IMF published their new Financial Stability Report, in which they claim that U.S. banks will have $250B drain on equity capital due to write-offs in the next two years. The simple math they go through is follows: total write-offs on loans and securities over the cycle for U.S. banks will be $1,050B. $500B of that has already been recognized, which leaves $550B remaining. They estimate after-tax pre-provision earnings in 2009-2010 at U.S. banks will be $300B. $550-300B=250B drag on capital. But what happened to applying a tax rate to write-downs, which would presumably reduce net write-down number to 360B, or result in only $60B drag? Pretty significant $200B delta, under which the capital ratios would look not so bad after all.

This not so well-thought out math only adds fuel to the fire burning the bank stocks and shaking the confidence in the system. Let's hope the Fed's stress test is more well-thought out, and somebody actually pays attention, rather than just saying 'they are all bankrupt, I don't care what numbers say', like many people seem to be prone to do these days.

The latest proposal put out by the Treasury with the Fed's blessing really makes you question whether they understand the real problems plaguing the U.S. financial system: undercapitalization of commercial banks, trillions of loans outstanding and an inability of both households and corporations to afford the debts they have subscribed to. If the government adopts the plan and buys the assets for anything close to current market prices, the banks will still be undercapitalized, people still will not be able to afford their payments, and credit contraction, along with plummeting confidence in the financial system, will continue spreading.

The only way for the plan to have any impact is for the Treasury to buy the assets at enormous premiums. "Hey Citi (C), you know those CDOs that you have marked at 50 cents on the dollar and Merrill (MER) recently sold at 20 cents? Well, we'll buy them for three dollars". I'm sure taxpayers would be thrilled with that strategy.

In the previous post I wrote that the strategy of patching holes that Fed is pursuing is not working, as every time one bank is bailed out or closes, two more get into trouble. We are seeing evidence of this now with Morgan Stanley (MS), Goldman (GS) and WaMu (WM) in the crosshairs..

Saving AIG (AIG) might in isolation seem like a good idea – they have a viable main business, the loan provided by the Fed is secured by the assets so taxpayers should not lose (and might even make) money, while the bail-out temporarily saves whatever banks and hedge funds were using AIG as CDS counterparty. However, it does not in any way solve the biggest problem: lack of confidence in the system. And this problem is snowballing. Non-finance people on the streets talk about how they will put all their money into gold. Companies are drawing down on their credit lines afraid that the banks will not have cash on hand tomorrow. I get calls from my friend abroad saying he read an article that Bank of America (BAC) is the next one in the failure line.

With Lehman (LEH) in Chapter 11, AIG (AIG) just downgraded three notches by S&P and potentially following Lehman's fate in the near future, who else will be the victim of this financial tempest? If the Bernanke & Paulson team continues the policy of trying to patch the holes without addressing the actual problem, unfortunately the answer will be everyone, although some will suffer earlier than others.

First we are going to see more pain among the major banks driven by further writedowns. Mark to market has been the main source of trouble so far and it will continue to occupy the main seat for the next several months. There are three things in play here:

NCR Corporation (NCR) stock has been bruised recently, along with anything else financial-related. While the CDOs, CLOs and other mysterious abbreviations are not lurking on NCR's balance sheet, the revenue for the company is expected to hurt in 2008 as its main customers, banks, cut on capex in an attempt to hoard some cash. This fear has driven the stock down from the highs of $28 in November to $21 in March, although since then it has bounced to $25. Despite the run-up, at current price the stock is a good buy, although substantial gains might have to wait until improving fundamentals in 2009. That is unless NCR is snapped up by a major industrial player, just like Diebold was by UTX, in which case returns will be that much richer.

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