In the 1980s and early 90s, a collapse in the Southern U.S. real estate market trigged what’s known as the Savings and Loan Crisis. In that debacle, $151 billion of Thrifts were ultimately bailed out by the Federal Deposit Insurance Corp. Of that amount, $75 billion went to Texas-based institutions alone. The 2007 crash of the U.S. subprime mortgage market has caused the demise of an independent Bear Stearns (NYSE:BSC), with the U.S. Federal Reserve agreeing Sunday to take on $33 billion of illiquid collateralized securities. Global banks have written off more than $250 billion of assets (and shareholder equity) during the past six months, with another $50 billion of write-downs still anticipated.
Oh, how history has a way of repeating itself.
Between 1980 and 1987, the concentration of real estate in the average S&L loan book grew from 13% to 26%. According to many bank analysts, Bear Stearns’ (BSC) and Lehman Brothers’ (LEH) reliance on revenue generated from packaging real estate transactions rose in a similar fashion over the course of this decade. Bear Stearns peaked as the #2 underwriter of mortgage backed securities. Lehman was #7 in the CMBS bookrunner market, for example, through much of 2007; #4 for global securitizations and #1 for private label mortgage bonds with $40 billion of underwritings in 2007 (Bear was #2).
Where are the problems today? Real estate-backed loans, just as with the Thrifts in the 80s. The Thrift industry had the benefit of FDIC deposit guarantees, and could attract individual deposits with high posted savings rates and leverage the absence of a national interstate banking network. The Thrift board turned around and lent that money to local commercial real estate developers, often advancing more than 100% of the value of the project.
Highly levered, long term loans backed by short term funding.
When the 1980s Texas oil boom corrected, the broader U.S. economy began to suffer and 1,320 different S&L institutions went under (almost 30% of all S&Ls). Over the past nine months, in excess of one hundred subprime mortgage providers have turned out the lights, with even the largest firms - GMAC and Merrill Lynch - shutting down their specialty divisions. Their crime? Lending far more money against a U.S. residential property than historical norms and prudence required.
Unlike the S&Ls, who had the FDIC playing the role of enabler by guaranteeing deposits and tacitly encouraging the growth in the commercial and industrial development markets of the 1980s, Wall Street took the lead on this recent mess by manufacturing a trillion dollar subprime industry, and then laying off that risk on a multitude of SIVs, CDOs, CLOs and whatnot.
For all of the caterwauling about the moral hazard question and the U.S. Federal Reserve’s role in taking $33 billion of risk off the hands of JPMorgan (NYSE:JPM) shareholders, the “bailout” number is still a far cry from the $151 billion (pdf file) that the FDIC paid out on the S&L crisis.
A crisis that reached it crescendo just 20 years ago. Real estate was a villan then, as well. As was the lack of industry oversight. But the true shame is that it took the loss of Bear Stearns for the U.S. Fed to open the discount window to the twenty brokers that were so desperately in need of access to liquidity. It’ll come as no solace to BSC shareholders, but the rest of the U.S. financial system is now far stronger than it has been since the wheel came off last summer (see prior post “‘Panic’ sets in to the debt markets,” July 29, 2007).
The shorts have already laid off Lehman Brothers as the positive premarket trading suggests, and according to The Daily Telegraph, the Treasury Department is rumored to have sent the message to its competitors: don’t bad mouth Lehman.
The high water mark of this financial markets crisis is now behind us, and Bear will likely be the last large institution to be pushed against a wall. Which is not to say there won’t be more large writedowns, and that some financial institutions won’t need to raise more capital. The leverage ratios of many firms are still quite breathtaking, according to the Wall Street Journal:
Morgan Stanley had a leverage ratio of 32.6-to-1 at the end of last year, nearly as high as Bear’s 32.8-to-1. Lehman was leveraged 30.7-to-1, and Merrill Lynch 27.8-to-1. And the would-be rock, Goldman? It was leveraged 26.2-to-1.
But the crisis of confidence has passed. It's time to exhale and get back to work at Wellington Financial LP, lending money to high quality companies looking for True Growth Capital. “All” we have left to worry about now is the depth and breadth of the U.S. recession.