Exposure at Default: Does Bank America Have Any Alternatives for Countrywide?
September 22, 2010
This week in The IRA we thought to go back to some of the comments we published during the early days of the crisis and update our readers on what has changed and what has not. Given the announcement today by the New York Times that economic guru Larry Summers is leaving the Obama Administration, but apparently Timothy Geithner is not, an inventory of the state of things seems in order.
In our most recent report in The IRA Advisory Service , "Deflation Update: Are We Closer to the End or the Beginning?" we update our view of the forward losses possible for the largest zombie banks. Why do we still refer to the ugly girls -- BAC, JPM and WFC in particular -- as zombies? Because the avalanche of foreclosures and claims against the too-big-too-fail banks has not even crested.
You will recall that when we released our Q2 2010 bank stress index (BSI) ratings for all U.S. banks, ROE and efficiency were the areas of stress that showed elevation, contrary to the view of the industry in the latest FDIC Quarterly Banking Profile. The point of course is not that one perspective is right or wrong. Instead these are two perspectives on the same data which each highlight different issues.
The increased BSI score for efficiency shows that the industry is under rising operational stress, a typical trend as a credit cycle matures. Banks are spending more money on servicing, for example, as well as funding repurchase of defaulted loans from other banks, Fannie Mae and Freddie Mac, and investors. Banks are also increasingly choking on the sheer size of the flow of foreclosed properties, as evidenced by the announcement by Ally Financial (Q1 2010 BSI Rating: "A+") to impose a moratorium on residential foreclosures. Think of the REIT as the new model for banking. The GSEs, Fannie and Freddie, are becoming the largest landowners in America.
Another important data point in this regard is the decision by the Bankruptcy Trustee in the Lehman Brothers liquidation to wind up Aurora Loan Servicing and the related FDIC-insured bank. Aurora is a significant player in the servicing business, but apparently there are no buyers for the servicing book and the Trustee cannot shovel money into the furnace. The most recent, incomplete CALL report for Lehman Brothers Trust Company shows a BSI efficiency score of 1.6 vs. 1.2 for the whole industry (1995=1). In actual percentage, that is an efficiency ratio of 111%, meaning each dollar of revenue was costing the bank over $1 to acquire. That's bad. The bank has apparently been liquidated.
The erosion of the profitability of the U.S. banking industry over the past two years under the glorious Summers-Geithner-Bernanke rescue scheme is the proverbial fly in the ointment for both major political parties. Democrats and Republicans alike are going to be fed into the meat grinder over the next several years as the banking sector deals with literally hundreds of billions of dollars in direct and indirect expenses from the deflation of the mortgage bubble. For the economy, this slow process of muddle along championed by Summers and Geithner will ensure that Barack Obama becomes the Herbert Hoover of the Democratic Party.
The economic carnage that will causes these losses, as we described in a recent post in Reuters, "Double Dip or Global Deflation?," is going to represent the worst economic contraction since WWI. Forget WWII. Think "shrinkage" to use the Gilded Age description for economic deflation. And frankly nothing that either the Fed or Treasury does in the near-term can change this basic economic fact of restructuring. Banks such as Ally, which is the owner of the ResCap legacy portfolio as we all know, can impose moratoriums and issue press releases, but the losses remain. It is only a question of when they are recognized.
Thus we turn the pages back to August of 2008, when we were just returning from our annual Maine fishing trip with David Kotok of Cumberland Advisors. In our comment "Is Countrywide Financial Headed for Bankruptcy?", we described the lawsuit by Bank of New York Mellon (Q2 2010 BSI Rating: "A+") to force Bank of America (JPM/Q2 2010 BSI Rating: "C") to formally take responsibility for the debt of Countrywide Financial. BAC management had made statements to investors during conference calls that Countrywide was being kept "bankruptcy remote" from the BAC parent.
Since then, most talk of a bankruptcy by Countrywide has been squelched because of the legal and practical obstacles involved. We�ll be going into these issues in detail for subscribers to the IRA Advisory Service later this week. Suffice to say that while the legal situation may seem clear and mitigate against a bankruptcy filing by Countrywide to limit legacy claims, both liquidated and unliquidated, the economic situation at BAC and among all of the legacy zombie banks continues to worsen. No amount of bullshit from Washington changes the fundamental economic situation inside the largest U.S. lenders.
In earlier comments, "An Involuntary Transaction: Why BAC + CFC May Never Close", May 6, 2008 and "Update: Are Countrywide Financial Bond Holders Bankruptcy Remote?", May 1, 2008, we had further described the shenanigans by BAC management with respect to the Countrywide acquisition in that year. And as we wrote then and we remind one and all now, the decision by former Treasury Secretary Hank Paulson, Fed Chairman Ben Bernanke and OCC Head John Dugan to slam Countrywide and Merrill Lynch into BAC, Wachovia Bank into Wells Fargo & Co (WFC/Q2 2010 BSI Rating: �B") and Bear Stearns into JPMorgan (JPM/Q2 2010 BSI Rating: �C�) was a fundamental error -- and one that is only creating the precursors for the next systemic crisis.
The difference between the Lehman Brothers bankruptcy and the JPM acquisition of Bear Stearns is that the unliquidated claims against the former firm for securitization and other exposures are all being managed by the U.S. Bankruptcy Court for the Southern District of New York. Jamie Dimon and his shareholders are on the hook for all of the claims against the legacy Bear Stearns securitization business, but Dimon is fortunate compared to his counterparts at WFC and BAC. The claims against Washington Mutual, for example, are sitting in the U.S. Bankruptcy Court in Wilmington -- except, of course, for the covered bonds issued by WaMu and conveyed to JPM via the FDIC receivership. Wonder if our friend Meredith Whitney has noticed this issue yet...
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