Rolfe Winkler

Arianna Huffington and Rob Johnson are organizing a big bank boycott. They want depositors to take their money out of Too-Big-To-Fail banks and put them in smaller, high quality banks.

They’ve launched a new website and have teamed up with Chris Whalen to give folks other options. Whalen’s firm, Institutional Risk Analytics, has a proprietary system that grades banks using FDIC data. Enter your zip code and Whalen provides a list of high quality banks in your area.

It’s a potentially powerful combination. Huffington has wide reach due to her media ubiquity and popular website. Johnson, once a portfolio manager for George Soros’s Quantum Fund, is a successful veteran of high finance who’s spoken out against the danger of derivatives and will head Soros’ $50 million Institute for New Economic Thinking. Leveraging Whalen’s data means the two can do more than simply ask folks to move their money. They can provide better options.

(You can read more about it in this column published at HuffPo.)

I applaud the effort and plan on taking them up on it. Some of my savings currently reside at a TBTF bank, earning nothing, and I plan to move the account shortly.

When bloggers like me talk about creditors holding banks responsible for the risk they take, that includes bank depositors. If you have deposits in a bank — a CD, checking or savings account, for example — you are a creditor of your bank. Moving your deposits out of banks that benefit from too-big-to-fail guarantees is a tangible way you can protest bailouts.

I do have one small quibble with the Huffington/Johnson site, in particular the YouTube video they’ve produced. The idea that fat cat bankers — “Potter” from It’s a Wonderful Life stands in — are solely responsible for the crisis oversimplifies the issue. Plenty of smaller banks have gotten themselves into trouble with irresponsible lending. FDIC’s problem bank list now stands at 552, composed mainly of smaller banks.That’s 7% of all FDIC insured institutions in case you’re wondering.

It also lets the rest of us off the hook. Without willing investors and an assist from Alan Greenspan’s low rates, big banks couldn’t have inflated the bubble. Yeah, many should have known better. But let’s face it, Wall Street bankers aren’t the only ones that are greedy.

I also worry that big banker baiting could lead to violence if/when the financial sh*t again hits the fan.

But again, that’s a small quibble. Huffington/Johnson/Whalen — all great folks I’ve had the chance to speak with in the past — are spot on with this effort.

What truly separates community bankers from the big boys is that they can fail. If they mess up, they end up in FDIC receivership. If they lose, they pay for their own mistakes. That’s why this effort should hold particular appeal to financial conservatives.

If it weren’t for the moral hazard created by deposit insurance, depositors would flock to banks that lend conservatively. In the meantime, the best thing we can do is take our money out of quasi-public banks like Chase, Citi, Wells, BofA, Ally, et al and move them to banks that operate free of government support.

More at Move Your Money.

Due to new accounting rules — FAS 166 and 167 — banks have to bring certain off balance sheet assets back onto their balance sheets starting next year. More assets, same capital = lower capital ratios. (More in this column about the individual impact on the large banks).

Anyway, the FDIC has agreed to give big banks a 6 month reprieve on raising new capital to buffer the new assets. From Ian Katz at Bloomberg:

The Federal Deposit Insurance Corp. gave banks including Citigroup Inc., Bank of America Corp. and JPMorgan Chase & Co. a reprieve of at least six months from raising capital to support billions of dollars of securities the firms will be adding to their balance sheets.Bank regulators including the FDIC and Federal Reserve want to permit a phase-in of capital requirements that rise starting next month under a change approved by the Financial Accounting Standards Board. The rule, passed in May, eliminates some off- balance-sheet trusts, forcing banks to put billions of dollars of assets and liabilities on their books.

“We’re still recovering from the damage these structures caused,” FDIC Chairman Sheila Bair said, explaining that the entities contributed to the financial crisis. The phase-in recognizes the “very fragile stage in our economic recovery,” she said at a board meeting Washington.

While Citi and Wells were raising capital this week to repay TARP, FDIC should have had them go for a few billion more to offset the impact of FAS 166/7.

From WSJ: Wall Street on track to award record pay

Major U.S. banks and securities firms are on pace to pay their employees about $140 billion this year — a record high that shows compensation is rebounding despite regulatory scrutiny of Wall Street’s pay culture.

Workers at 23 top investment banks, hedge funds, asset managers and stock and commodities exchanges can expect to earn even more than they did in 2007, according to an analysis of securities filings for the first half of 2009 and revenue estimates through year end by The Wall Street Journal. Total compensation and benefits at the publicly traded firms analyzed by the Journal are on track to increase 20% from last year.

