Tuesday, August 19, 2008

Former IMF Economist Sees Big Bank Going Under

From Reuters:

The worst of the global financial crisis is yet to come and a large U.S. bank will fail in the next few months as the world's biggest economy hits further troubles, former IMF chief economist Kenneth Rogoff said on Tuesday.

"The U.S. is not out of the woods. I think the financial crisis is at the halfway point, perhaps. I would even go further to say 'the worst is to come'," he told a financial conference.

"We're not just going to see mid-sized banks go under in the next few months, we're going to see a whopper, we're going to see a big one, one of the big investment banks or big banks," said Rogoff, who is an economics professor at Harvard University and was the International Monetary Fund's chief economist from 2001 to 2004.

"We have to see more consolidation in the financial sector before this is over," he said, when asked for early signs of an end to the crisis.

"Probably Fannie Mae and Freddie Mac -- despite what U.S. Treasury Secretary Hank Paulson said -- these giant mortgage guarantee agencies are not going to exist in their present form in a few years."

This is not an outlandish claim in the current environment. We've seen about a year worth of writedowns and terrible news in the financial sector. Bear Stearns has already gone under. In short, it's surprising that Bear Stearns isn't the only institution to go under at this point.

So, let's look at this guys statement and see what institutions look like they're on the brink. I'll use Yahoo's Yahoo's Money Center Bank List organized by market cap.

Bank of America

BAC bought Countrywide, which BAC is still saying was a good deal. OK -- stop laughing. Here's a 1-year chart of BAC:


Clearly, the market is having second thoughts about this company. The stock has lost 43.6% of it's value since its peak in mid-October last year. While it has enjoyed a nice bounce over the last month or so, my guess is short covering was at least partially responsible. Regarding the Countrywide merger, BAC used a forward triangular merger, which is a standard corporate reorganization tool under the IRS code (for those of you who are really curious, the actual code section is 26 USC 368(a)(1)(B)). What BAC is doing is creating a "bankruptcy remote" vehicle. Essentially, BAC is placing all of Countrywide's assets into a third company and then looking at them before they bring them onto BAC's balance sheet. This is completely legal and a damn smart move on BAC's part.

But, let's return to BAC's stock chart and make this observation. Traders are not thrilled with this company. They have $147 billion in owner's equity. That's basically total assets minus total liabilities. However, there's a really big rub with this number. According to their balance sheet, BAC has $1.1 billion (65% of their assets) in "long term investments. That means portfolio assets. Those are the assets that everybody is writing down right now. This explains why BAC's stock price has been dropping for the last year -- the market really has no idea what these assets are worth.



That chart looks like a winner, doesn't it? (Of course, if I were to go on a televised news show, I would have to say it was time to buy it because it was so low it must be a bargain at right now). Citigroup has lost 63% of it's value since October of last year -- not a good sign.

Here's problem number one. With a balance sheet in the billions, owner's equity is in the millions. Not good. And it gets worse. Long term investments (think portfolio investments) are 7 times the size of owner's equity. In other words, one good writedown and Citigroup goes to negative net worth. Not a good development in any way shape or form. Citigroup has also reported three straight quarterly losses. Bottom line -- this company is ripe for a fall.



Here's another chart that is clearly in a bear market pattern. WB has lost 70% of it's market value over the last year. And again, there's a really good reason for this. Wachovia purchased Great Western Financial over the last few years. Great Western issued a ton of ARMs, which are now doing poorly. Those ARMs still on the books are really digging into WB. In addition, this is another bank that is hanging on by the skin of its teeth. Long-term investments are 7.8 times the size of owner's equity. In other words, one good writedown and book value turns negative. Not a good development.

The above three are good candidates for big problems down the road. The primary reason is their precarious net worth position -- one good writedown and all three turn negative from a book value perspective. And that's not good in any way.