Big Banks: Pulling Off the Ultimate Bait and Switch

We’re not quite as healthy as we thought we were. Oops. (WSJ)

J.P. Morgan Chase Chief Executive James Dimon said…that March was a little tougher than the first two months of the year….Bank of America…CEO Kenneth Lewis also said that March had been a tougher month for his bank.

Convenient that they decided to dump this information on Friday afternoon, and at the close of a very good week.

Readers may recall that a few weeks ago, those two CEOs—along with Citi’s (C) Vikram Pandit—said the first two months of the year had been very good:

Pandit, March 10th: “We are profitable through the first two months of 2009 and are having our best quarter-to-date performance since the third quarter of 2007.”

Dimon, March 11th: “Jamie Dimon, the chief executive of JPMorgan Chase, said Wednesday that the bank was profitable in January and February…”

Lewis, March 12th: “We have been profitable for the first two months of the year,” Lewis told reporters after a speech in Boston today.

This was possibly the most nakedly self-serving bullshit the big bank CEOs have offered to date. (”bullshit” being a technical term of course, see Harry Frankfurt.)

By February, it was understood that the big banks are all insolvent, certainly Citi and BofA (BAC). To deal with them, consensus among the cognoscenti was finally tending to a proper recapitalization: wiping out shareholders and forcing losses onto creditors via debt-for-equity swaps. Call it nationalization, call it pre-privatization, call it FDIC receivership, it was clear that losses had to be recognized and by those to whom they properly belong: investors across the banks’ capital structure.

But no one really wanted to do this, not in Congress and certainly not in the Obama administration, where Timmy Geithner has made it clear that his priority isn’t a cleansed banking sector, it’s a privately-owned one. For obvious reasons the banks don’t like this solution either. So they offered up their self-serving b.s. regarding January and February, buying just enough time for Congress/Bernanke to badger FASB into changing mark-to-market rules and for Geithner to roll out his private-public partnership plan.

Now whatever losses the banks can’t hide with revised accounting treatments, they can simply fob off on taxpayers via the partnerships. They got what they always wanted: A bad bank! An entity that will actually absorb losses from the asset side of the balance sheet! Shareholders and creditors don’t have to worry about further writedowns, not the ones that can’t be hidden anyway. Taxpayers will pick up the check!

Even better, the Geithner plan is so ridiculously complex—and public disclosure is likely to be so minimal—that toxic asset transfers are likely to happen largely out of view. Maybe Treasury will have to increase its borrowing substantially in order to fund the losses, but by that point everyone will be celebrating that banks have started lending again. Hooray!

By the way, are there ANY substantial protections to prevent banks from gaming this plan? What’s to stop them from acting as the equity investors in the partnerships, ponying up a sliver of equity to effect a transfer of toxic assets from their own balance sheets to the public’s? The FDIC’s FAQ for the legacy loans program doesn’t even address this particular Q. Is it not being frequently asked?*

This is all of a piece. The longer CEO/policy-maker collusion can delay loss recognition, the more time they have to invent ridiculous leverage schemes (more money printing! more government borrowing to fund “stimulus”! more FDIC “guarantees”!) to inflate those losses away…and to continue looting the public’s wealth.

But losses aren’t going away. Trading smaller private liabilities for larger public liabilities in order to artificially inflate asset prices does nothing to repair the economy’s aggregate balance sheet. At the end of the day, we’re still just lending more and more against a dwindling pool of real equity. The unwind is coming. Adding more leverage to delay it will only increase the pain.

——–

*A reader points me to the following from FDIC’s legacy loan term sheet: “Private Investors may not participate in any PPIF that purchases assets from sellers that are affiliates of such investors or that represent 10% or more of the aggregate private capital in the PPIF.” That’s something at least. Though what’s to stop mutual back-scratching? “I’ll vacuum up your legacy loans in my partnership if you deal with mine in yours…”

BTW, the following bit I found in the WSJ is quite worrisome:

“Federal Deposit Insurance Corp. Chairman Sheila Bair said Thursday she would be open to letting banks see some of the profits if they dump problem loans that ultimately recover some value….