These companies paid $130 billion in compensation and benefits in 2007, at the stock market’s peak. That fell to $117 billion last year.

Using company filings for the first half and revenue estimates for the second half, WSJ estimates projected compensation per employee at top Wall Street investment firms. Here is a link to the raw data, below a list of the top 10.

NOTE: This includes only public companies

• Blackstone: $4.04 million per employee
• Och-Ziff: $878k
• Goldman Sachs: $743k
• Jeffries: $514k
• Lazard: $473k
• BlackRock: $318k
• Legg Mason: $291k
• Eaton Vance: $280k
• IntercontinentalExchange: $279k
• Morgan Stanley: $263k

Investors have more than one reason to celebrate two new accounting rules. Besides forcing banks to fess up to the risks they are carrying on their books, new standards for off-balance sheet assets will make it harder for companies to inflate earnings artificially.

The new rules – FAS 166 and 167 – are desperately needed to prevent banks from hiding assets to increase leverage. Lending that isn’t supported by capital is a main ingredient behind unsustainable credit bubbles, and banks’ off-balance sheet games played a big role in the most recent one.

But another reason banks like off-balance sheet structures is that it enables them to manufacture profits.

Coming up to the end of a quarter, if a company is a bit short of its earnings target, it can package some assets together into a security and “sell” them to an off-balance sheet entity.

The entity is conjured out of thin air with a small equity investment by the company itself. The entity “buys” the securitized assets at a nice markup, enabling the company to book a profit on the sale.

Is it really a sale if the company still owns the risk? Of course not. If I sell an asset to you, a share of stock for instance, then I transfer all the rights of ownership. Any gains or losses in the stock are yours alone.

With many off-balance sheet entities, however, companies aren’t really transferring risk to anyone else. They’re just pretending to do so in order to lever up and recognize a gain.

It’s the acknowledgment of risks that is most important. Pushing assets off balance sheet — into the “shadow banking system” — put them beyond the reach of regulators, whose job it is to make sure banks have enough capital to absorb losses.

For their part, banks like to fly as close to the sun as possible, operating with as thin a capital cushion as regulators will allow. This is the essence of leverage. The more assets a firm controls relative to the equity on its balance sheet, the higher its potential returns on equity.

If you put down 20 percent to buy a house, and the house’s value appreciates 10 percent, then the return on your equity is a tidy 50 percent. But if you put down 5 percent, that same 10 percent increase in price is a 200 percent return.

The trouble with this strategy is that it works in only one direction. If asset prices fall, banks with smaller equity cushions go horizontal rather quickly.

At the height of the bubble, big banks were operating with equity cushions in the range of 2 to 3 percent. And that was before accounting for off-balance sheet assets.

Since then, banks have raised more capital, putting them in the range of 4 to 5 percent, but bringing assets back on balance sheet will have a meaningful impact. Citigroup will be adding $159 billion of assets, Bank of America $150 billion, JP Morgan Chase $130 billion and Wells Fargo $109 billion.

Goldman Sachs and Morgan Stanley haven’t yet disclosed how much they will be bringing back on, according to their most recent quarterly filings with the SEC.

Unfortunately, and contrary to recent comments about the importance of raising capital from President Barack Obama and Treasury Secretary Timothy Geithner, regulators are considering giving banks a year to phase in these assets for regulatory capital purposes.

This seems foolish. With equity markets nice and bubbly again, it’s not very difficult for banks to sell stock. If regulators make clear that additional capital will be required soon, banks may actpre-emptively to raise it now.

The system will certainly be stronger if they do.

President Barack Obama pledged on Monday “to put an end to the idea that some firms are ‘too big to fail.’”  Though he outlined some worthy prescriptions, he failed to face up to the very size and power of the financial institutions that makes “too big to fail” possible.

For the big have gotten even bigger since the start of the financial crisis. At the end of 2007, the Big Four banks — Citigroup, JPMorgan Chase, Bank of America and Wells Fargo — held 32 percent of all deposits in FDIC-insured institutions. As of June 30th, it was 39 percent.

(If the image doesn’t load, click here.)

In total, they had $3.8 trillion worth of deposits as of June 30th. Compare that figure to the FDIC’s Deposit Insurance Fund, which showed a balance of just $10.4 billion on the same date.

The FDIC has been the most effective regulator since the onset of the crisis, closing down failed banks in order to limit risk to taxpayers. But its resources are woefully inadequate to deal with the largest institutions. (I am excluding the $500 billion credit line it has at Treasury; those are taxpayers’ resources, not FDIC’s.)

