"Let them fail; let everybody fail! I made my fortune when I had nothing to start with, by myself and my own ideas. Let other people do the same thing. If I lose everything in the collapse of our financial structure, I will start in at the beginning and build it up again." Henry Ford, February 11, 1933
The quotation above refers to an
important but little known fact about the Great Depression, namely the role of
Henry Ford in forcing Washington
to address the issue of bank insolvency. The great inventor hated "the banksters"
and was no less concerned about the safety of his money than today's subprime shocked
investors. Not only did he reject President Herbert
Hoover's eleventh hour appeal to provide additional loans to support Detroit's
insolvent banks, but he threatened to "take his boys" into town that Tuesday
following Lincoln's birthday and withdraw some $60 million in cash
deposits.
Hearing of Ford's
threat, Michigan Governor William A. Comstock declared a week long bank holiday, beginning the
process that would see nearly every bank in the US closed just prior to the
inauguration of President Franklin Delano Roosevelt in March. In
some cases, banks would remain closed for months. Yet in a very ironic way,
Ford's mean spirited and supremely selfish stance forced Washington to deal
with the problem head on, closing all commercial banks and forcing them to meet a solvency
test before being allowed to re-open.
Fast forward to the
present day and consider the temporizing and lack of leadership coming from the
Bush Administration. It should be apparent to all by this time that Treasury Secretary
Hank Paulson's first two proposals to address the subprime crisis, call
them "MLEC" and "Forbearance," have the very same object: revive the now moribund market for
complex structured assets, the chief area of activity by Wall Street for the past
decade or more. Paulson's former employer, Goldman Sachs (NYSE:GS), has benefited enormously
from the structured asset fiasco, both long and short.
"What is the next 'new thing' for Wall Street to
hock?," asked one reader of The Institutional Risk
Analyst.
"Securitization and the corresponding three-letter alphabet soup is
now a four letter word in most people's book. We've had the
nifty-fifty, conglomerates, de-regulation, LBO's, privatization, .com
mania, hedge funds and now mortgage securitization. We need a new money
machine..."
Sad to say, Humpty Dumpty cannot be reassembled, no matter
what Paulson or other government officials may say or do, at least not
unless and until investors are convinced that the bad news is behind
us. Markets are waiting for tangible corrective action in the form of
asset sales and write-downs, one reason why we focused last week on
Wells Fargo & Co. (NYSE:WFC) and that institution's decision to
bite the bullet and write down 3% of total loans in a single quarter.
Of interest, WFC's ratio of
loans held to maturity vs loans marked for sale shifted dramatically over the
past several quarters, evidence of the death throes of the structured asset
racket. In Q3 2005, loans marked for sale equaled $46.7 billion or
15% of total loans, while in Q3 2007 loans available for sale were just $30
billion or 8% of total loans. Over the same period, income from
securitization has dropped from 11% of total income to just
6%. And OREO, short for "other real estate owned," has risen
from $158 million in Q3 2005 to almost $900 million as of Q3 2007.
Click here to see a chart
of WFC's total loans, loans
marked for sale and loans held for inventory since Q3
2005.
Perhaps more significant, WFC's total loans and leases have risen more than
10% in the past six months, this after remaining essentially flat for the previous
two years. Indeed, looking at the sharp move in the Economic Capital numbers of the
largest banks in Q3 of 2007 (See IRA News -- Economic Capital for Q3 2007 ),
it seems fair to conclude that the collapse of the securitization assembly line
is causing many banks to make significant balance sheet adjustments, additions
mostly. With the ability of banks to sell assets now sharply curtailed, balance
sheet management -- and restraint -- is back in vogue.
The solution to the subprime crisis has nothing to do with
the level of interest rates set by the Federal Open Market Committee. We
note with approval
the efforts by Citigroup (NYSE:C) to shed assets in that bank's off balance
sheet funds, apparently some $15 billion so far. But the real question going
forward for C, WFC and many other banks which have been dependent upon loan
securitization, both for fees and to free up balance sheet
capacity, is how to reconfigure their operations for a market
where originating and selling assets to investors is not the primary
objective.
The inability of banks to
originate and sell loans and other assets implies a vast
reduction
in the supply of credit available to the US economy, an outcome which
must surely be unacceptable to both political parties. Trading volume in
structured assets is nonexistent and volume in other OTC products such as
credit default swaps is likewise facing a sustained drought. One would
think that eventually we're going to see Paulson, Fed Chairman
Ben Bernanke and SEC Chairman Chris Cox on national TV telling the Street to take
the pain, clear the decks and get on with the cleanup process. But do Paulson and
his peers have the guts to do the right thing?
The biggest
threat facing the markets today is inaction by public officials who
are reluctant to force all of the major banks (and their Buy Side clients) to
recognize reality. As our friend Alex Pollock at American Enterprise
Institute likes to say, "the loss has already occurred, but it has yet to be
recognized." If Secretary Paulson and others in positions of
leadership in Washington and on Wall Street want to fix the subprime crisis
and restore investor confidence, then the solution must start with a
comprehensive, mandatory write down of all illiquid complex structured
assets held by every bank, dealer and fund.
Only when investors are convinced that the
rot has been cut out of the financial system and that banking institutions are honestly
disclosing their full liabilities will the global capital markets
start to clear and recover in terms of liquidity. The result will
be some bank failures and fund insolvencies, but the next day
the markets will start to rebound. As in the dark days of
the Great Depression, the more our leaders in Washington try to restore the status quo ante,
the larger will be the scope of the financial crisis and the longer it will take
to truly restore investor confidence.