Ms. Bair said banks might be able to take an equity stake in those funds as partial payment for their loans, which would give them a payoff if the loans ultimately rise in value and would provide bankers with more incentive to sell troubled assets.

“We’d be open to comments on that,” Ms. Bair said.”

Nothing about this smells good.

Comments

[PeteK:]

Just stay away from the Big guys.
Go with your local regional banks.
Most are doing fine.

Mar 29 06:59 PM

[Mad Hedge F...:]

Or there is plan "B". There is an easier, cheaper, and faster way to solve the banking crisis which no one is talking about on Capitol Hill. If collateralized debt obligations (CDO’s) are the problem, just get rid of them! Desecuritize them! Just convert them back into the underlying loans. There are $1.4 trillion in CDO’s outstanding backed by Alt-A and subprime loans in the form of 3,700 individual securitizations of perhaps 3.7 million loans. Over 68% of the loans backing these bonds are current. Mark to market rules are forcing the banks to carry this paper on their balance sheets at 50%-80% discounts. The problem is that mark to market is a meaningless accounting fiction when there is no market. If you break up these securities and place the underlying loans back on the banks’ balance sheets, the good mortgages can be valued at 100% of face, and those behind in their payments or in default can be discounted to maybe 70% because they are still secured by the value of the homes. This would boost the value of the entire asset class from the current 20-50 cents up to 90 cents on the dollar. Restored balance sheets would enable banks to resume lending. Of course it would be a massive admin job unwinding the rats’ nests behind some of these securities, but Heaven knows there is abundant subprime and Alt-A expertise available for hire these days. Just sift through the ashes of Lehman Brothers and Bear Stearns. It is a workable plan, and therefore is unlikely to ever see the light of day.

Mar 29 08:25 PM

[Allan Frain:]

When you buy a bank you become the bank. It seems that too many are willing to invest in a business model whereby the taxpayer subsidy is the goal of the investor. When private investors consider our sovereignty more valuable than dirty money these banks are done--govenment subsidy notwithstanding. Only then does the recovery begin.

Mar 29 09:10 PM

[expat in China:]

Shortly I will remove my cash from my big bank!

Please no one else do this because I do not want a run on the bank and them to be short of money before I move mine to a safe haven say Canada where banks are regulated.

Yes I am taking SHORT position they are scary, in debt and deserve it! Any rally is speculation caused by manipulation and not based on real recovery signs.

Sure the market will show a rally ahead of recovery but the recovery is not until 2011 and that will be a short one. The unemployment rate will grow larger for this year and next to 50 million, world wide? Who’s buying anything?

The debt driving programs will this year high light the lack of CHANGE in the USA and the real change in international sentiment towards our practices and our plans. G20 meeting will be laud one and will be reported quietly!

Mar 29 09:29 PM

[Bar Lock:]

My understanding is that the big banks return to profitability in Jan/Feb was directly related to their getting paid from Treasury via AIG.

It would also explain why March got a little tougher for them (lol).

Mar 29 09:55 PM

[nova:]

The same bank management that ruined their financial institutions by their criminal incompetence, corruption, thievery, and greed will have the second chance to do it again. But this time, they will do it on a much larger scale with taxpayers money.

The Obama administration, the Congress, and the media are telling us that, by doing a Ponzi-scheme at a much larger scale, US and world economies somehow will be miraculously cured making US stupid & naive taxpayers filthy rich. WOW!

Mar 29 10:14 PM

[bones33:]

Geithners plan is akin to pumping up a tire with a hole in it before the patch has been applied.How long can the Treasury keep it up before the tire goes flat?

Mar 29 10:57 PM

[Kinabalu:]

"“Federal Deposit Insurance Corp. Chairman Sheila Bair said Thursday she would be open to letting banks see some of the profits if they dump problem loans that ultimately recover some value"

Hey, Sheila, how about letting the WaMu shareholders share some of JPM's profit on the gift you gave to JPM shortly after WaMu's regulator, the OTS, said WaMu was well-capitalized.

