The Big Banks: A Sucker's Rally

Are the big banks really coming back? Are the bank stocks coming back? Can the Geithner and Bernanke plans and actions save the shareholders of the large banks.
No. No. No. Meredith Whitney, great diva of banking, said so this morning. I agree - and my agreement began in October of 2007 when I met Ms. Whitney on a TV set and she blew me away. My take is almost as dour as hers so read this and then check her appearance on CNBC this morning (Squawk Box).

There are probably less than 20 banks that are insolvency or getting close - unfortunately, they hold the vast majority, 85% plus, of deposits in the US. Their lending is shrinking, which means their ability to generate margins and profits is shrinking and they cannot, anywhere in the short term, "earn" their way out of the current situation. For example, they continue to cut back credit card lines and these will be half their former size by year's end, down more than $2 trillion dollars.

Two years ago many of these banks - new entrants into certain markets after the repeal of Glass Steagall in 1999 - were leveraged more than thirty to one - in Europe, up to 50 to one - and they are now retreating to a 10 to one or 12 to one ratio. Then you have write downs - massive write downs in the past 18 months, massive write downs to come. These write downs are moving from mortgages to credit cards - check out American Express' numbers - to commercial real estate and loans - and then they will move again to the next wave of mortgages.

The solution, so far, is public capital. Geithner wants private capital to flow into the banks. He is not going to get it until toxic assets are wiped off their books or their real value is made perfectly transparent. Very loud pundits with political axes to grind but no integrity about numbers or the truth scream this is only a temporary situation, the assets are perfectly fine. Sure, right. Mortgages continue to default more than banks anticipate; ditto for credit cards; ditto for commercial loans; ditto for private equity loans. Don't be surprised if more than 60% of option ARMS default or if credit card default rates top 10%. That is a lot of bad debt still to come.
If this happens the banks that are in reality insolvent will now be seen as insolvent - so they will delay this as long a possible. Eventually toxic assets will be written down and sold in some form and transparency provided to investors. Then assets will be sold to re-capitalize the banks. And when all this happens current shareholders will get creamed.

Whoa. What about the Fed and Treasury actions? It all starts with housing - prices will fall throughout the year, putting more and more homeowners under water and more and more homes into foreclosure, putting more pressure on prices. And you cannot fix housing - we don't have enough money or political support and the new program is a palliative for constituents.

Whoa? What about the new TALF? Everyone always forgets that by statute the Fed can only buy triple AAA rated assets and even when it fudges on this issue it does not fudge much. So it cannot buy toxic assets and can only buy some new assets based on debt that can be sold anyway. And, perversely, the TALF program creates a two tier bond market - Fed backed and non Fed backed - and will widen credit spreads for debt other than what the Fed buys.

Whoa? What about Obama hinting he will ask Congress for more bailout money to stabilize the banks if needed? Let's say he gets it - do you think Congress and Obama will protect current shareholders after AIG, and the other deaf management groups at all the banks have absolutely hacked off Congress and the vast majority of Americans. We live in a democracy - with all its warts and wrinkles - and people are not going to let Congress do another TARP - or do it without incredible strings. And one of those strings will be "wipe out common equity."

Just look at four big banks. Citi is such a mess it is almost funny, with a $1.2 trillion in off balance sheet assets and a management group behaving like a traffic cop on valium; BOA still does not know what it bought when it bought Merrill Lynch; WFC bought more than $60 billion in option ARMs it holds and is writing down as they are impaired; JPM is doing the same with the $50 billion plus in option ARMs it got with the purchase of WAMU. Over time, Citi will be broken up; BOA will sell Merrill or at least what is left of it; WFC will do the same with Wachovia Securities; JPM has the least amount of asset shedding in its future but times will still be difficult. So avoid the big banks until they stabilize - then, when you see a trading top, feel free to short them. C, BOA, WFC, JPM.

For purposes of full disclosure, most of my assets are with Citigroup and I bank in the private banking program at BOA. Oh, I just got kicked out of that program because I will not deposit $250,000 in assets with a Merrill Lynch broker. Do you want to call a commission based program for insight into when to re-finance? If you do, he or she will send you to an 800 number. I will be moving my account. And my Citi broker left with his entire group (eight brokers) to Wachovia Securities. I asked him where he will go when that unit is slid next year. He did not laugh.