Crony Capitalism Strikes Again
How the Federal Reserve is juicing speculators... again.
Consequently, total business debt now amounts to 29.4% of business assets -- a considerable rise from the 25.2% ratio at the bubble peak in late 2007. What the bullish cheerleaders of recovery constantly forget is that in an epochal deflation like the present one, debts remain at their contractual amounts, even as asset values wither.
So the real question regarding the Fed’s green light for bank dividends and buybacks is quite clear. Banks don’t need more capital to make new loans to households and business. What they actually need is to preserve their current artificially bloated retained earnings accounts in order to protect the taxpayers from the next -- virtually certain -- banking meltdown.
In this light, the Fed’s action is especially meretricious. If it weren’t in such a hurry to juice the stock market and thereby keep the illusion of recovery going, it might have considered extending the regulatory sequester on bank capital for a few more quarters or even years -- thereby preserving a shield for the taxpayers until it has been demonstrated by the passage of time, not by the passing of phony stress tests, that the American banking system is truly out of the woods.
After all, the bottled-up profits currently alleged to be resident in the banking system have not been expropriated by the Fed; they have just been temporarily sequestered -- a condition that these wards of the state should gladly endure in return for continued access to taxpayer backed deposit insurance and the Fed’s borrowing widow, as well as their license to engage in the lucrative business of fractional reserve banking. Indeed, the fast money should be as capable of pricing-in any “excess” capital in the banking system, as it has already been in goosing bank stocks in anticipation of higher profit distributions.
And it is here where the historical data on Bernanke’s 12 out of 13 crashing financial dominoes essentially speaks its own cautionary tale. At the peak of the credit and housing boom in 2006, these 13 most important financial institutions booked $110 billion of net income, and disgorged more than $40 billion of that amount in dividends and stock buybacks.
Would that these fulsome profits and attendant distributions had been real and sustainable, but the historical facts inform otherwise. By 2007, the groups’ profits had dropped to $64 billion, and then in 2008, the ten institutions which survived to year-end reported a staggering loss of $56 billion. Moreover, if the massive loses incurred by the bankrupt three -- WAMU, Wachovia, and Lehman -- during their final, unreported stub quarter are added to this tally, group losses for the year would approach $80 billion.
The unassailable truth here is that in 2006 and 2007 the banks were disgorging phantom profits to their shareholders. When the crunch came in 2008, bank capital had been badly depleted by these unwarranted dividends and stock buybacks, and soon Mr. Bernanke was running around with his limited shock of hair fully ablaze.
The danger, of course, was buried in the balance sheets all along. Back in their 2006 heyday, the top 13 financial institutions had $10.2 trillion of total assets -- and a not inconsiderable portion of that figure was worth far less than book value, as ensuing events proved. Today the nine banks which are the survivors and assigns of these 13 institutions still have $10.1 trillion in asset footings---hardly a measureable reduction despite the goodly amount of write-offs which have been taken in the interim.
The Fed’s foolish wager -- and it is foolish because there is no real purpose other than a momentary boost to bank shares -- is that this once toxic waste ridden $10 trillion balance sheet is now squeaky clean. Yet why would any sane observer embrace that dubious proposition?
While the banks have been relieved of mark-to-market accounting, they are still knee-deep in the very asset classes whose ultimate recoverable value remains exposed to the real estate meltdown. Residential housing prices are now clearly in the midst of a double dip, and rates of new construction and existing unit sales are spilling off the bottom of the historical charts.
Still, the banking system holds $2.5 trillion of residential mortgages and home equity lines -- plus $350 billion of construction loans and more than a trillion of mortgage backed securities. Maybe they have enough reserves to cover the remaining sins in this $4 trillion kettle of residential debt, but betting on housing bottoms has been a widow-maker for several years now -- and there is nothing on the horizon to suggest that this epochal bust will not make a few more.
Likewise, the banking system is carrying $1 trillion of commercial real estate loans, and the open secret is that “extend and pretend” refinancing is the primary underpinning of current book values. Similarly, the Fed has rigged the steepest yield curve in modern times, but it is a fair bet that as it is gradually forced to normalize interest rates, current record net interest margins will be squeezed. And it is also probable that some of the $2.7 trillion of government, corporate and other securities owned by the banking system may be worth less than par in a world where money rates are more than zero.
In short, a banking system that by the lights of the Fed was on the verge of extinction just 28 months ago could not possibly have gotten well in the interim. In shades of 2006, the nine survivors did report net income of $54 billion in the year just ended, and it is these retained earnings that have purportedly brought bank capital ratios to the pink of health. Then again, the cynic might wonder whether the trading book and yield curve profits of 2010 might not vanish just as fast as did the mortgage origination, securitization and trading profits of 2006-2007.
One thing is certain, however, and that is that these behemoths are now truly too big to fail. At the end of 2006, the asset footings of the Big Six -- JPMorgan (JPM), Bank of America (BAC), Wells Fargo (WFC), Citigroup (C), Morgan Stanley (MS), and Goldman Sachs (GS) -- were $7.1 trillion. Saving the system through shotgun marriages, our financial overloads have permitted the group to grow its assets during the interim by 30% to $9.2 trillion.
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