Tuesday, September 15, 2009

EC Investigates One of the Dutch Government's Deals With ING/Janet Yellin Speech/PPI & RETAIL SALES

1. Janet Yellin Fearful About Deflation and a Tepid Recovery: Yellin, President of the Federal Reserve Bank of San Francisco, made it clear yesterday that she would like to see an accommodative Fed policy for some time to come. She expects a "tepid" recovery "vulnerable to shocks." She expects a continuation of job losses at a "rapid" rate, and a long period for consumers to repair their balance sheets. President's Speech: The Outlook for Recovery in the U.S. Economy (09/14/2009). I have excerpted some of her comments and highlighted a few of her comments:

"I am hugely relieved that our financial system appears to have survived this near-death experience. And, as painful as this recession has been, I believe that we succeeded in avoiding the second Great Depression that seemed to be a real possibility....

But I regret to say that I expect the recovery to be tepid. What’s more, the gradual expansion gathering steam will remain vulnerable to shocks. The financial system has improved but is not yet back to normal. It still holds hazards that could derail a fragile recovery....

Moreover, the slack in the economy, demonstrated by high unemployment and low utilization of industrial capacity, threatens to push inflation lower at a time when it is already below the level that, in the view of most members of the Federal Open Market Committee (FOMC) best promotes the Fed’s dual mandate for full employment and price stability.....

I’m happy to report that the downturn has probably now run its course. This summer likely marked the end of the recession and the economy should expand in the second half of this year....

A sputtering financial system is not the only challenge before us. The chances are slim for a robust rebound in consumer spending, which represents around 70 percent of economic activity. Of course, consumers are getting a boost from the fiscal stimulus package. But this program is temporary. Over the long term, consumers face daunting issues of their own. In fact, it’s easy to draw a comparison between the financial state of households and that of financial institutions. For years prior to the recession, households went on a spending spree. This occurred during a period that economists call the “Great Moderation,” about two decades when recessions were infrequent and mild, and inflation was low and stable. Credit became ever easier to get and consumers took advantage of this to borrow and buy. Stock and home prices rose year after year, giving households additional wherewithal to keep spending. In this culture of consumption, the personal saving rate fell from around 10 percent in the mid-1980s to 1½ percent or lower in recent years. At the same time, households took on larger proportions of debt. From 1960 to the mid-1980s, debt represented a manageable 65 percent of disposable income. Since then, it has risen steadily, with a notable acceleration in the last economic expansion. By 2008, it had doubled to about 130 percent of income. (this part of Yellin's speech makes the same points that I have emphasized in a post written yesterday morning before her speech :Ariad Update on Ridaforolimus Trial/Mueller Water/Will the U.S. Be the Engine for Growth over the Next Decade?/Corporate Bonds Played Out?)

The slow recovery I expect means that it could still take several years to return to full employment. The same is true for capacity utilization in manufacturing. It will take a long time before these human and capital resources are put to full use. ...

My personal belief is that the more significant threat to price stability over the next several years stems from the disinflationary forces unleashed by the enormous slack in the economy..." (End of Excerpt of Yellin's Speech)

I thought that I would force feed part of her speech to my readers.

I am far more concerned about the long run inflationary impact of the large budget deficits, the fall of the U.S. dollar, and the Fed's quantitative easing than Yellin. Otherwise I agree with her remarks as they relate to the U.S. Possibly, economists may be overestimating the slack in real productive capacity (i.e. capacity that has not been permanently idled and mothballed), and the time it will take to reduce that slack. One factor that led me to add some ETFs containing industrial stocks is a belief that the recovery in the U.S. will be led by American industry, not by consumers, and part of the return of demand for industrial products made by U.S. firms has to do with the weakening of the dollar and the growth in emerging markets.

CPI for August is scheduled to be reported on Wednesday.

2. EC Investigation of the Dutch Government Aid to ING (own ING hybrids): In January, I mentioned that one of the aid packages provided to by the Dutch government to ING was the government's assumption of 80% of the risk of ING's 27.7 billion in Euros U.S. mortgage portfolio. ING news The deal valued the mortgage portfolio at 90% of its face value. This is separate and distinct from the 10 billion in Euros of Junior Securities bought by the Dutch government back in October. The EC is investigating whether the rescue package involving the mortgage guarantee was too generous in that it overvalued the mortgages. MarketWatch One analyst in the MarketWatch story noted that the transfer value could be lowered to 80% of face value which could have a negative impact of 1.7 billion Euros on ING's profit and reduce the Tier 1 ratio by .6%. As noted in the WSJ story, the mortgage loans were originated in the U.S. and consisted mostly of Alt-A loans. WSJ.com Those mortgages are owned by INGDIRECT, a U.S. based online bank, and ING Insurance Americas.