Mar 30 01:19 AM

[j_remington:]

If any banks are allowed to invest in buying their own toxic assets (directly or indirectly) then this would be the biggest SCAM OF ALL TIME. BAC and C already buying MORE toxic assets on the open market to inflate market values.

The conspiracy to inflate toxic assets is about to come. We all must write our congressman to stop this.

Mar 30 02:17 AM

[andruomail:]

If they have operational profits, why the rush to fix things if they really could limp through another year or two or 5 with some accounting blindness? does the impetus for all this come from the banks or Congress, or the newspapers?

Mar 30 03:09 AM

[schlumpf:]

nationalisation = when pros short
capitalisation = when pros long

Mar 30 06:08 AM

[Gabs in Con...:]

Can you site a source Jim?


On Mar 28 05:10 PM Jim in Virginia wrote:

> We were informed this past week that C and B of A were buying toxic
> mortgages on the secondary market. I think it is highly likely that
> someone at the banks has some inside information as to how much discount
> the assets will be bought for by the government and is scurrying
> around buying assets a deeper discount in order to have plenty of
> product to sell the taxpayers when the government steps up with the
> taxpayer checkbook in hand.

Mar 30 08:20 AM

[felixd:]

I contend that the PPIP offers some great new opportunities for small investors. My contention is that the big banks participating in the Geithner plan (morgan, Goldman et al) are not going to have to put in any of their own money at all. They are going to raise the money from clients, and tack on the 2-20 fee structure. If the investment turns out well, banks pocket around 15% of the entire upside without any captial at risk. If the scheme goes bust, they still get the 2% fee, so there is no downside at all. Bottomline is that this is a great time to invest in the big banks that will be participating in the program, but dont invest directly in PPIP.

Mar 30 09:04 AM

[EMS News:]

The reason the bankers are being bailed out in such a fashion, they get to keep all past and FUTURE profits is due to the sad fact, they own our entire political process via giving donations to BOTH political parties. Writing to your representative or the 'President' will fail utterly due to the fact, you don't pay them. True, they collect taxpayer money, have excellent retirement rights as well as the best medical care on earth, via the taxpayers.

But we don't give them all the other money, the real money that is real fun. Since the biggest banking houses OWN the Federal Reserve which is also OWNED by FOREIGN BANKS like the Rothschild clan, the Federal Reserves services these entities, not the US public. Bear Stearns owned none of the Federal Reserve's stocks [which are KEPT SECRET!!!!] so they went under. Ditto, Lehman Brothers.

Goldman Sachs deals with all this by controlling the TREASURY. They insure this control by hiring officials in Treasury positions and letting all the rest know, they will be multimillionaires if they, too, help Goldman Sachs. So the entire system is skewed towards assisting a bunch of piratical gnomes who are intent on looting the US public so they can give themselves immense bonuses that won't be taxed.

Then there are the many pirate islands which are tax havens and where all the hedge fund hell hounds like Cerberus live. Presidential candidates and members of Congress use these pirate coves to hide incomes and to avoid taxes and regulations. They never talk about this, of course. It wasn't included in any Presidential debates, either. So long as we allow these guys to preserve their system which enriches them and puts us in deeper debt, we will continue our economic decline. Note that US worker's incomes have been falling, not rising. While these guys pocket more and more loot.

Mar 30 09:58 AM

[bpk6:]

Some big banks are aggressively bidding for toxic debt in the open market.

Specifically "Citigroup and Bank of America have been aggressively scooping up those same securities in the secondary market," Mark DeCambre of The NY Post reported earlier this week.


On Mar 30 08:20 AM Gabs in Connecticut wrote:

> Can you site a source Jim?

Mar 30 10:17 AM

[partnerj:]

Thanks for the NY Post article.

OK, let's see. The big banks could write new mortgages at 5% or so and immediately mark them down to market and apply for more TARP funds to replace the phantom reduction in their capital, or as the article says, they can buy existing mortgages that are yielding up to 22%.

