More and more real-world data and forecasts are conflicting with the “green shoots-surely things are getting better” story. One view comes from Institutional Risk Analytics’ Chris Whalen.
In his monthly Special Feature (pdf only, no online source), Whalen suggests that banks are far from out of the woods. Although he believes that damage will not be as bad as that of the 1930s, he generally concurs with the IMF’s observation, that US banks are only partway through recognizing their losses (the IMF believes US banks have taken only 60% of their total writeoffs, and European banks, a mere 40%). Whalen sees the crisis extending at least several more quarters, and possibly into 2011.
Whalen believes aggregate loan losses could hit 4%, twice the level of the savings and loan crisis, but short of the 5% level seen in the Great Depression. FDIC losses on failed bank resolutions are also running at much higher levels than in the 1980-1995 period (11% then versus nearly 25% now).
Some tidbits from this report:
To put the current crisis in perspective, consider the amount of debt incurred in the form of bonds issued to fund the savings and loan crisis of the 1980s are still being paid off. Given the far larger cost of cleaning up the current crisis, a similar amortization of debt could stretch well into the second half of the 22nd century….
Recent statements by Timothy Geithner and other finance chiefs have emphasize the need for more bank capital, expecting that his will make the financial system more viable. Yet, missing from the discussion is any meaningful acknowledgment that 1) it was the activities of banks, not their capital levels, that caused the financial crisis; 2) that larger banks as a group do not have the earnings power to support higher equity capital levels, at least capital provided by private investors; and 3) that large banks are well behind the rest of the industry, in terms of capital, especially when assets are truly market to market and off-balance sheet exposures are consolidated.
Item 2) on Whalen’s list has extremely serious implications. It means that the current approach to dealing with the financial crisis is inherently flawed. Banks are unlikely to be able to secure enough capital on private terms, or if they manage to (say by retaining earnings) their stock prices will be under pressure and bank management will be under pressure to increase returns. That will lead to a combination of getting into riskier activities and “freeing up capital” which is a fancy way of saying use even more off balance sheet vehicles.
Thus the pressures will be to institute an even more extreme version of the pre-crash paradigm. The other option, of turning banks into utilities and letting them offer simple products but also allowing them to earn a decent regulated return is simply inconceivable to the powers that be, and of course unacceptable to the industry. But that would be a far better course of action than the type of dysfunctional behavior we are likely to see to finesse the dilemma Whalen set forth.
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If the Europeans were creating new debt-money as fast as Bennie the Bomber, their banks would be at 60 percent as well.
This is all a sham.
The message I get is that the present plans for fixing the financial system are ineffective. We thus await the reversal of the bankshare charade.
Turning banks into utilities?
Turning banks back to banking, with real money.
This was the solution that Irving Fisher put forward after identifying the disastrous effects of debt-deflation.
Full-reserve banking.
Commercial and Investment.
Deposit and Savings.
Banks do banking.
The New Chicago Plan for Monetary Reform.
The Money System Common.
Whalen (I assume it’s him but the posts are never signed) has put up a solid piece at IRA with interesting details on how dire the situation is for the money center banks regarding securitization.
==quote==
The thing that many people still don’t understand about securitizations is that it was not just overtly profitable for the sponsors. There also was a hidden profit in many deals that were not disclosed, a profit that is now become a liability.
==end quote===
If I understand correctly (that’s a big if), he believes they’re fucked regardless of whether or not they wiggle out of FASB changes for off balance sheet entities; the difference seems to amount to how much money will go to lawyers.
I’ve just started Reinhart & Rogoff’s latest, but maybe I’d be better off to re-read Carl Zimmer’s excellent Parasite Rex to really get a handle on things.
PS I’m not seeing a “preview comment” option recently, and I miss that feature.
Point 2 in Whalen’s piece is a critical element toward explaining the fallacy of the bailouts.
What we are experiencing is the realization that our fiat currency has absolutely failed. A legitimate currency is all of: a medium of exchange; a unit of account and a store of value. For value think purchasing power. What our currency has not done over a period of nearly seventy years is to fulfill the function of being a store of value.
A dollar today buys more than a dollar tomorrow will buy. Of an by itself, that is a powerful inducement toward consumption.
The resolution, done quickly or slowly, is the same. Extinguish the debt that cannot be serviced. If that triggers bankruptcy, sell the solvent parts of the bank to NEW ownership and begin to address the core problem, the fiat currency. Big depression, probably so. Civil unrest, probably so. Could we lose the republic, we may have already lost it!
I read Whalen’s missive titled “BAC: How much should bond holders be haircut to restore solvency” last night.
In this missive, in which he disses the Lewis’ BAC corp culture as a Lewis crammed down “mediocrity” he states “the departure of Ken Lewis as CEO is probably the best news for BAC equity and bond holders in many years… , a culture where competent managers where systematically forced out by the human resources department of BAC… [the] HR department ruthlessly squeezed down personnel costs. These are “process” people, after all, who believe that you can identify tasks that can be done by one person, then train that person and pay him/her well below average. This is what they call “synergies” at BAC. This goal of short-term cost cutting pervades BAC and has led to an organization that produces narrowly focused employees and business units, with no incentive to innovate or manage risk…And the same penny-wise mentality has now stripped most of the value — that is, highly skilled, experienced people — out of Countrywide and Merrill Lynch. ”
Lewis made his purchases of ML and CFC before going through FDIC resolution. By buying these companies before having been restructured through the FDIC “they face the daunting task of cleaning up the mess left by the troubled acquistions” says Whalen.