More information about this transaction involving mortgage securities with the Dutch government can be found at ING's web site: Transactions with Dutch State - ING . This is a link to the ING press release on the deal: ING update on results and measures to reduce risk and costs - ING

I view this development as a potential negative for the ING hybrids, though those securities are up in early trading today (possibly, that may have something to do with the offer made by KBC to acquire its hybrids at 70% of face value). My first thought was that the EC may want to cancel this deal or substantially revise it, which will cause a delay in ING's recovery and make a deferral more likely at some point for the ING hybrids (This transaction appears to have only an indirect and tenuous connection to competition in Europe since the ING entities compete in the U.S.) Since I view the burden sharing policy, squarely aimed at owners of subordinated debt, as having at best a tenuous connection to the EC concerns about state aid and competition, this is just another negative point to emphasize for U.S. investors considering an investment in European hybrids. It is just impossible for me to understand the reasoning of the EC. This recent development also reinforces the point that I have made recently that the ING hybrids are in more danger of deferral than the ones from Aegon due to ING being much deeper into Dutch government aid, the time table for paying it back and the consequent increased opportunities for the EC to cause harm to ING: More On Deferral Issues: Aegon & ING Hybrids-Investors are not Helpless before the All Powerful and Knowing EC

While I do not know the basis for how the Dutch government and ING valued those Alt-A mortgages, I did note back in January that some analysts viewed their current value as being 65 cents on the dollar. I suspect ING would argue that those securities were going to be held for the long term, and ultimately 90 cents on the dollar was a good prediction of their ultimate recovery value. While that could conceivably end up being reasonable, it may be difficult to convince anyone now that 90 cents was a reasonable estimate.

Another point is that our government provided all kinds of aid to our financial institutions including guarantees and purchases of junior securities. Some institutions like Citigroup received more than others. Citigroup received a guarantee on 306 billion of its assets in addition to the tens of billions invested by the government in preferred stock. Citigroup Bailout Yet, no one in a position to make policy has advanced an argument to my knowledge about how that state aid would distort competition in the U.S. And certainly no one in a position to make policy in the U.S. would argue that a guarantee connected with mortgages owned by a U.S. bank subsidiary in Europe and originated in Europe would impact competition among lending institutions in the U.S. "common market". Many would view such a contention as idiotic, silly in the extreme. My extremely negative view of the EC is increasing by the day.

3. Retail Sales & Producer Prices: The Census Bureau reported that August retail sales (seasonally adjusted) rose a greater than expected 2.7% but were still 5.3% below the level from August 2008. Excluding auto sales which surged 10.6%, retail sales still gained 1.1%: Monthly & Annual Retail Trade Economic Indicators.gov Producer prices rose a greater than expected 1.7%. Producer Price Index News Release text

4. EBAY (owned): PIPER JAFFRAY upgraded EBAY to overweight from underweight, and raised the price target from $19 to $30, based on its survey of increased consumer satisfaction and improved web traffic: Reuters Eric Savitz from Barron's wrote a negative article about EBAY when it was around $12: Item # 2 EBAY and Eric Savitz /Savitz on Ebay/ After my shares almost doubled to around $21, betting against Eric, I decided to allow my magic coin decide whether to sell or to hold. The flip was done in July and the coin said to hold the shares, so I still own them. (Last Sentence in Bought 50 OPXT as Lottery Ticket/ Digirad/EMC earnings/)


  1. Hi TennIndependent,

    I think the different approach between Europe and the US in this matter has to do with the not-so-united countries here vs. the united states over there. The EC has to try and avoid unfair competition between (banks of) different nationalities, who get aid from their own government. With your central FED you don't have that problem.

    As to the valuation of ING's Alt-A mortgages, it may be interesting to know that the Dutch Department of Finance hired Dynamic Credit to do so. This company was co-founded by Tonko Gast, who already warned about the housing bubble and an impending credit crisis in December 2007, so he knows what he's talking about. But I admit most reports about ING's deal with the state claim they got too much out of it.

    BTW, I found a nice article about this on SeekingAlpha (ING Delivers a Big Alt-A Surprise).

    PS: Nice to see your old geezer photo.

  2. DUTCHPERPLEX: Thanks for the link to the SeekingAlpha article. I would agree with the author that the EC is opening a Pandora's box of issues when it seeks to start re-valuing these toxic type assets. The Alt-A mortgages are held by ING North American subsidiaries. I can understand why a Dutch taxpayer would object to bailing out those subsidiaries but I do not see how it would impact competition in the European common market for financial services. INGDIRECT is a U.S. online bank after all. But, maybe the other toxic assets bought by the U.K. from RBS and Lloyds were owned by the parent banks, and that connection to the European common market would be more direct. It would also raise the spectre of discriminating against the British banks if the EC looked at them on this type of issue and then avoided doing the same for ING's deal.

    It is not too complimentary on ING's investment skills that it loaded up on these Alt-A U.S. mortgages to the tune of over 30 billion U.S. dollars in principal value. We call them liar loans in the U.S. You might want to read the transcript of this documentary to get the drift of how bad it was in the U.S.: http://www.msnbc.msn.com/id/29827248/