Interest Rates Start to Matter Again November 7, 2005
You would expect that a man of the stature and
reputation of Federal Reserve Board Chairman Alan Greenspan would have no
trouble finding employment after his years of government service. Thus our surprise when we saw a report
in the American Banker noting that the venerable central
banker had started writing research reports again, his first in over a
decade.
In cooperation with senior economist James Kennedy,
Chairman Greenspan authored a study entitled �Estimates of Home Mortgage Originations, Repayments, and
Debt On One-to-Four-Family Residences,� which among other things looked at the size of
mortgage finance vs. overall consumer spending. He discovered that some $600 billion or
roughly 7% of all disposable income was financed in cash terms through home
equity loans.
Far from a conundrum, the role of mortgage finance in
keeping Americans consuming at the levels we all expect is apparent and has
created a number of anomalies in the US economy, particularly within the portfolios of banks
and investors who facilitate the housing mania. This fact is apparently what troubles
Chairman Greenspan and has fueled some of his criticism of the role of the GSEs
in encouraging �home ownership.�
Suffice it to say that the latest Fed rate hike and the
promise that US interest rates � and also the dollar -- will continue rising has
caused us to assume an even more bearish stance than is usually our custom. Fact is, the only way that the Fed can
squeeze the inflationary tendencies out of the
US economy is to take the cost of money and the�international�value of
that paper dollar to levels where employment and domestic business activity
will slump, to put it mildly. If
incoming Fed chief Ben Bernanke follows a true inflation rule, a
US recession is a given.
Subscribers to the IRA Bank Monitor, who for the past
several years have been puzzling over historic low bank loan default rates and
business model skews in favor of mortgage and consumer finance, will not find
Greenspan�s concerns surprising.
Nor will they be taken unawares by our decision today to downgrade the
last three positively rated banks in our model portfolio � US Bancorp
(NYSE:USB), Wachovia (NYSE:WB) and Comerica (NYSE:CMA) � to �3-Neutral� and to
put a negative bias on the entire group.
The surge in US home prices has not only imbedded a huge
proportion of the mortgage market�s aggregate risk on the balance sheets of US
banks and broker dealers, but has done so at a time when tangible levels of bank
capital are at all time lows, a shown in the chart below.
Lead Bank Equity Capital vs. Total
Assets
June 30, 2005
Bank |
TIER ONE
(%) |
TANGIBLE
(%) |
Bank of
America |
9.7 |
4.7 |
JP Morgan
Chase |
8.5 |
4.2 |
Citibank |
7.8 |
4.3 |
Wachovia |
10.4 |
4.7 |
Wells
Fargo |
9.4 |
3.5 |
Washington Mutual |
7.8 |
3.1 |
US
Bancorp |
9.7 |
3.7 |
SunTrust |
10.8 |
5.4 |
HSBC |
8.6 |
6.5 |
World
Savings |
6.9 |
6.5 |
|
|
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SOURCE: FDIC/IRA BANK MONITOR
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Notice that measured based on tangible capital, the bank
subsidiary of Golden West Financial (NYSE:GDW), one of the most conservative
mortgage lenders in the US, and the $141 billion unit of HSCB, are the best
capitalized lead bank units among the ten largest US banks.
Question for the
US bank regulators appearing Thursday before the Senate
Banking Committee in Washington regarding Basel
II : If tangible levels of capital at the
largest US banks are already so low, especially at this stage in
the economic cycle, why should the US seek to further reduce bank capital levels by embracing
Basel II?
As rising interest rates slowly wean Americans off of
their addiction to mortgage refinance as a surrogate for creating real wealth,
the revenue and earnings of banks will also come under pressure � and this at
precisely the time when banks need to be building capital levels to offset
rising default rates.
If
you have questions, comments or for additional information, please contact
us.
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