And that’s just the commercial banking side. These banks — especially Citigroup, Chase and Bank of America — have huge investment banking operations that are maddeningly complex and, systemically-speaking, very dangerous.

Obama certainly recognizes the problem — “the system as a whole isn’t safe until it is safe from the failure of any individual institution.”

But his recommendations — more stringent capital requirements, stronger rules and a “resolution authority” to cope with systemic meltdowns — won’t solve it once and for all.

To be sure, higher capital requirements are a very good start. They not only give banks a bigger cushion to deal with losses, they also limit the amount of credit they can flush through the system. This is a good thing: Too much credit is the air that inflates dangerous asset bubbles in the first place.

But higher capital requirements won’t make too-big-to-fail banks much smaller. At best they will penalize the biggest banks by reducing their returns on equity, giving smaller banks a leg up competitively.

A tax on assets is another good idea to discourage growth, but what we need is more aggressive action to force shrinkage.

For instance, resurrecting a version of Glass-Steagall would be highly sensible. Commercial banks have no business using their federally-insured balance sheets to finance risky investment banking operations. The two functions should be split.

And what ever happened to anti-trust laws? Among them, Citigroup, Chase and Bank of America control two-thirds of the credit card market. That stranglehold gives them significant leverage vis-à-vis consumers.

Another issue is derivatives, which Obama didn’t really address.

Notional exposure still totals tens of trillions at the biggest banks. Sure, many of these positions offset one another, but that assumes the daisy chain won’t break. To insure market integrity, the biggest players in it all have to get an explicit “there will be no more Lehmans” guarantee.

This gets to the heart of the issue. Though Obama says a return to “normalcy” means emergency rescue facilities can end, it’s a safe bet that they’ll come right back the next time we have a systemic event.

The only way to ensure we’ll never need them again is to eliminate too-big-to-fail banks. The fastest way to achieve that is to break them up.

Paul Miller, the analyst that covers banks and thrifts for FBR Capital Markets, put out a report today breaking down Tim Geithner’s Framework for Reforming Banking Firms. Geithner’s plan is a good document, showing that Treasury takes very seriously the need to establish tougher, more robust capital requirements for banks. Miller broke down the recommendations in the handy chart below.

If you have trouble reading it, here is the PDF (linked to with permission).

(Click the table to enlarge in a new window)

Miller can take some credit for influencing Geithner’s report. More than any other analyst, he has emphasized the importance of tangible common equity as the best buffer to protect banks from collapse.

There were five bank failures tonight.  Two of meaningful size, but none in Georgia!

We’re still waiting on two big fish, however, Guaranty and Corus.  In an SEC filing today, Corus said it was “critically undercapitalized” with Tier 1 Capital of $157 million.  They also admitted is was “highly unlikely” they’d be able to raise capital, so FDIC seizure is a matter of when, not if.  Next Friday may be the day. (ht CR)

And we have a new addition to the Bank Death Watch list: Colonial BancGroup, which late today expressed doubt it can continue as a going concern.  With $26.4 billion of assets and $24.6 billion of deposits as of March 31st, it’s larger than Corus and Guaranty put together.

#65

• Failed Bank:  First State Bank of Altus, Altus OK
• Acquiring Bank: Herring Bank, Amarillo TX
• Vitals: At 6/19/09, assets of $103.4m, deposits of $98.2m
• DIF Damage: $25.2m

#66

• Failed Bank:  Integrity Bank, Jupiter FL
• Acquiring Bank: Stonegate Bank, Ft. Lauderdale FL
• Vitals: At 6/5/09, assets of $119m, deposits of $102m
• DIF Damage: $46m

#67

• Failed Bank:  People’s Community Bank, West Chester OH
• Acquiring Bank: First Financial Bank NA, Hamilton OH
• Vitals: At 3/31/09, assets of $705.8m, deposits of $598.2m
• DIF Damage: $129.5m

#68

• Failed Bank:  First Bankamericano, Elizabeth NJ
• Acquiring Bank: Crown Bank, Brick NJ
• Vitals: At 7/16/09, assets of $166m, deposits of $157m
• DIF Damage: $15m

#69

• Failed Bank:  Mutual Bank, Harvey IL
• Acquiring Bank: United Central Bank, Garland TX
• Vitals: At 7/16/09, assets of $1.6b, deposits of $1.6b
• DIF Damage: $696m