Despite a full year of being in detox, the U.S. banking system is still lurching around in a hospital gown.
What is working, and what is not, and how will the incoming Administration deal with one of the worst economic crises to hit the world's largest superpower since the Great Depression?
The markets need to clear, and clear out now, the bad assets acting like an anvil on bank balance sheets across the country, in order to stop this financial crisis--if we continue to prolong it with ad hoc government bailouts, we will soon look like our Pacific neighbor, Japan.
Forced mergers, forced shotgun weddings, forced liquidations, all must be on the table. Because all of the central bank's liquidity and all of the Treasury's bank capital injections can't cure a bad bank asset.
"If Treasury gives a bank capital and the value of troubled assets keeps falling, it's like throwing money down a hole--eventually the bank is going to need another capital injection," says Michelle Girard, top economist at RBS Securities.
[caption id="attachment_494" align="alignleft" width="300" caption="Merrill Lynch's John Thain"][/caption]
Bank executives wasted all of last year defending the status quo. From Bear Stearns' Alan Schwartz to Washington Mutual's Kerry Killinger to Lehman Bros.' Richard Fuld to Merrill Lynch's John Thain, all covered up with a multitude of spins the severe troubles on their books, leaving it to the press and to analysts to do that painspotting for the government. All of them are now gone from their companies.
And the government's plans have careened so badly from pillar to post, you have to put a GPS system on the thought processes down in Washington, D.C. to keep track of what is going on.
Because following the government's constant changes to its bailout plan is like trying to follow a mosquito in a tornado.
The latest idea: Now there is talk of a massive, US mega-bad bank, an outsized trash compactor, a gigantic dumpster much like the one Sweden launched in the early ‘90s to take on its country's bad bank assets--which means we could be taxed like Sweden to pay for this entity.
A US Mega-Bad Bank that could get, say, $100 bn in TARP money, where it would then, ironically, lever that $100 bn up to $600 bn, with debt backed with FDIC guarantees, to start buying and taking off bank balance sheets $2.4 tn worth of rotting loans and securities issued for pie-in-the-sky projects like empty strip malls, condos and townhouses on swamplands.
Motion sickness? Me too.
Meanwhile, the Bernie Madoff Ponzi scandal is tying up the FBI's efforts to catch the throng of scamsters engaging in white collar street crime, mortgage frauds, as well as other Ponzi scams and crooked hedge funds.
Because, sure enough, the SEC, it being an agency not populated with market cops but market crossing guards, doesn't flush out frauds as they occur, neither do auditors--recessions do.
Where Are We Now?
Despite the fact that the US government is now providing insurance on $428 bn in bad assets from Bear Stearns, AIG, Citigroup, and Bank of America, despite the Federal Reserve morphing into the world's largest
[caption id="attachment_495" align="alignright" width="216" caption="Federal Reserve Bank Chairman Ben Bernanke"][/caption]
junk investor as it has taken on $75 bn in bad assets from Bear and AIG, with more coming from Citigroup and Bank of America, despite the Fed nearly tripling its balance sheet, the economy still faces an estimated $2.4 tn in bad bank assets, now ticking time bombs.
The top four banks hold $1.4 tn in bad assets, out of a total of $2.4 tn of potential rotten eggs for the entire bank sector.
Because of these stinkers, some $2 tn in market value in the S&P financial sector has been lost since May of 2007, with Citigroup losing 10 times as much, analysts' estimates show.
The Worst Two of All?
In the last week of trading, Bank of America has lost more in market cap than the $24 bn it spent buying Merrill Lynch itself. The $45 bn BofA got in government capital injections is now nearly twice its $25 bn market cap.
The government has had to invest twice in both Citigroup and Bank of America, as the two represent 40% of the assets in the sector, and are the two most levered up banks, from a tangible common equity perspective, says Goldman Sachs.
Citigroup, the world's biggest financial supermarket, has hung its fire sale shingle on about a third of its balance sheet, $600 bn, selling anything not screwed to the walls. With a gun to its head, Citi sold Smith Barney, the only one of its main units to post a profit in the third quarter.
BofA is tenuously capitalized, says Friedman Billings Ramsey, going into 2009 with just $61.7 bn of pro forma tangible common equity supporting a colossal $2.4 tn of tangible assets.
Back to the Future
So it's back to the future time, a revival of TARP 1.0, a United States Mega Bad Bank, is now under serious debate in Washington, to take on this Kryptonite. That would be a return to the initial incarnation of TARP, which would have held a Dutch auction for these assets.
The breakup of Citigroup could be a harbinger of what is to come.
As Fox Business first reported starting in November, Citigroup has split into Citicorp and Citi Holdings, with Citicorp a return to its roots as a deposit taking bank, and Citi Holdings housing its bad assets.
