The Big Banking Emperors' New Clothes

How can you tell when a banker is lying - a major, top five, money center bank CEO? Their lips are moving, Jamie Dimon (JPMorgan Chase (JPM)) excluded of course.

With mark to market rules changing today - probably -- the bank stocks are back! The bank stocks are back! As a trade, not an investment -- so please read on about the banking emperors and their new clothes. Or lack thereof - and for you younger people with the new American education, look up Hans Christian Andersen to learn more about the emperor's clothes at Citigroup (C) and Bank of America (BAC).

I write about these two embarrassingly discredited CEOs and their companies because the ultimate lie - the changing of mark to market rules - will come about Thursday under Congressional interference with a supposedly independent group, the Financial Accounting Standards Board. The new rules essentially say a bank can use their own model if an asset is to be held for a long time and is illiquid. The market is way up pre-open, banks stocks are rising, everyone is happy.

Of course, the emperor - in this case, emperors Pandit (Citigroup) and Lewis (BofA) - have no clothes. My teenage twin sons understood, over dinner last night, what was going on and figured out the banks are using the change to avoid mandatory increases in capital - and this move will actually repel private capital, the intent of the administration. Better yet, once the stress tests are complete and the toxic asset auctions begin, the rule changes will boomerang on Citi, BOA and other banks using them. How so?

Once the auctions are in place, how can banks claim they are illiquid? Once the stress tests are done, the debate on the definition of core capital will accelerate and where will the banks hide? But, more importantly, once the auctions begin, banks that aggressively dump toxic assets and take their hits will have far more transparent books and will be able to attract private capital. At the same time, banks that obscure and obfuscate and continue to hide bad assets inside their own models will not be able to attract private capital - now. And their stock prices will fall as investors assume not just dilution in the future but a re-casting of current profits sometime in the future when they finally sell assets they said they were going to hold for a while and have to adjust previously declared profits.

If you think I am wrong about this, consider how Citi dealt with its near insolvency when Mexican bonds blew up in the late 1980s - even backed by Brady bonds it took them, if I remember correctly, five to seven years to write them down. And those were pocket change compared to what they are sitting on now.

Vikram Pandit said his company, Citigroup, was profitable in January and February. Dimon said March was rough - and based on history, whom are you going to believe? Not to mention Pandit was talking about operating profits - without write downs of those annoying toxic assets. Pandit failed to discuss the $1.2 trillion dollars in off balance sheet assets of unknown quality - never, and I mean never, discussed in public. This in addition to the two trillion in assets everyone is worried about. If they are great assets that could support his Tier I capital, why are they not on the balance sheet, Mr. Pandit? He also did not mention how much they are losing in earnings power with the end of their broker franchise, now part of a joint venture with Morgan Stanley (MS). I still have most of my liquid assets at Citi - my broker and his entire group of eight left for Wells Fargo (WFC) and Wachovia Securities. Like many others at Citi, of course, he too will be moving on once Wells is forced by circumstances to sell Wachovia's brokerage operation.

Ken Lewis was on CNBC Thursday morning and I had to turn it off or lose my breakfast. Everything is about to get sunny - sort of - according to Lewis. The same man who bought Merrill Lynch for ten times its value did not know what was on their books but went ahead and bought the company anyway, using shareholder money to fulfill his personal ambition. He now has his fully diverse bank complete with legendarily avaricious stock brokers - a model that worked real well for Citigroup, right? In the interview he talked about an economic turnaround sooner than any CEO should and also bragged about paying back $400 million in TARP money. If memory serves, he got $20 billion - so he paid back two cents on the dollar and is bragging about it. I am also a BOA customer - in their private banking program - excuse me, I was in their private banking program. I was kicked out because I don't have a quarter of a million in a Merrill Lynch brokerage account. I called my banker of fifteen years and learned if I moved assets over to stay in the program, and I want real banking information about mortgages and such, my broker will refer me to an 800 number. Good move Ken. I am moving on - looking at the private banking program at a smaller regional bank.

The bottom line: the Wall Street Journal article Thursday morning talking about how investors are getting back into Citi "because it looks cheap and I am down 50%" points out the reality; that stock, and to my mind many other bank stocks, are trades, moving on headlines and technical factors. They are terrible investments with another trillion dollars in write-downs and greatly reduced earnings power for three to five years due to their own mistakes and the recession.