“In the case of BAC, we hear that this includes buying defaulted mortgage paper at par from the various securitization vehicles sponsored by BAC directly or acquired from Countrywide and/or Merrill Lynch. The latter, in case you’ve forgotten, was the biggest CDO sponsor on Wall Street. This one reason we told our friends at Fast Money that we believe BAC is next in line behind Citigroup in terms of financial problems and could be back in the arms of the US government by the middle of 2010.”
The reason I went to all the effort to requote excerpts from Whalen’s missive is because of a Bloomberg article this morning putting a positive spin on BAC’s acquisition of Merrill that was titeld “Merrill Bringing Down Lewis Gives Bank 30% Profits.”
The lead sentence to Bloomberg’s rosy outlook for BAC is “Merrill Lynch which helped bring down Ken Lewis may end up savign his bank.” The article goes on to say that MER is “generating more than 25% of the banks profits…
Merrill’s businesses contributed $1.8 billion to Bank of America’s first-half net profit of $7.5 billion, or 28 percent, even after the bank posted $27 billion in loan charge-offs and higher loan-loss reserves, according to company filings.”
The maligned and discredited Richard Bove said regarding BAC’s purchase of MER: “This merger made sense from just about every angle one could look at,” Richard Bove. In hindsight this deal was a steal because it now appears that the bank can pay for Merrill’s price with one year’s worth of Merrill revenues.”
The juxtaposition of Whalen, a long term reputable and outstanding Bank Analyst against biased company filings from BAC to put Ken Lewis in a positive light, well who you gonna believe. I have pointed out elsewhere time and again, we could not trust anything that came out of BAC spokesman Robert Stickler, so why should market participants trust company filings that would appear to have the clear aim of boosting Ken Lewis’ profile as he faces almost certain indictment from AG Anthony Cuomo.
Whalen goes on to say :”Securitization was once a hidden cash cow, but now that the situation is reversed. Collateral values have fallen dramatically and will fall further in the next 12-18 months, thus banks such as BAC, WFC and C must take that hidden windfall profit out of their pockets and essentially reverse the original transaction – and then some. Otherwise they get sued.” Apparently, says Whalen, “by the early part of this decade, the practice of under-collateralization of securitizations became a pervasive problem for any organization that had scale” particularly among “institutions for whom cheating was the business model, including CFC, C and LEH.” No mention of MER undercollateralized cheating was made, to MER’s credit, but that does not mean it did not happen.
Back to Whalen: “So now you know why we remain so bearish on BAC, WFC, C and other aggressive sponsors of the trillions of dollars in securitizations originated over the past decade. And the sad part is that for retail investors, there is still virtually no disclosure by these banks describing this specific risk factor. That is why many Sell Side firms are still able to post “Buy” recommendations on BAC and its peers, because they can point to the paltry public disclosure filed with the SEC and say: “Gee, we didn’t know.” But you can bet that just about every Sell Side analysts who follows money center banks for a living knows precisely those hidden risk factors of which we speak.
And now too you understand why the banking industry and even federal bank regulators have been making noises about delaying the change in the FASB rules regarding OBS vehicles like QSPE1 in our hypothetical example above. But as we explained to subscribers to The IRA Advisory Service last week, whether the FASB changes the rules or not will be irrelevant to the economic and true legal reality facing the large issuers of securitization. We’ll be digging into the details of BAC’s OBS black hole in the IRA Advisory Service in coming weeks.
Whalen closes out the piece by stating “If you assume, as we do, that the equity of BAC is a zero, where should bond holders be haircut in order to recapitalize the bank without further financial support from the US taxpayer? We’ll start the bidding at 70 cents on the dollar.”
Personally, I am not an expert in the financial sector, Whalen is, so I can’t comment on what the junk bonds or equity is worth over there, but I do know this, Whalen has proven himself to be one of the best damn watchdogs we got in that sector.
Remember the part Whalen mentioned about the sell-side firms buy recommendations on BAC, “they can point to the paltry public disclosure filed with the SEC and say: “Gee, we didn’t know.” In short, Whalen is discounting the material disclosure docs by BAC made to the SEC. I would suggest too, that no one rely too heavily on BAC’s SEC disclosures for their investment decisions.
Sources: http://us1.institutionalriskanalytics.com/pub/IRAstory.asp?tag=385
http://www.bloomberg.com/apps/news?pid=20601109&sid=a5LQNbYX8dQ4
The IMF’s assertion about bank write offs seems meaningless to me. Mark to fantasy, writing down liabilities, bank books nowadays are what people used to be sent to jail for. So in an environment where the concept of fraud no longer exists, what does it mean to write off some losses while lying about many others?