With this move, Citi may be positioning itself to unload a huge slug of the $895 bn in bad assets at Citi Holdings onto the US Mega Bad Bank.
Who Will Oversee the US Mega Bad Bank?
[caption id="attachment_496" align="alignleft" width="189" caption="Treasury Secretary-designate Timothy Geithner"][/caption]
Be mindful that the TARP program will be overseen by incoming Treasury Secretary Timothy Geithner, also the incoming boss of the IRS, who didn't pay about $34,000 in self-employment taxes, who only paid his 2001 and 2002 self-employment taxes in November 2008 when he was tapped as nominee, and who wrongfully deducted as dependent care costs on his personal tax returns summer camp fees for his children.
Geithner is a former New York Federal Reserve official who oversaw the Bear Stearns bailout, the government's Emily Litella moment, who is criticized for not doing enough in the interim to stop another primary dealer, Lehman Bros., from collapsing, who lives by his own tax rules as he makes up the bank bailout rules as he goes along.
An official who, with incoming Obama economic advisor Larry Summers--a self-made man who worships his own creator--will now oversee the rescue of the world's biggest banking system.
Market Impact of the Mega Bad Bank
Would a mega trash compactor trigger a bank stampede, would banks then dump assets en masse onto the US taxpayer, and would doing so in turn potentially create fresh new values for this landfill, or marks, and thus more writedowns?
Would the US government then be forced to suspend mark-to-market accounting, a flawed bookkeeping methodology which even Enron used to inflate its profits, a methodology which has created colossal bank writedowns as it has forced banks to write down these assets as if they were selling them today in an iced-over market, even though many are not selling them?
The Problems with TARP
The TARP capital injections, in the form of stock purchases in troubled banks, have acted as blood thinner to existing shareholders, as the banks have had to issue more shares, diluting existing investors, explains economist Ed Yardeni.
There are more problems with the TAR-PIT.
The Treasury said it would give money only to healthy banks to jump-start lending. But at least two-thirds
of the 314 banks who got TARP money were already in violation of federal regulatory guidelines for lending because they blew out their construction, development and commercial real estate loans, says bank analyst Richard Suttmeier.
However, Suttmeier says that OneUnited's commercial real estate loan exposure is 2,005 times federal regulatory guidelines for capital requirements. Two thousand and five times.
"The regulatory guideline is no more than 300% [of capital], and this ratio is the worst among all [of the] 8,384 FDIC insured financial institutions," Suttmeier says, adding that "a bank in Alpharetta, Georgia had a heavier concentration, but [it has] already been seized by the FDIC."
World's Biggest Junk Investor: The Federal Reserve
Meanwhile, the central bank's balance sheet has surpassed $2 tn, triple what it was a year and a half ago.
The Fed has taken on a mountain of potentially bad paper assets that, stacked, could reach to outerspace.
Among other things, the Fed $73 bn in assets from Bear Stearns and American International Group, warehousing them in off balance sheet vehicles much like Citigroup did and valuing them with the help of the credit rating agencies, who helped get us into this mess by rubberstamping as triple A all sorts of junk.
The Fed also has given massive guarantees of almost $300 bn to Citigroup and Bank of America.
What of all this monetary intervention? The Fed is now blowing out its balance sheet to fix a bursting credit bubble that the Fed helped create by keeping interest rates down too long. Inflation will be coming in the next five years.
Remember this quote: Business expansions never die of old age--they are routinely murdered by the Federal Reserve.
Why Aren't Banks Lending?
Banks who have received $350 bn in TARP money are under attack for not lending enough money, notes economist Yardeni.
But actually, the banks are lending. However, they are lending almost exclusively to the Fed, Yardeni notes-or they are lending to panicked companies who are drawing down on existing credit lines. Yardeni says:
*As of January 14, depository institutions had $827.5 bn on deposit at the Federal Reserve Banks. That's up $795.4bn since September 10, the week just before Lehman died. It is up $555.6bn since October 14, when the banks started to receive TARP money.
*On January 7, commercial banks had a record $1.1 tn in vault cash, cash items in process of collection, balances due from depository institutions, and balances due from Federal Reserve Banks.
*Since October 14, when TARP funds were first given as capital to nine major banks by the US Treasury, through January 7, cash held by banks rose $524.3bn, while loans and leases fell $148bn.
So, why aren't they lending it? Would you want to lend money in a deepening recession, and who do you trust now to pay those loans back, says Yardeni.
All at a time when the banks have to roll over their own debt and pay interest on those liabilities, and when corporate borrowers are demanding cash to rollover their bonds, says Yardeni.
And when new accounting rules take effect later this year, banks will be force to put back onto their balance sheets hundreds of billions of dollars in assets and liabilities now warehoused in off balance sheet vehicles.
We are in a new year, 2009-can we expect more of the same that we saw in 2008?
The answer, unfortunately, is yes.