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Saving Mr. Moynihan From the Real Problem at Bank of America


While many were blaming the recent move down in BofA stock on S&P's latest ratings downgrade, stock price has a much more important correlation that investors need to consider.

Last night, before the central bankers' magic wands were "coordinatedly" waved, Bank of America (BAC) stock dipped in the aftermarket below $5 per share, a Maginot Line for investors. And while many TV pundits and financial analysts were blaming the latest move down in the stock on S&P's latest ratings downgrade, I'd offer that BofA's stock price – both current and long term – has a much more important correlation that investors need to consider, and that is the bank's (and arguably all banks') inexorable link to social mood.

At their core, financial institutions are nothing more than a real time confidence barometer. When you cut through it all, borrowers' willingness to borrow and lenders' willingness to lend reflect their confidence in the future. And the same is true for investors and traders. The net though, particularly for an integrated financial services firm like BofA, is that their revenues are tied like few others to how we feel.

But so, too, are their assets, liabilities, and capital. To a bank balance sheet, confidence acts like adrenaline boosting loan volumes and greater and greater risk taking, while fear serves as Kryptonite with borrowers retrenching (and defaulting) at the same time the markets want to see both higher quality liabilities and more and better quality capital. And so, too, do the regulators.

For BofA CEO Brian Moynihan, it must feel like he's George Clooney in The Perfect Storm. Honestly, though, he shouldn't be surprised by the current weather. Better than any analyst report, I think this chart, which plots Bank of America's common stock price against the Bloomberg Consumer Comfort, describes why life is so hard today for the firm.

Click to enlarge

After an 11-year decline in confidence, is it any wonder consumers don't want more debt? Or that firms like BofA are being vilified for their actions? Or that home prices are weak? Or even that litigation is rising and that the consequences of adverse rulings are becoming greater and greater?

I don't think so.

But I also couldn't help when looking at the chart above but think about all of the common stock that Bank of America bought back from 2004 to 2008 believing that the prices were only going to go higher and higher, and how the confidence inside of Bank of America had decoupled from the mood of the clients the firm served.

Not only is Mr. Moynihan now having his George Clooney moment, but his predecessors sold his raincoat because they never bothered to look outside to see the social mood storm clouds looming on the horizon.

But I'd also offer that Mr. Moynihan is not helping himself. The notion that asset sales and higher debit card fees will be sufficient to stem the firm's capital needs, I am afraid, woefully ignores the historical linkage with social mood. Unless mood improves, asset values will decline further, liabilities will grow (particularly those related to litigation), and the clamoring for higher and higher levels of capital from both the market and the regulators will swell. And needless to say, any further deterioration in mood will only add to the toxicity of bank bailouts and higher fees in Washington and on Main Street.

Banks' earnings and balance sheets directly reflect the mood of those they serve. Heck, even the rating agencies now get that.

From my perspective, rather than fight it, BofA and many other financial institutions would be wise to accept the clear correlation. And as one who has been writing about the systemic need for more capital for some time (see Why Our Banking System Needs More Capital Now), I would strongly encourage financial services firms to stare long and hard at the chart above. No longer do I believe the question is if banks will raise capital, or even when banks will raise capital, but simply whether banks will still have the opportunity to raise capital at all when they finally realize that they need to.

For financial services firms, the same deterioration in mood that so adversely affects their earnings and balance sheets is also the same mood decline that makes capital raising more and more difficult.

Hopefully somewhere out there are a few young bank trainees will write that thought down on a piece of paper and put it in their desk drawer so they can pull it out again when everyone 50 years from now is once again talking about the Goldilocks Economy like they were in 2007.

Needless to say, no one left Mr. Moynihan that note.

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