Considering it was just a year ago when we were jolted into this banking-induced recession, you can imagine my astonishment when I read this recent Forbes headline:
“Dubai's Failure Exposes A U.S. AdvantageI’m also equally perplexed by Dick Bove, a widely followed banking analyst, suggesting “Bank of America (BAC) should beg Ken Lewis to stay,” and that “The success of this bank is due to the brilliance of Ken Lewis as a visionary and tactician.”
The well-regulated U.S. financial sector has a lot to show for itself.”
We are talking about Ken Lewis, who has failed his fiducially duty to shareholders by not disclosing the Merrill Lynch loss, and who literally charged Bank of America (BAC) into bankruptcy all the way till the end if not for the taxpayers.
Many experts have debated whether the systemic problem is the excessive consumer debt or primarily an issue of leverage within the financial system. Although a high US consumer debt was certainly a contributory factor, arguably it was the excessive leverage within the financial system that pushed us into this recession.
The mark-to-market accounting further exacerbated the net impact of this high leverage after the U.S. housing bubble burst. That subsequently led to a domino effect spreading across the globe due to the interconnected global banking system.
Since then, lending has come to a screeching halt as financial institutions hoarded cash (from the government, i.e., taxpayers) to shore up their balance sheet. Businesses reacted to the credit freeze by cutting production, deferring spending, and slashing employment, leading to the current 10% headline unemployment rate.
Worse yet, the mess from the over-leveraged financial sector may not be over. The International Monetary Fund's chief, Dominique Strauss-Kahn, was quoted last week as saying half of the losses suffered by banks could still be hidden in their balance sheets, more so in Europe than in the United States.
Reuters also reported that U.S. banks held $1.65 trillion of commercial real estate loans on their balance sheets as of November 4th, and that the banks could still face a “major commercial real estate storm.”
This means a possible second or even third bailout may be on the horizon at a time when the U.S. national debt has hit a record $12 trillion, and is expected to soon exceed the $12.1 trillion maximum amount of debt allowed by law.
Moreover, there are deeper and wider issues surrounding off-balance sheet disclosure and reporting (remember Enron?). For instance, Wells Fargo (WFC) could face up to $1.1 trillion in off-balance sheet exposure, which might partly explain why Wells Fargo has not paid back its $25 billion in TARP borrowings yet.
Another example of the questionable banking regulation lies with the derivatives market - the billions of dollars in derivatives profit masked by the opacity of the market, but controlled by the biggest dealers like J. P. Morgan (JPM) and Goldman Sachs (GS). These same big bankers are now feverishly lobbying Congress for exemptions from the proposed derivatives legislation.
A recent IMF study of 88 post-war banking crises showed that on average, the typical banking crisis results in a permanent loss of output near 10% of GDP. Main Street is already paying dearly for Wall Street. The U.S. Treasury admitted for the first time that taxpayers lost $30 billion on the AIG bailout. This week, the Obama Administration decided to extend the TARP program until next October, while projecting losses from the bailout program at about $141 billion.
Banks have only profited this year thanks to the bailout, various government programs, and the Fed's easy money policies. Under these measures, banks are able to borrow at a virtual zero interest rate and invest in high return assets. The return to profits also has prompted a resurgence of outlandish bonuses and vigorous defense of established vested interests.
But it is simply not acceptable to taxpayers that they have to foot the bill for losses in a deep downturn, while institutions enjoy all the gains as the economy recovers. This crisis has made us recognize the dire need of a tighter global financial regulatory approach on leverage and transparency to reduce the risk to the taxpayer for the longer term, and to prevent the hidden risk that almost destroyed the global economy.
For once, U.S. banks do not seem to have as much exposure as their European counterparties in the Dubai debt debacle, but don’t become complacent towards the state of our financial sector either. Nonetheless, a naiveté seems to have emerged as an unexpected "Dubai effect" when JP Morgan Chase CEO Jamie Dimon received a ringing endorsement from Bove as a possible replacement for Treasury Timothy Geithner.
Now seriously, is Wall Street the best candidate to watch over Main Street?
Disclosure: No Positions