The amount of credit risk that the banks have hiding in off-balance-sheet vehicles was a fairly big deal at the onset of the credit crisis. I haven’t seen much about it recently and assumed, mistakenly, that it had become a non-issue. Bloomberg has an article Thursday that suggests that isn’t the case at all.
David Reilly contends that the banks have a mountain of hidden assets that have to be accounted for sooner or later.
At the end of 2008, for example, off-balance-sheet assets at just the four biggest U.S. banks — Bank of America Corp., Citigroup Inc., JPMorgan Chase & Co. and Wells Fargo & Co. — were about $5.2 trillion, according to their 2008 annual filings.
Even if only a portion of those assets return to the banks - - as much as $1 trillion is one dark possibility — it would take up lending capacity the government is trying to free.
The hidden assets that may return to banks consist of mortgages, credit-card debts and auto loans, among others. Over the years, banks bundled them together and sold them to investors as securities.
Whether these assets are “troubled” or “toxic,” their return to bank balance sheets could slow efforts to get credit flowing again. After all, banks shed the loans to make their balance sheets look smaller, allowing them to hold less capital to act as a buffer against losses. Until a couple of years ago, that boosted profits.
According to Mr. Reilly, it is an open question at this time whether these assets must be brought back onto the banks balance sheets. The discussion regarding mark-to-market accounting also encompasses the accounting treatment of these vehicles. Since the thrust of the accounting changes as dictated by the Congress seems to be towards a system that papers over the current problems, the requirements to properly account for these assets will probably be watered down.
While the banks may be able to avoid consolidation, they cannot avoid the eventual necessity of recognizing the losses when they do occur. Based on the information in the article, there are probably some sizeable losses embedded in these portfolios. Some examples from Mr. Reilly include:
- $92 billion of credit card loans at Citigroup (C), $70 billion at JP Morgan (JPM), $114 billion at BofA (BAC).
- $355 billion of securitized commercial loans at Wells Fargo (WFC).
- $360 billion of securitized non-agency mortgage debt at BofA. Of that amount $58 billion are subprime loans and $138 billion Alt-A mortgage debt.
- BofA and Wells may have as much as $600 billion of assets that have to be consolidated.
What perplexes me is that we are still dealing with estimates, maybes and perhaps this will happen scenarios at this late date. Why? It’s a pretty universal principle that if you want to solve a problem, you first have to define it. If we don’t know at this late date the extent of the toxic assets for which the banks have to account how did the Treasury design a program that is reputed to be the solution?
The Fed and Treasury really do need to come clean about the extent of the problem. Their credibility is shrinking by the day. The Geithner Plan has received at best a lukewarm reception, probably because it is viewed as simply better than nothing. If the banks start replacing bad assets they sell to the public private partnerships with bad assets lurking in the shadows it is not going to sit well at all.