Rolfe Winkler

The BBC reports on the latest subprime writedown at a major bank. The conventional wisdom is that most of the subprime related credit losses that have to be taken already have been. Going forward, a larger problem for bank net income will likely be increasing provisions for loan losses, as opposed to straight writedowns on holdings gone South. Here’s a list of writedowns to date for major banks worldwide:

MAIN CREDIT LOSSES SO FAR

• Citigroup: $40.7bn
• UBS: $38bn
• Merrill Lynch: $31.7bn
• HSBC: $15.6bn
• Bank of America: $14.9bn
• Morgan Stanley $12.6bn
• Royal Bank of Scotland: $12bn
• JP Morgan Chase: $9.7bn
• Washington Mutual: $8.3bn
• Deutsche Bank: $7.5bn
• Wachovia: $7.3bn
• Credit Agricole: $6.6bn
• Credit Suisse: $6.3bn
• Mizuho Financial $5.5bn
• Bear Stearns: $3.2bn
• Barclays: $3.2bn

Source: Bloomberg and company reports

The main impact of credit losses is that they reduce bank lending. A handy way to think about it, is that banks typically lend out $10 for every $1 in capital on the books. So credit losses of this magnitude can be incredibly DEflationary.

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….is to sell assets. Citigroup has cut its dividend, raised billions from new stock offerings and preferred placements to foreign wealth funds, but they’re likely sitting on billions more of credit losses, depending on how the residential and commercial real estate markets perform. And credit losses will continue to be a hit to earnings (and capital) as the bank is forced to maintain higher than average credit loss provisions over the next few years.

All the losses are giving CEO Pandit cover to shed assets. It’s been clear for some time that the behemoth Sandy Weill built is totally bloated and not benefiting from “synergy.” The Travelers insurance business was spun off years ago. Now it’s time to shed more assets.

It will be interesting to hear details from the company’s analyst day.

Some early details from the WSJ:

Citigroup Inc. plans to wind down more than $400 billion in assets over the next two to three years as the financial-services giant moves to slim down under new Chief Executive Vikram Pandit.

The disclosure is part of the company’s presentation at its annual investor & analyst day.

Citi has recorded some $40 billion in write-downs the past three quarters amid the fallout from the credit crunch and seen credit costs surge amid increased delinquencies and charge-offs. As a result, the company has raised roughly $40 billion in new capital in recent months, including some $12 billion the past several weeks.

Citi said it had nearly $500 billion in so-called legacy assets as of the first quarter, nearly half of which being low-return. Nearly two-thirds is in consumer banking and one-third in securities and banking segment. The company plans to shed all those assets from securities and banking — excluding alternative investments — and more than 50% at consumer banking. The company plans to cut the amount to under $100 billion in two to three years.

For Central Banking junkies out there, Grep Ip is the journalist you need to read. He covers all things Fed for the WSJ. Yesterday he published a fascinating article about the Fed’s request to start paying interest on reserves held in its vaults. This would give the Fed yet more power to control the money supply, and would help avoid the consequence of pushing the Federal Funds rate toward 0% if they’re forced to act more aggressively to pump liquidity into the markets (see Economic Busts: Japan, circa the last 18 years).  It would probably also discourage banks from hiding assets in off balance sheet vehicles.  The more assets banks have ON the balance sheet, the more 0% interest reserves they must park at the Fed.

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Good to see the NYT jumping on board the argument I made in January on the op-ed page of the Baltimore Sun (hat tip JJW) (update: the CS Monitor is joining the bandwagon too–hat tip Patrick). A snippet from the NYT piece:

As home prices continue their free fall and banks shy away from lending, Washington officials have increasingly relied on two giant mortgage companies — Fannie Mae and Freddie Mac— to keep the housing market afloat.

But with mortgage defaults and foreclosures rising, Bush administration officials, regulators and lawmakers are nervously asking whether these two companies, would-be saviors of the housing market, will soon need saving themselves.

The companies, which say fears that they might falter are baseless, have recently received broad new powers and billions of dollars of investing authority from the federal government. And as Wall Street all but abandons the mortgage business, Fannie Mae and Freddie Mac now overwhelmingly dominate it, handling more than 80 percent of all mortgages bought by investors in the first quarter of this year. That is more than double their market share in 2006.

But some financial experts worry that the companies are dangerously close to the edge, especially if home prices go through another steep decline. Their combined cushion of $83 billion — the capital that their regulator requires them to hold — underpins a colossal $5 trillion in debt and other financial commitments.

The companies, which were created by Congress but are owned by investors, suffered more than $9 billion in mortgage-related losses last year, and analysts expect those losses to grow this year. Fannie Mae is to release its latest financial results on Tuesday and Freddie Mac is to report earnings next week.

The companies are sitting on as much as $19 billion in additional losses that they have not yet fully acknowledged, analysts say. If either company stumbled, the mortgage business could lose its only lubricant, potentially causing the housing market to plummet and the credit markets to freeze up completely.

And if Fannie or Freddie fail, taxpayers would probably have to bail them out at a staggering cost.

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Two weeks ago, I said it. Now commentators are saying the same thing on the WSJ op-ed page and on SmartMoney.com (snippets below): house PRICES may still be at historical highs, but house AFFORDABILITY is not, which may mean prices don’t have to fall any farther. The crucial forgotten variable is mortgage rates.

Here’s what I noted two weeks ago:

With a fixed rate 30-year mortgage of 18%, a $2000 monthly payment will buy $132,000 worth of home. Cut the interest rate to 6% and the same $2000 payment will buy $334,000 worth of home.

In terms of affordability, the two homes are totally equivalent. Remember, when you buy a house with a mortgage, your monthly payment has two components: a principal payment to pay down the debt on the total cost of the home AND interest on that debt.

While I agree overall that house prices have to fall, I’ve become skeptical about conclusions drawn from [analyses comparing house PRICES to median income]. The fundamental flaw I see is that it is based on a home’s price, not the total cost of home ownership. Maybe I’m missing something here, but it strikes me as obvious that house prices relative to income were lowest in 1982…interest rates were 18%!

If incomes are stagnating, and they are, then affordability is the key. What percentage of your income is actually being used on a monthly basis to pay for the roof over your head? The two authors I’ve cited use the house affordability argument to claim that the housing market has hit bottom.

But I’m not so sanguine. There are three problems with concluding that home affordability today means house prices have no farther to fall:

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Warren Buffett hosted the annual shareholders meeting in Omaha today. If the investing world has a rock star, Buffett is it:

31,000 people attended the meeting. Once upon a time (when I was in junior high) I wrote a letter to him, recommending a stock. [Cracker Barrel, ticker CBRL: seems I was enthralled with the synergy of selling tchotchkes in a restaurant.] And I got a letter back! Which I lost. He (=his ghost-writing secretary) wrote back that I had a good nose for stocks and included an invite to the annual meeting….I never made it.

Probably a mistake. As my nose for stocks wasn’t really that well developed:

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