Let's Not Face It - The Banks are Bankrupt

Posted by jeff

Tue Jan 27th, 2009 09:34 PM

Naked%20Emporer.jpgI have previously mentioned the likelihood that the U.S. banking system's total capital will be burned through as the mountain of bad debt is recognized and written off. Last night I heard Nouriel Roubini tell Bloomberg News that he estimated that the $1.8 trillion in losses during this financial crisis means that the largest U.S. banks are effectively bankrupt. I have been trolling around for some data on total bank capital in the U.S. (without resorting to adding up the tangible equity of a bunch of banks one at a time.....business is a little slow, but it's not that slow). I recently found some data on the Federal Reserve web site aggregating the assets and liabilities of all commercial banks in the U.S. Now this means we are missing S&Ls/thrifts and credit unions from the calculation, but let's face it - these organizations are numerous but in aggregate don't add up to a pile of beans, versus the big money center banks and super regionals captured here. As of January 14, 2009, the total assets of the large banks totalled $12.3 trillion. On the other side of the ledger, the total liabilities - including to a great degree deposits of $7.3 trillion (I have seen this data point before) , but also borrowings from other banks - totalled $11.2 trillion. The "residual" as the Fed calls it, would ordinarily be called shareholders' equity (the actual money the bank owns supporting all the loans it has made and all the deposits and loans it owes) came to a grand total of $1.1 trillion. The $12.3 trillion in total assets equates to 11.2x the "residual." Commentators like to talk about the higher leverage ratios that the investment banks were carrying going into the crisis to illustrate how quickly capital can be burned through due to leverage. As Nobel prize-winning economist Joseph Stiglitz of Columbia University recently wrote in an editorial for CNN:

"At 'just' 25:1 leverage, a 4 percent fall in the price of assets wipes out a bank's net worth -- and we have seen far more precipitous falls in asset prices. Putting another $20 billion in a bank with $2 trillion of assets will be wiped out with just a 1 percent fall in asset prices."
As you can tell that the 11:1 ratio I refer to above is still pretty awfulI. I do not know if these numbers include the accounting gimmickry of goodwill or whether the "residual" is hard tangible equity, but it dosn't really matter, because the losses in this credit crisis are widely believed to exceed $1 trillion. It doesn't take a rocket scientist to figure out that these large banks will see 50% to 150% of their capital wiped out over the course of the crisis if the estimates are correct. Since the estimates seem to keep rising, I would wager it's more likely that the losses will be even greater and, oh, by the way, I am sure the banks' assets and liabilities don't include off-balance sheet vehicles and credit derivatives positions which, in many cases, tilt the balance further towards the liability side and carry the risk of significant losses.

I would go as far as to say that the Federal Reserve data suggest that Nouriel Roubini is actually on pretty safe ground in saying that the biggest banks in the country are effectively bankrupt. I am actually willing to take that a step further....and I am not breaking new ground here.....the FDIC, which is insuring all these deposits, would be effectively bankrupt if they ever had to deal with the insolvency of these large banks. Way back in August, the Wall Street Journal discussed the FDIC's funding shortfall. You can read about it in this Reuters article.

Now for the latest twist. Even those conservative Savings & Loans and Thrifts...yes they learned a thing or two from the ass whoopin they took in the 1980s...have something to fear. The Federal Home Loan Banking System, which was created in the Great Depression (1932 to be exact) to help promote home lending, acts as a mini Federal Reserve to the thrifts of the world. It has equity which is contributed by the banks, each of which owns a significant amount of its regional Federal Home Loan Bank's (FHLB) stock, which it can lever up significantly through Federal Reserve borrowing and it then lends those funds to the banks in its region to lend out to their customers. You can read about it in this Bloomberg article entitled FHLBs May Fall Below Capital Minimums, Moody's Says.

The FHLB of Atlanta reported a loss for the fourth quarter, which has finally stirred concern about these highly levered quasi-government institutions.

So the banks are bankrupt and by association so is the FDIC; throw in the FHLB system for good measure. What's to be done? I'll tell you what. I'll make a deal with all of you. I will pretend that my bank still has all my money and can pay me back, and that if there is a problem, the FDIC will backstop the bank, as long as you promise to do the same. If we all do this for the next few years, the government can print enough money, while paying interest on the excess reserves the banks are not lending, to paper over the losses that need to be recognized. We will raise the money to pay for this from foreigners....and our own citizens.....who will buy U.S. bonds at super low rates to safeguard their savings (as the rate of those savings necessarily increase). We will all collectively pretend that the huge number of new dollars are still worth the same amount, because hey, who wants to own the peso when drug traffikers run the whole country, or the ruble, for that matter, when arms traffikers run that whole country. Sound like a plan? Great!

From the Blogosphere:

Jim Rogers Calls Most Big U.S. Banks Bankrupt

Why Bank's Still teeter After $232 Billion in Aid

FDIC to Go Bankrupt by 2009

The Next Bank Bailout - federal Home Loan Banks Positioned to Need Taxpayer Help

Naked Emporer image pen and ink on paper to illustrate Jean Roberton Hans Andersen’s Fairy Tales (1961). Borrowed from Cambridge Book & Print gallery.

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