Back on 25th March, I wrote in regard to the Geithner toxic asset PPIP scheme that:
'The key issue isn't investor appetite, but bank reluctance to face up to the true market value of their portfolios; less than 20% is currently marked to market, the rest at par or marked to model. Will they really sell into auctions that will explicitly confirm the inadequacy of their capital positions and undermine the credibility of their internal risk models?'
Well, now we have our answer; they won't. Astonishingly, the Treasury is quietly shelving the PPIP scheme, hoping that $100bn of equity issuance (including the imminent Citi deal) and the boost to earnings from a steep yield curve and economic recovery will somehow be sufficient to bolster bank balance sheets. That looks quite unbelievably reckless to me, and pretty much guarantees another solvency crisis sooner rather than later. Of the ten banks now returning TARP money, eight had been pressed by the government to take funds in October, amid efforts to shore up the banking system. Although some individual institutions now claim that they took the money unwillingly, government intervention was necessary to prevent the entire system from collapsing as trust between banks evaporated as they all held unknowable quantities of impaired derivative assets; we were literally hours from systemic financial meltdown.
Even today all banks remain plugged into government life support systems. Central banks still provide generous collateral rules for borrowing, in an effort to provide banks with liquidity. Although some banks have managed to issue debt without government guarantees, the global banking system needs to refinance some $25.6 trillion of wholesale funding by 2011: without an implicit state back stop this would be impossible. And the value of banks’ assets is being sheltered by central banks’ asset purchasing programmes and in some cases flattered by more generous accounting rules.The fact is that the US has a dangerously under capitalized banking system even now after huge equity issuance, that is being spoon fed by Fed policy to earn its way back to health.
I've been reading through Moody's recent Annual US Banking System Review in which they predict that US rated banks will incur a total of approximately $470 billion (pre-tax) of loan and security losses and write-downs in 2009 and 2010. The lending portion of this estimated loss is $415 billion, or 8% of the industry’s outstanding loans at the end of last year. As a result of these substantial asset quality problems and the need to build reserves, many US banks will be unprofitable in 2009, placing considerable strain on their capital levels. Despite heightened provisioning over the past several quarters, banks’ coverage of bad loans continues to drop; the ratio of allowance for loan losses to non-performing loans stood at 70% at March 31, 2009 versus 100% in the first quarter of 2008.
The conclusion is sobering, and at odds with the Wall Street cheerleader's view: "Under more adverse conditions, numerous US banks could become insolvent by the end of 2010,” said Moody’s.“More specifically, based on our modeling of such an adverse scenario, we calculate that US rated banks could incur a total of approximately $640 billion (pre-tax) of loan and security losses and write-downs in 2009/2010; without additional capital, this means that more than a third would fall below investment grade on a standalone basis.”
The window of opportunity to tackle the political and economic dominance of finance in the US has now closed, at least until an even deeper crisis unfolds. We are left with a dysfunctional and unreformed sector, that is systematically misreporting both earnings and balance sheet marks, with the connivance of the regulators meant to enforce objectively (the FDIC is an honourable exception, but toothless). The Obama Administration has pulled its punches in tackling the bank Oligarchy, allowing bankers to resume their intense lobbying for favour in Washington. It, and the broader economy, will pay a heavy price for the failure.