Comments

[dcb:]

you can't do this because there isn't a profit for the banks in it. :-)


On Apr 02 02:37 PM Robert Minneman wrote:

> I just wish the american tax payer ACTUALLY got something out of
> all this, and worse nothing done so far actually resolves the REAL
> problem.
>
> I believe that if you totalled up the amount of money spent so far,
> plus the amount of money the government is going to spend, plus the
> interest on all that you'd have a number easily exceeding the amount
> neccessary to pay off all the PRIMARY home mortgages out there in
> the US (not second homes, rental or investment properties, these
> are the homes that the mortgage holder is actually living in).<br/>
>
> I believe the ULTIMATE real solution would have been for the government
> to buy all those primary home mortgages, and then BURN THEM.
>
> This would resolve the actual problem that's retarded our economy:
> There's not enough cash, or credit, available to keep the economy
> moving.
>
> You remove the primary month-to-month expense from most of american
> households, you add a TON of month-to-month more spending cash, AND
> by they way, you also ELIMINATE the largest tax deduction most americans
> have, AS WELL AS, accelerating the real estate market home value
> reset, and it resets most home values to something more reasonable
> AND makes the home market more liquid/mobile.
>
> The majority of american tax payers get something out of it, more
> cash, or more affordable homes if they're not currently a home owner,
> the banks get their cash to maintain solvency, the government gets
> a long term increase in tax revenue, and the economy gets frenzied
> burst of credit cards getting paid off, new cars getting bought,
> and kids college funds being paid into.
>
> Hell, if the government is going to 'stick its toe' into socialism,
> at least do it right...

Apr 02 02:48 PM

[Robert Minn...:]

I think that if walked up to any banker and said, "Let me buy ALL the mortgages for primary residences at the current pay off amount," and he came back with any response other than, "Would you like them gift wrapped?", he should be fired.

The banks can still make a profit on all the investment/rental, second/vacation homes, business real estate, etc.. Plus, then they'd have capital to afford to make the new mortgages that would come into play from new home buyers looking to take advantage of the guy who has lost his job, has a job offer across the country and needs to sell. The guy who needs to sell won't have a large outstanding mortgage he's got to cover on his sale price, or worse accept a short sale, so he can take an amount considerably lower than his original purchase price, come out with a significant amount of cash that he can use to move and put down on a new home in the new location, i.e.: new mortgage for the banks to maybe start making money on.

As it is now, everyone, and I mean EVERYONE not already sitting on an 8 digit stack of cash somewhere, is ever so slowly, and painfully, bleeding to death economically.

Let's put one big damn band-aid on it, not keep applying leeches...


On Apr 02 02:48 PM dcb wrote:

> you can't do this because there isn't a profit for the banks in it.
> :-)

Apr 02 02:57 PM

[FlyingAfrican:]

Robert... your points are pretty valid.

I wonder if the Fed / Treasury just took the $750 BILLION and opened the National Bank of America (not 'nationalising' a bank, actually OPENING a government owned bank), and then use that $750 billion to issue car and auto loans, buy mortgages (not MBS, just straight mortgages) etc. it would have been a way more effective solution.

Who would run this? NOT Congress. Instead of the government building branches, they just buy (at the liquidation sale) branches, data centers, etc. of whatever banks go under (no federal support for the banks).

Run on the bank? well those banks that go under can transfer their customer deposits to the national bank of america.

Mike... you're 100% correct, all they doing by changing the rules is delaying the pain, but making the eventual outcome even worse. If we say its not a recession and close our eyes long enough this wouldn't have happened is the current thinking it seems.

Apr 02 03:08 PM

[Chimpwithpants:]

By having good friends in the treasury of course.


On Apr 02 12:29 PM James Wilson wrote:

> GS has 5 times the toxic loans how do they fly so high ?

Apr 02 03:17 PM

[Andrew E Bu...:]

The tragedy is that changing M2M is the right thing to do.

Just instead of adopting International Valuation Standards for valuing those assets they went with the Emperor

Apr 02 04:31 PM

[schlumpf:]

Blah,Blah, Blah.
Yeah Michael ,you are the best. Dont watch tv while you eat breackfast.
Cover your short.

