We’re not quite as healthy as we thought we were. Oops. (WSJ)
J.P. Morgan Chase Chief Executive James Dimon said…that March was a little tougher than the first two months of the year….Bank of America…CEO Kenneth Lewis also said that March had been a tougher month for his bank. [Convenient that they dumped this on Friday afternoon, and at the close of a very good week.]
Readers may recall that a few weeks ago, those two CEOs—along with Citi’s Vikram Pandit—said the first two months of the year had been very good:
Pandit, March 10th: “We are profitable through the first two months of 2009 and are having our best quarter-to-date performance since the third quarter of 2007.”
Dimon, March 11th: “Jamie Dimon, the chief executive of JPMorgan Chase, said Wednesday that the bank was profitable in January and February…”
Lewis, March 12th: “We have been profitable for the first two months of the year,” Lewis told reporters after a speech in Boston today.
This was possibly the most nakedly self-serving bullshit the big bank CEOs have offered to date. (“bullshit” being a technical term of course, see Harry Frankfurt)
By February, it was understood that their firms are all insolvent. None could stand on its own; certainly not without the trillions of dollars committed by the public to backstop the banking sector. To deal with them, consensus among the cognoscenti was finally tending to a proper recapitalization: wiping out shareholders and forcing losses onto creditors via debt-for-equity swaps. Call it nationalization, call it preprivatization, call it FDIC receivership, it was clear that losses had to be recognized and by those to whom they properly belong: investors across the banks’ capital structure.
But no one really wanted to do this, not in Congress and certainly not in the Obama administration, where Timmy Geithner has made clear that his priority isn’t a cleansed banking sector, it’s a privately-owned one. For obvious reasons the banks don’t like this solution either. So they offered up their self-serving b.s. regarding January and February, buying just enough time for Congress/Bernanke to badger FASB into changing mark-to-market rules and for Geithner to roll out his private-public partnership plan.
Now whatever losses the banks can’t hide with revised accounting treatments, they can simply fob off on taxpayers via the partnerships. They got what they always wanted: A bad bank! An entity that will actually absorb losses from the asset side of the balance sheet! Shareholders and creditors don’t have to worry about further writedowns, not the ones that can’t be hidden anyway. Taxpayers will pick up the check!
Even better, the Geithner plan is so ridiculously complex—and public disclosure is likely to be so minimal—that toxic asset transfers are likely to happen largely out of view. Maybe Treasury will have to increase its borrowing substantially in order to fund the losses, but by that point everyone will be celebrating that banks have started lending again. Hooray!
Speaking of which, there are no substantial protections to prevent banks from gaming this plan.* What’s to stop them from paying an investor to put up the equity for one of Geithner’s partnerships in order to effect a transfer of toxic assets from their own balance sheets to the public’s?
And of course other credit investors love this plan because it takes them out of the line of fire. It’s no wonder PIMCO’s Bill Gross threw his support behind the plan so early. As one of the world’s largest credit investors, he’d be next in line after shareholders to absorb losses on “toxic assets” if they were properly handled, that is, written down. That’s why Gross has argued so vociferously that we must “support asset prices.” Now he can do so himself at little cost, putting up a sliver of equity to fund a Geithner partnership in order to remove risk from his own balance sheet. This gets him a free lunch courtesy of taxpayers.
This is all of a piece. The longer CEO/policy-maker collusion can delay loss recognition, the more time they have to invent ridiculous leverage schemes (more money printing! more government borrowing to fund “stimulus”! more FDIC “guarantees”!) to inflate those losses away…and to continue looting the public’s wealth.
But losses aren’t going away. Trading smaller private liabilities for larger public liabilities in order to artificially inflate asset prices does nothing to repair the economy’s aggregate balance sheet. At the end of the day, we’re still just lending more and more against a dwindling pool of real equity. The unwind is coming. Adding more leverage to delay it will only increase the pain.
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*A reader points me to the following from FDIC’s legacy loan term sheet: “Private Investors may not participate in any PPIF that purchases assets from sellers that are affiliates of such investors or that represent 10% or more of the aggregate private capital in the PPIF.” That’s something at least. Though what’s to stop mutual back-scratching? “I’ll vacuum up your legacy loans in my partnership if you deal with mine in yours…”
BTW, the following bit I found in the WSJ is quite worrisome:
“Federal Deposit Insurance Corp. Chairman Sheila Bair said Thursday she would be open to letting banks see some of the profits if they dump problem loans that ultimately recover some value….
Ms. Bair said banks might be able to take an equity stake in those funds as partial payment for their loans, which would give them a payoff if the loans ultimately rise in value and would provide bankers with more incentive to sell troubled assets.
“We’d be open to comments on that,” Ms. Bair said.”
Nothing about this smells good.
on modeling structured finance cash flows. Recently he wrote his 
book and is now planning a third. With all the talk of increased financial regulation, Keith wrote a post about one corner of the structured finance world he hopes won't be overlooked. He can be contacted at keith.allman at enstructcorp.com]
