 appraisal and figures he will need to evaporate another $4M.  This is what happens to real estate values when the discounted future cash flows decline because of huge vacancies and leases being renegotiated.


My suggestion for valuing the building if the market was not clearing and there were no comps was a simple $0.  Then I told him the story of my encounter with a senior partner from DLA Piper whose client had a 40+ story condominium that was worth less than worthless.

Why is there such an effort to keep the asset prices high? If these assets are being ‘held for the long-term’ then it should not matter if they are carried on the balance sheet at tremendously understated values.  After all, Mr. Buffett often takes this approach.

I have never heard of an investor suing or regulator prosecuting fraud, except perhaps in divorce, tax or similar cases, because assets were undervalued on the balance sheets.  They can always be marked up later or a gain can be taken at a sale.  Additionally, this may even have beneficial tax consequences.

Of course, this type of accounting methodology may have a negative effect on fraudsters, Ponzi scam artists and fractional reserve bankers who are by definition engaged in embezzlement.  These immoral individuals always want to misrepresent asset values to the upside but never the downside and prosecuting fractional reserve banking as embezzlement would be beneficial for society and lead to a more efficient allocation of resources.


So let me get this straight:  the greater depression is intentionally exacerbated with a skyrocketing unemployment rate, construction and commercial loans become impaired as projects are either stopped because the unsustainable consumer economy is grinding to a halt or phantom equity is evaporated.  This causes the banks to either go under or become more of a credit risk.  If the bank survives then it is an even a higher credit risk as their debt trades at a discount and that discount is booked as income.  The banks record profits, CNBC declares all is well and the stock market soars.

By comparison, a consumer charges up a bunch of credit card debt at McDonald’s, loses their job, their credit worthiness diminishes and the bid for the consumer’s credit card debt in the market declines so the the consumer books income.  Which begs three important questions:  Is there any real income?  Will a real economic loss be taken?  By whom?

Wealth can take two forms:  (1) a financial asset or (2) a tangible asset.  Tangible assets have intrinsic value and can never become worthless.

Uncertainty from the lying on financial statements and by costumed government officials is briskly eroding the confidence of a inherently unsound confidence based system.  In times like these there stands only one safe haven:  commodity currency.  At all times and in all circumstances gold and silver remain money.  Their value is not subject to counter-party risk and accounting sorcery, unless it is fool’s gold or silver held in the GLD or SLV ETFs, and the metals will always buy something.  Gold is the risk-free asset and does not require fraudulently induced confidence because it generates real confidence.


Fractional reserve banking is embezzlement and the accounting rules have changed to protect those engaged in fraud.  The intrinsic value of the financial companies mentioned is almost impossible to accurately determine, may be nothing and therefore should be avoided.  Asset values are rapidly evaporating and the credit quality of borrowers is quickly deteriorating which will lead to more banks failing.  On 20 March 2009 FDIC Chairwoman Sheila Bair said some very scary words, “Without additional revenue beyond the regular assessments, current projections indicate that the fund balance will approach zero.

The Great Credit Contraction grinds on and holders of capital continue migrating down the liquidity pyramid seeking the safest and most liquid assets.  Your electronic digits representing illusory currency are not safe in any of the fractional reserve banks and when the FDIC fails there will more pandemonium.  With the FDIC begging to increase its line of credit from the Treasury from $30B to $500B the likely cure, whatever it may be, will inflict another laceration on the already mortally wounded FRN$ and further destroy wealth and hobble the economy.

During these relatively calm times for your businesses and daily transactions I recommend developing an alternative plan, and eventual substitute, to the current monetary system.  For reducing your risk and keeping your capital safe there are three main options:  (1) using gold and silver coins, (2) using the services of a full reserve institution, like GoldMoney, or (3) withdrawing the Federal Reserve Notes, putting them under the mattress and using cash as much as possible.

Disclosures:  Long physical gold and silver with no position in GS, JPM, BAC, C, CCB

The Market Demand for Government Investment

In my previous article on the bloated private sector, I failed to adequately explain my main point.

For the past 3 decades faith in the free market powers of the private sector have led to a massive misallocation of resources away from public sector investment. A careful reading of price signals reveal a severe under investment in public goods relative to private sector goods. I would further argue that the unstable bubbly nature of financial markets is the result of excessive capital being allocated to the narrow range of goods and services in which the market works well.

The following contrasting sets of investments opportunities demonstrate how the private sector has become bloated while the public sector has been starved of necessary resources.

Public Education vs. Information Technology

The development and rapid proliferation technologies such as the internet, cell phones and other communication tools has brought undeniable benefits. But is the market calling for more resources to be dedicated to these industries. Not really. Over the past couple of decades, the price of computing power and communication technologies has been in nearly continuous free fall. New innovations quickly become commodities while many of the best and most popular innovations from Youtube to Facebook have failed to find a revenue stream.

If some of the investment in IT has been misplaced, what would be a better use of the bright mathematically inclined minds. Over the long run, human capital is the limiting factor in innovation and growth. The wage differential between educated and uneducated workers is a clear price signal indicating demand for education. Yet we have ignored this rapidly rising price signal by failing to provide adequate support to schools at all levels. The rapidly rising tuitions at public universities is another indicator of declining public support for education at precisely the time when this sort of investment is most needed.

Public Health vs. Processed food

Public health spending is one of the ultimate public goods as it benefits the society as a whole. There is no doubt that American’s spend a lot on healthcare, more per capita than any other country. Yet our health outcomes are hardly impressive. Investing a little more in creating an environment that promotes health could save far more in future healthcare and lost productivity due to preventable disease. From teaching basic nutrition principles to providing safe places for people to be physically active to preventing outbreaks of food borne illnesses our public health efforts have been pathetic due to a lack of commitment.

While, we have barely attempted to create a healthy environment, the food industry has had no trouble bringing new food like substances to market. Given this failure it is not surprising that today’s young people may be the first generation in American history that fails to outlive their parents.

Urban Infrastructure vs. Suburban housing

The housing collapse of the last couple of years makes the misallocation of resources in the housing sector abundantly clear. Yet the market has been sending out the same signals for years. Developers always justified suburban car based residential development as providing what the market. Yet a simple look at price data tells a different story. Real estate prices in walkable urban areas have consistently been far higher than in suburban car oriented areas. In the current crises real estate markets in places like Manhattan, DC and San Francisco have held up far better than the rest of the country.

Yet it would be impossible for private developers to recreate high quality urban environments. These places require significant investment in transit, law enforcement, parks and other amenities that require government support. Without public investment private developers could only create a limited range of housing options. Hence the appreciation of urban real estate prices relative to suburban areas.

The market is incapable of providing the full range of investments needed to maintain a healthy growing society. If we come out of the current economic crises with a more balanced distribution between public and private investment we will be in a better position to maintain long term growth.