Apr 02 04:42 PM

[Jesse99:]

The changes in regulation sound both reasonable and principled. It is reasonable because there is already a well established measure of liquidity - anything that sells below what you think it is worth does so due to insufficient demand, and is therefore illiquid - and a known value for these assets - just ask the asset holder. It is the principled thing to do because reality is just a code word for "ontological regulation". I don't like mathematics telling me what I can and can't do.

While I applaud this move, it would be both forward thinking and noble for banks grasp the banner of the free market and extend it to their customers. Bankers of the world: I want a million dollars for a house and have a 10% down payment in the form of 2000 "illiquid" shares of AIG. Contact me if interested.

Apr 02 05:36 PM

[The Geoffster:]

The Sim is correct. This is a solvency crisis. The banks should have been allowed to fail.

Apr 02 06:27 PM

[Minlita:]

Bank stocks are off their bottoms, but I'm waiting for more facts before buying.

If the news are good, it could be the first of many more profits, and the stocks should improve for some time.
If the news are bad, testing the old lows won't be a challenge as investors will give up once again and move to other industries (I like gold).

Is it safe to buy know? There are a few rules that can help:
1) Buy the best bank stocks (JPM, WFC).
2) Buy and only a little.
4) Wait for the quarterly reports, to see how the profits were made and what kind of loan loss reserves were taken.
5) Wait for the sell of toxic asset lons/mortagages they won't be sold at premium prices, and this is going to make more losses than expected
6) Wait for new equity offerings.
5) Watch in the founds are buying or not, they can buy billions of stocks/lons/mortagages and when they do that stocks to improve quickly.

Apr 02 08:01 PM

[ed233:]

I'm up here in Canada and I can guarantee you that our banks are solvent and have in the last quarter made money legitimately. And I can tell you that I read recently that the global financial markets rank the Canadian banks as one of the best anywhere in the globe. Guess what? I wouldn't buy them either. So anyone contemplating buying the so called big banks in the USA need their head examined. You could wake up any morning and find that you bank has been nationalized and as a shareholder what will you get????

Apr 02 09:42 PM

[castlegard05:]

Thank you for excluding Jamie Dimon and JP Morgan & Company. I believe JPM, GS, MS, BAC, C, and WFC will all be great buys right now with the release of the MTM. Buy Buy Buy like Jim Cramer says.

Apr 03 12:45 AM

[iel76:]

Cover your short positions and stop whining. Everyone is an expert on the cash flow of these assets. Hell, it's almost as if saying the phrase "toxic assets" is fashionable. If the market is valuing an asset where 85% - 90% of the mortgages are paying as if 70 % were in default; that ain't my problem. Diluting the existing shareholders when no loss has been incurred is ridiculous. AND NO YOU DON"T KNOW WHAT THESE INVESTMENTS ARE ULTIMATELY WORTH...

This mark to market change makes perfect sense. When the loss is actually incurred, write it off. I'm tired of the shorts destroying the banking system. Cover your short positions and shut up.....

Apr 03 01:14 AM

[Hillsfar:]

Ahh, yes. Trust the SAME people whose mathematical models regarding derivatives and credit default swaps were flawed... to create new mathematical models to value their toxic mortgage-backed securities. The irony would be sweet if it weren't so bitter for the American people.

Apr 03 02:36 AM

[gtmcduffy@g...:]

bloggingstocker.blogsp...

Apr 03 06:36 AM

[pacman1947:]

Pinocchio's nose was shorter while he was wooden.

Banker CEOs don't have noses -- they have shafts for their investors.

Apr 03 08:00 AM

[sunny12945:]

Most of the articles at SA are 'eye' opener, conveniently ignored by pumping channels.

The coming 'core capital debate',unintended consequences of removal of MtM, credibility of Banks' balance sheet are just a few. Churning of all kind ideas incl comments where we have a chance to see the glimpse of truth buried in a lot of mush!

Apr 03 10:51 AM

[aarc:]

What if the economy recovers?

We are not going to stay in this deflationary recession forever, are we? We also have the major threat of "inflation of the century" the Fed may not be able to control with relative ease. When inflation rears it's ugly head and the banks can still use M2M, their value are going to soar. The more "toxic" assets they hold now, the more potential profits they will reap under an inflationary environment.

