Thursday, 28 October 2010 11:18

Reggie Middleton with Max Keiser on the Keiser Report Discussing Banks, Fraudclosure and Derivative Exposure

Reggie Middleton with Max Keiser on the Keiser Report and RTT Television

Go to 12:20 in the video to see the portion with Reggie Middleton

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The topics in this interview stem from the post Four Facts That BANG JP Morgan That You Just Won’t Hear From The Sell Side!!!

On the difference between accounting earnings and economic earnings...

... accountants have not been – and currently are not, trained in the economic realities of corporate valuation. They are trained to tabulate business operations data. There is a marked and distinct difference. That difference is as stark as night and day for investors, yet despite this stark difference, Wall Street still reports corporate performance metrics strictly in accounting terms, and the media (both mainstream and the more specialized financial media) simply follow suit. Hence we hear much about easily manipulable and manageable accounting earnings, revenues, operating margins, earnings per share, etc. These measures are highly flawed in a variety of ways, with the primary flaw being that they do not account for the efforts both required and undertaken to achieve them. Basically, they measure JUST HALF (and coincidentally, the positive half may I add) of the risk/reward equation that should be at the root of every investors move. Long story short, they do not account for, nor do they EVEN RESPECT, the cost of capital. This concept ties in closely with Chairman Bernanke’s current course of action as well as the ZIRP discussion later on this missive demonstrates (capital offered at zero cost causes reckless abandonment of risk management principles which eventually causes crashes – yes, more crashes). Acknowledgment of the cost of capital enforces a certain discipline on both corporate management and investors/traders. Without respect for such, it is much too easy to create and portray a scenario that is all too rosy, since we are only looking at rewards but never bother to glance at the risks taken to achieve said rewards. I reviewed this concept in detail as it relates to bonuses and compensation on Wall Street in The Solution to the Goldman (and by Extension, the Securities Industry) Compensation Dilemma.

Net revenues, net profits, and earnings per share are totally oblivious to what took to generate them. As a result, anyone who adheres solely to these metrics is probably oblivious as well to what it takes to generate these measures. It’s really simple, put more money into the machine to get more money out – damn the risks taken, or the cost of the monies used. This has been the bane of Wall Street for well over a decade, is the direct and sole reason for this current crisis, and is the reason why bonuses based upon revenue generation alone engender systemic risk. Just sell more, do more, to get a bigger bonus. It doesn’t matter what you sell or who you sell it to, as long as it blows up AFTER the bonus is paid. This short term-ism is now so deeply ingrained within the investor psyche as to allow companies’ to rampantly destroy economic shareholder value with the abject blessing of the shareholders, with cheer leading by the analysts – as long as those accounting earnings per share keep rolling in higher and higher!

Ignoring the cost of capital inflates returns by default, because those returns were never costed in the first place. The problem is, ignoring something does not make it go away. Capital does have a cost whether you acknowledge it or not, and if you ignore that cost you may skate for awhile but eventually it will come back to reassert itself, and often with a vengeance towards the wayward investor. On that note, here is JPM’s return on average equity – and here’s JPM’s return on average equity less the cost of said equity. It’s negative, very, very negative!!!

On Zero Interest Rates (ZIRP) and How It Is Literally Starving JP Morgan

Even as the Fed tries to reduce the cost of debt capital to damn near zero, bad things are still happening to those this exercise was meant to save. Why??? Because the responsible world wants capital to have a cost, for if it does, it enforces discipline upon those who use it – whether they acknowledge that cost or not (here’s to you Wall Street).

In regards to JP Morgan and despite zero interest rate policy (ZIRP), fed funds as a proportion of interest bearing assets have increased due to lower risk appetite. The proportion of fed funds to interest bearing assets have increased to 12% as of end September 2010 from 7.7% as of end March 2009 while proportion of loans have declined to 35.8% from 38.9% in the corresponding period. Lower interest rates together with a higher proportion of lower interest bearing assets have taken a toll on banks spreads and net interest margin.


ZIRP, low demand, plus the slow investment banking environment is what forced a disgorging of reserves and provisions by management. In a catch 22, ZIRP is not so slowly starving the patient it was intended to save. This is analogous to the use of chemotherapy in treating cancer. The treatment needs to eradicate the disease in a confined period of time or the patience is at risk at succumbing to the treatment, itself.

On JP Morgan's Foreclosure Pipeline: Not Only Is It Packed Tight, It Is Progressively Getting Much Worse As The Time To Foreclosure Extends AND the Delinquency Rate Continues to Climb At The Same Time That Real Economic Housing Sales Value Is At An All Time Low As Well – and Getting Worse!!!

Future Losses Are Mounting at an Incredible Pace Yet JPM is reducing provisions due to improving credit metrics. See JP Morgan’s 3rd Quarter Earnigns Analysis and a Chronological Reminder of Just How Wrong Brand Name Banks, Analysts, CEOs & Pundits Can Be When They Say XYZ Bank Can Never Go Out of Business!!! and JP Morgan’s Analysts Agree with BoomBustBlog Research on the State of JPM (a Year Too Late) but Contradict CEO Jamie Dimon’s Conference Call Statements

JP Morgan’s average delinquency at foreclosure is 448 days (with Florida and New York having a record 678 days and 792 days of delinquency at foreclosure). Average delinquency for the industry is about 478 days and is increasing consistently since the start of the crisis.  During 2009 the average days from delinquent to foreclosure process was 223 days while as of August 2010 average days from delinquent to foreclosure process is 478 days. A very important, yet often under appreciated fact is that although serious delinquencies are still climbing, the lengthening of foreclosure process has resulted in these loans still being classified as delinquent. The difference between delinquency rates and foreclosure rates has increased to 5.3% (9.8% delinquency rate vs 4.6% foreclosure rate) in August 2010 from 3.6% in March 2002 (5.1% delinquency rate vs 1.5% foreclosure rate). As the difference between delinquencies and foreclosure rates normalizes, and shadow inventory overhang moves to further depress real estate prices, real estate related write-downs could further balloon. So, you see, the marginal improvements in credit metrics that JP Morgan’s management has used to justify the releasing of provisions (which also just so happened to have padded a weak quarter of accounting earnings) is really kicking the can of reckoning down the road…

Add to this the difficulty in getting rid of the properties once they are foreclosed upon and you will find that the big banks such as JP Morgan (or after looking at these numbers, particularly JPM (although I suspect BAC and certain others are worse off) will become the nations largest distressed residential housing REITs!!!

Last modified on Thursday, 28 October 2010 11:32

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