It’s just a Ball of Infusion

I’m having a difficult time reconciling the new found bank profitability driving more executive bonuses to this article at the WSJ. It’s called “Troubles for ‘Prime Borrowers Intensify” and it has some startling data. First there’s these numbers on prime mortgages which are undoubtedly creating some of the problems at the FHA that’s fueling rumors of the need for yet another bailout.

The mortgage-delinquency rate among so-called subprime borrowers reached 25% in the first quarter but appears to be leveling off, rising only slightly in the second quarter. The pace of delinquencies for prime borrowers is accelerating. Since prime loans account for 80% of U.S. bank exposure to mortgages and credit cards, these losses could ultimately exceed those from weaker borrowers.

Losses are also mounting in that group for credit card debt. This is because of the increased duration of unemployment for many folks. They basically are tapped out and don’t even have their home equity as a source of potential liquidity. Since unemployment, and especially duration is not really on the mend, how long can this go on before bank capital takes a hit again?

In addition to cutting back on spending, strapped prime borrowers often can keep up with their bills longer than subprime borrowers by draining savings accounts, reducing contributions to retirement plans and turning to family members for money. They also are typically slower than subprime customers to seek help for financial problems because they are concerned about the stigma associated with such assistance, credit counselors say.

About 40% of the strapped consumers seeking help from the OnTrack Financial Education & Counseling center in Asheville, N.C., are prime borrowers, up from 15% last year, says Tom Luzon, director of counseling services at the United Way agency. Many of these clients already scaled back their lifestyles after losing their jobs or seeing their salaries slashed. Some are small-business owners whose companies foundered as a result of the recession.

“They have made adjustments and made adjustments, but then you get to a point where you can’t adjust anymore,” says Mr. Luzon, who is a former banker.

“People who are middle-class wage earners initially may have severance pay and think they have plenty of time to find a job, but then they start using credit cards to support living expenses,” he says.

So, my question is this. If some of the original bank profitability recently has been due the availability of cheap funds through the FED, TARP, and other government sources, if prime borrowers are now having increased difficulty paying their obligations, what happens to bank profitability if the government funds dry up? How long do we have to keep propping the banks up while they merrily repeat the same portfolio decisions that can’t work once the market rates are back at market levels? Also, how are they going to absorb these increasing level of loan losses?

I frankly can’t see the end to banks requiring cheap sources of funds like the Fed window. I can’t believe the economy is going to recover fast enough for this to change. How long will we have to infuse the banks with tax payer dollars and on-the-cheap loans through the discount window? I don’t think most of these institutions could function without it.

Go back and check that July article showing how bank profitability at the moment is pretty clearly linked to government programs. Also, consider how we haven’t changed regulations or done anything with how executive pay is determined (unlike our European cousins who are all over these behaviors).

To estimate the savings that will flow to the eight largest users of FDIC guarantees, the Journal compared the interest being paid on each slice of $238 billion in medium-term debt issued under TLGP with the trading level of existing bonds having a similar maturity. Fees and surcharges were subtracted. The difference represents what the companies likely would have paid had the debt not been backed by the FDIC.

For GE Capital, the GE unit that issued about $50 billon in guaranteed medium-term debt, more than any other company, the savings likely will reach $3.3 billion, according to the calculations. A GE spokeswoman said in an email that the difference is “something much less” than that amount. Representatives at the seven other companies either declined to discuss the matter or didn’t return calls seeking comment.

One example of the lower financing costs made possible by federal assistance: On Nov. 25, Goldman issued $5 billion in debt maturing in June 2012. The debt has an annual interest rate of 3.25%. On the same day that the government-backed bonds were sold, outstanding Goldman debt maturing in September 2012 was yielding 8.51% in the open market.

Based on the gap between the two interest rates, Goldman will save about $754 million over the life of the FDIC-guaranteed bonds. It will reap lower interest costs of about $2.33 billion for all the corporate debt sold under the government program.

At J.P. Morgan Chase & Co., the total reduction in financing costs is likely to be $3.1 billion, or $246 million per quarter. In the second quarter, J.P. Morgan made a profit of $2.7 billion.

An executive at one of the largest issuers of FDIC-backed debt says market rates for bank debt surged when the guarantees were most popular, largely because investors were dumping bonds to raise money.

I’m sorry but I managed bank assets long enough in my career to know that when the liabilities reprice, this is not going to be a pretty picture. The Europeans get this. I’m not sure we do. There’s not much discussion about the G-20 finance minister meetings in London. Perhaps it’s because the Europeans are pushing to actually solve the systemic problems as well as cap bank executive pay because none of their pols get donations from the likes of Goldman Sachs and their chief economic advisers don’t consult there. Treasury Secretary Timmy-in-the-Well-Again Geithner is there with his usual lackluster performance. Geithner’s solution to everything appears to involve some form of procrastination.

The communique said that work will continue on the possibility of introducing a cap mechanism for financial sector bonuses but did not commit to the measure after U.S. and British objections to the French-German proposal.

Instead, the G-20 proposed clawback mechanisms to ensure that bonuses are linked to the long-term success of deals and could be forfeited if they fail to deliver over a period of years.

Darling said the new measures would make sure that institutions ”are focused on long-term sustainability and long-term strength.”

Darling said banks must realize that ”they would not be here had it not been for the efforts of countries, underwritten by the taxpayer,” and there must be no more cases in which ”people are being rewarded for reckless behavior.”

The Financial Stability Board, an international body established at the London Summit of G-20 leaders in April, was given the task of drawing up practical proposals for implementation at the Sept. 24-25 leaders meeting in Pittsburgh.

The United States had tried to put the focus of the London meeting, which is a preparatory gathering for the leaders summit, on its proposal for a new international accord to increase banks’ capital reserves. The U.S. wants to establish stronger international standards for the reserves banks are required to hold to cover potential loan losses.

Going into the meeting, U.S. Treasury Secretary Geithner wanted to reach agreement on an accord by the end of 2010, with implementation by the end of 2012.

The communique did not directly address that plan, but called for rapid progress in developing stronger prudential regulation, including a requirement that banks hold more and better capital once recovery is assured.

I just don’t get this at all. We and the Brits are holding off on ‘stronger prudential regulation’ until the recovery takes hold. Meanwhile, the banks are scurrying around making the same stupid portfolio mistakes because they’ve got subsidized liabilities with which to do so. If we’re serious about restructuring their capital, then we should be forcing them to do it now since they’re using our funds. From everything I can see, this isn’t happening. The executives of the banks (especially those who just repaid the TARP funds) will scoop up their bonuses shortly and we’ll be stuck with the same mismatch of assets and liabilities. With clawback provisions, the executives have to clean up their balance sheets or risk loosing these short term boosts from the availability of cheap money. It makes them more likely to achieve a proper long term match.

The big concern that I have is the high probability that we won’t really have a strong recovery and we will repeat this situation for some time. We’ll continually infuse cash into banks that won’t change their investing behavior. Somebody needs to force these guys to identify and price their Toxic Assets and be realistic about their potential loan losses. They’re not going to do this as long as they get their low priced government loans. We’ll just continue to fund increasing loan losses and we’ll continue to bleed the FDIC of capital. This won’t solve anything. We’re just pushing the problem along and hoping a good economy will cover it up again. I suppose a good part of politics, however, is giving most people a false sense of security. Since the Europeans aren’t buying it, however, I’m not sure how that’s going to work in the real world. This is especially true when the real world is one of perfectly mobile capital. Oh, I forgot, we’re not relying on private capital right now, we’re relying on public treasure.

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