What if all those toxic assets written down during the last 18 months are really not worth the massive write downs but actually have intrinsic values at or near or more than their par value after 10, 20, 30 years time? They may be worthless today. How about a few decades from now?

The banks, to some of the articles I read, have also gotten rid of most of the trash assets they had been holding, long before the major writedowns - thus leaving them with relatively less toxic assets. They also took CDS protections just in case those assets implode in value. That leaves them relatively scotch-free if things go from worse to worst.

Remember, the banks have the most knowledge and experience in how to handle and manage RISK. They had been doing that for centuries.

They made a major fiasco this time around due to government insistence of "a home for every American" dream. But that does'nt mean they've also lost their knowledge, experience, and capabilities/capacities on how to manage risk.

What is the major asset of banks? Cash on hand or the knowledge, experience, and contacts they can depend upon? They start their business with a dime and turn that into a dollar - not because they have the hard cash, but because of their intrinsic assets. Intrinsic assets that go through the ups and downs of economic cycles. Worthless today, priceless tomorrow.

When are you going to buy the bank stocks, when they are worthless or when they are priceless?

This is not the end of the world, is it? We are not going straight to WWIII, are we?

Apr 03 11:01 AM

[sunny12945:]

'Remember, the banks have the most knowledge and experience in how to handle and manage RISK. They had been doing that for centuries.'


OMG!!!!!!!!!!!!!!!!!!!!

Apr 03 11:22 AM

[Consider_this:]

RE is coming back this year, or soon; don’t doubt it.

With the new FASB mark to fantasy ruling, the following changes to key statistics is under way:

1. Banks capital ratio is now fantasy ratio, and will allow them to lend.
2. Banks can now hold onto REOs, indefinitely. There’s no incentive to sell at market. By holding REOs, banks can rate that REO asset at 2007 level. Sure they’ll have to put taxes and maintenance, but that’s going to be like a cost of business to keep 2007-model alive.
3. Similarly, Banks can now DRAGGG ON the NOD and foreclosure process. Expect things like allowing people to stay, semi-permantly (as in for months and years at a time), rent free; without any foreclosure NODs or auctions or what not. Next few months you’ll see a sharp decline in new foreclosures as the banks adapt.
4. Commercial RE (CRE) was going to be a bomb in 2009, because all those commercial loans are due and the market valuation means no bank will refi them. Well no more, we’re not using market valuation anymore, so those model all says these CREs are awesome profits, so there’ll be increased refi of CREs and the crisis averted.
5. With the new model, HELOCs may even be a viable source of credit for consumers now; Those on the margin may find banks offering HELOC now, the home ATM is now open!
6. Ditto to Credit Card ABSs, the model says much better profitability; In fact, there’ll be more solicitations for people to own more cards; coz the model says it’s such good business, plus the customer can use one card to pay off another — further enhancing default rate for their model!
7. The obvious is that all the bank’s financial releases for the rest of 2009 will beat expectation now. So now permabulls have ammunition to say recession is over.

Bears are fighting a losing cause with the deck to heavily stacked against them.

Are these going to be a permanent solution, or actually save us from impending doom? Heck no. It’s the same playbook from Japan that pretty much sealed their fate to the 20 year economic decline. *BUT* it’ll drag everything into SLOW MOTION decline.

Kinda like treating an acute disease that *MAY* kill you, by taking a poison that kills the bacteria and the short term disease problem, but guarantees you will die SLOWLY. We just did that.

I thought I could time the market and buy a house in 2010 or 2011; I can see my folly now. The govt will make it a money losing proposition to own a house for 20 years. The govt will stretch it out so long, so maximum number of people are bearing the housing decline and nobody can “time” and get “out” — in the end you need a place to stay, and that is their trump card.

I think I’m so depressed I’ll go jump off a bridge somewhere now.

Apr 03 04:29 PM

[damienhaas:]

"Remember, the banks have the most knowledge and experience in how to handle and manage RISK. They had been doing that for centuries."

aarc, If the bank know how to manage risk(manage risk by massive leveraging???), we won't be in this mess now.......

Apr 03 09:16 PM