25 to 1 Is Reduced Leverage?

The Stress Test used a leverage ratio of 25:1 when determining the ability of a Bank to withstand bad economic times. That 25:1 ratio only takes into consideration the assets that the banks on “on the books” and does not consider the toxic assets the hold “off the books” (SIVs and other Enron-like accounting tricks).

The rule before 2004 was that banks needed to have a maximum ratio of leverage at 12:1.

The Fed wants the banks to “earn their way out” of the overhang of their toxic assets. There are only three ways to do this – economic expansion, inflation and steepening the Yield Curve (make short term rates low versus long term rates). The Stress Test only looks out two years, so if there is weak growth, then the banks will be forced to beg for new Capital.

The bottom line is that banks still have no capital and can’t lend. All the Geithner new speak has done for banks is buy them time in the graveyard before they get buried. Geithner knew that he could not go back to Congress to get enough new money (via TARP 2.0) to recapitalize the banks and he knew he could not generate enough political capital to Nationalize the insolvent banks. So he punted and chose Government-assisted inflationary growth over short-term economic hardship and future growth.

While banks take a number of years to slowly write off their bad debt, the creator of credit and lending will be Uncle Sam. How fast do you think the economy will grow with the Government making decisions about how to deploy a scare asset like Risk Capital?

The bankers won (does that surprise anybody with all of the money they threw at the politicians). That will mean if they turn things around, then the banks win big and if they fail, then the Taxpayer will lose again (TARP 2.0). Maybe that installs a Put Option on Bank Debt. I will have to think about that one…

Increase Aggregate Demand
The words of Bernanke echo in my mind. The words mean use Inflation to drive up the nominal numbers like Income, Consumption, Spending and Savings, while understanding that Real Income, Savings and Spending will at best stagnate or worse.

That leads me to Commodities, Commodity-Based Economies and Currencies, Metals and Foreign Currencies. But again, from a risk management standpoint, I have to wait before I enter these areas with new money – Impatiently Patient. I would rather buy a little higher and avoid a 1 or 2-day 7% pullback than buy now and hope things don’t pull back on Monday. I am note sure what other sectors actually get strong enough economic growth to justify owning them…

Again, look for the Fed to increase their allocation for US Treasury purchases in the very near term. That should help Gold and The Euro.