So, the FASB has defined "market" to be secondary transactions, rather than the primary negotiation between lender and borrower. With disfunctional securities markets, this FASB definition clobbers new lending. However, the Post article mentions that other opportunities have emerged. www.nypost.com/seven/0...

IMO, why should private hedge funds and mutual funds, who do not have capital requirements or M2M requirements, be the only ones to benefit from the disfunctional mortgage markets?

Mar 30 12:01 PM

[rich c:]

They got what they always wanted: A bad bank!

~~~~reply~~~~~~

We already have 'bad banks' - they go by the names of C, BAC, JPM..... I see no need to create new ones, do you? Let’s liquidate the ones we have, shall we?

Wobatus, how would all this impact the little guy, 401(k)s, pension plans.....? It already has. You, me, the author... are already saddled (or will be) with ALL the losses. Those in NY who are in bed with those in DC will make sure THAT happens, rest assured. As someone once said, ‘Washington-based solutions are designed to protect the guilty by wrapping the solution around the innocent.’ That’s what is happening here.
Plus, the beneficial ownership I have in 'Mutual Fund ABC' of .0000000099999 of a share of C or BAC has already been destroyed by the several hundred thousands of dollars in bailout and 'stimulus' that my family has been saddled with over the next generation.

Soooooo the question to me is, when and how to take the medicine? For me, they are insolvent so shut 'em down NOW. Go ahead and shoot the full dose or medicine up my butt NOW. I’m know that time is capitalism's friend, not Washington or Wall Street.

IF I WERE KING FOR THE DAY, I WOULD: Shut-down the five largest banks and back-fill as needed with smaller community banks; bring back Glass-Steagall…. NOW!; require hedge funds and private equity to register as broker/dealers, regulated by the same FINRA and SEC rules the ‘rest of us’ follow - no access to our free (and regulated) markets without full registration and regulation!!; revise the outdated Reg D ‘accredited investor’ code; install a tougher ‘up tick’ rule; term limits (retroactive!); force the State of New York to pay $5 Thousand to each tax payer in America for each year they’ve sent Chuck Schumer to Washington…. And then I would break for an early lunch before tackling tougher issues.

Mar 30 02:56 PM

[partnerj:]

If the banks used the same accounting rules that the hedge funds use, then they are not "bad banks".

So tightening up the accounting rules on the banks, then encouraging them to sell assets to firms with realistic accounting rules is how the Treasury and the FDIC want to turn "toxic assets" into "legacy assets". The banks lose and the hedge funds benefit. How's that for change?

When you read through SFAS 157 and the amendments and SFAS 159 and the SEC's announcement 2008-234, you start to realize the terrible unintended effect of M2M on future lending. Then it is no mystery why FDR's administration threw out similar Mark-to-Market accounting in 1938.

"Those who do not learn from history are destined to relive it."

Mar 30 03:29 PM

[Rock Johny:]

Subterfuge Spin is the name of the game, man!! While USA is getting more involved in the Opium Wars Part IV, (Russian involvement there was Part III) having to spin that in a tenuous but politically correct (at least to the ears) way, you have other self-gratifying 'leaders' doing their own spin in whatever way suits the current need.

Mar 30 04:46 PM

[jstratt:]

Some thoughts to consider or disregard as you see fit.

1) Dont hold financial stocks going into earnings season.
2) The big bldg in Boston selling for 50% of its previous sale price is a bad oman
3) It would be a profitable time for banks with cost of funds low and loan spread high if not for asset impairment
4) Unfortunately it is not just the US that is highly indebted. It is the whole world.
5) Geithners comments about some banks needing a whole lot of capital should be an eye opener
6) Bank CEOs will be replaced after we get through the worst of this crisis. Now is not the time for most to fall on the axe
7) When the President calls Bank CEOs to the White house for a meeting - watch out!

I thought on Mar 6 and 9 I was seeing the bottom and perhaps we did. Bought a lot of Financial issues and rode them up. Thought we had turned the corner for a few weeks. With what I see I had to change direction. Sold riskier financials on Friday and the rest today.

Mar 30 05:36 PM