Money Center Banks - The Greater Fool

For the last decade or more, money-center banks have generated huge fees for themselves by underwriting corporate loans at ridiculously low prices to borrowers with weak credit. The key to the scheme, of course, was that the banks could then turn around and unload the credits to other banks and loan buyers; the originators held on to just small pieces.

Now we see the logical outcome of this “business model.” The buyers have stampeded from the scene—so the originating banks find themselves larded down with billions of iffy paper they never intended to own in the first place.

The media blames the lenders’ dilemma on “market conditions,” but of course that’s nonsense. The real cause of the banks’ problems’ is that they came to rely on a business model that was doomed from the beginning.

If you can’t identify the next “greater fool,” you’re not going to be pleased when you find out who it ends up being.

Comments

[nmau:]

Same old song.What else is new. But the yield curve will save them all.

2008 Apr 02 09:19 AM

[DSX Lover:]

Vernon you're a fool. Money-center banks only underwrite corporate loans, to increase the liquidity of those assets, and to decrease to total costs to the borrower. They make more money by keeping those loans themselves, and earning the interest spread on them. So now because nobody wants to buy corporate loans in the secondary market these loans are no good ah? that's the biggest nonsense I have ever heard. These loans will remain in the books of the banks, forever because the default rates are lower than they have ever been, and the Net interest margin is now huge with the fed lowering the rates. Whoever thinks is getting corporate loans for 70 cents on a dollar is dreaming. Banks can take the writedowns under FASB157 rules, but they will become writeups once the nonsense clears the market.

2008 Apr 02 04:29 PM

[Ghost rider:]

Good article by the man who brought real serice to the banking business. We miss you Vernon, the service at Commerce has slipped already.
Hit 'em straight.

2008 Apr 03 07:58 PM

[Andrew:]

Good comments. To me, it's still too early to tell how deep the ultimate value of a lot of these debt securities are worth. Much of it still depend on overall housing value. If home prices continue to drop then expect another step down on these security values due to higher default risks. At this point though, its safe to say that CDO's based on 2nd and 3rd mortgages are basically worthless.

At least two other things would worry me if I was a bank (money center and shadow):

- as Mr. Hill stated, all the buyers have left the market. U.S. debt security market has suffered significant and wide spread damage. Even the most cash rich investors such as Chinese and Middle Eastern oil countries will not buy these securities, and they will take much lower stakes in future secuities created (i.e. a shift in total demand). In turn this will hurt the ability of banks to generate new credit, which will then hinder the recovery of the real estate market. Remember, most people buy based on net payments not overall price. Next to the broad exportation of these securities, the lead-paint toys that China has exported to the U.S. pales in comparison.

- Threat of inflation: most of these 04-07 vintage securities are at pretty low interest because there was very little risk premium built in (most were sold as AAA securities). As the reality of how much inflation U.S. is facing due to commodity inflation and weakening $ due to stretched balance sheets (both government and consumers) hits the market, the entire yield curve is going to shift upwards. This is going to shrink the nominal value of the 04-07 vintaged securities, which is a double whammy from write-down of their intrinsic values.

I guess this is why analysts are saying C and MER need to raise more capital.

2008 Apr 05 02:34 PM