What Will the Banks Do Now?

Nouriel Roubini asks an excellent question, and it deserves some thought. We include only a brief excerpt, cutting to the chase as it were. The entire piece can be read here.

For the short term the investment banks can live off the public dole, scamming lunch money by short term manipulation of the markets, and copping the odd fee or so from corporations that have not fallen by the wayside.

In the longer term there will be far fewer money center banks, more small and regional banks, and more a return to banking regulations.

Certain parts of the economy are going to be dead money for a long time. The pit traders are going to get a lot of practice making paper airplanes.

The hope will be that the corporate sector will build up its cash reserves, start capex spending to regenerate the real economy, and of course buy up competitors generating goodies for Wall Street.

There will be an effort to find fresh countries to despoil overseas.

The US financial system is a teetering wreck, and a significant amount of liquidation and consolidation lies ahead of us. The problem with bankers in key roles like the Fed is that they NEVER like to see a bank fail, so they keep propping up losers far beyond their natural life, wasting dear resources for the real job ahead, infecting society with the stench of rotting Ponzi schemes.


How will financial institutions make money now that the securitization food chain is broken?
Nouriel Roubini
May 19, 2008

The most severe financial crisis in decades has not only damaged the balance sheet of financial institutions. It has also severely affected their P&L, i.e. the process of generating revenues and profits. ....

So how will mortgage brokers, banks, broker dealers, monoline insurers, rating agencies generate revenues and profits now that this slice & dice scheme has unraveled? The current market delusion that the worst is behind us for financial institutions is based on the view that most of the writedowns of the toxic assets have already been done.

But this is not just a balance sheet problem. Now financial institutions have a more severe P&L problem, i.e. how to generate income and earnings from now on when they cannot originate junk any more. The entire income generating model of financial institutions – make income out of securitization fees rather than by holding the credit risk - is broken now that the generalized credit bubble (not just subprime mortgages) has burst; thus, how will these financial institutions generate earnings over time?

Capital losses are one-time problems; but destruction of the income generation process is a more severe and persistent problem that will require banks and other financial institutions to rethink their overall business model of credit risk transfer. But there is no clear and sound new business model for them: going back to the old days of “originate and hold” is not fully possible while the new “originate and distribute” model has shown all of its wrong and distorted incentives, risks and systemic failures.

So banks and other financial institutions will have to seriously rethink their business model and how they are going to make money: the model of slice and dice and pile fees upon fees and transfer the credit risk is broken. It is not clear if banks and other financial institutions have a better model. May they will have to go back to old fashioned banking: carefully assess the creditworthiness of their borrowers, lend on sensible terms and hold a good part of the credit risk now that the easy fee/profit generating machine of securitization is terminally broken.

Banks Suffer Losses From Bets On Their Employees' Deaths

Here's a good parable of our highly advanced service economy. Not only can we make money doing each other's laundry, but now we can make money out of each other's death.

Banks have been buying life insurance policies on their employees, not for the workers' benefit, but rather for their own. If the employee dies the bank gets an insurance payment that is tax free. They can report the death payments as quarterly income. If an employee dies the survivors must certainly turn in a death certificate for the company benefit program. This gives the banks the proof they need to collect on a life insurance policy on said former employee. (That's the hitch by the way, in case you were thining about taking out blanket policies on the unsuspecting.)

The lawsuits are not related to this particularly ghoulish scheme. Rather, the suit is against insurance companies that apparently invested the premium payments in some dodgy places, including a Falcon Hedge Fund run by Citigroup which is faltering.

This raises some interesting questions. First of course is the quality of bank earnings, which are pretty poor. Secondly is the obvious tax loophole here. Its one thing for a death insurance payment to be tax free to a spouse or a family member. But to a bank taking out blanket policies on their employees? Gee if it works, why not expand it. Think of the possibilities. China and India take note.

But secondly, if insurance companies managing life insurance for banks death-to-our-employees-for-the-sake-of-the-bottom-line programs are hurting because of investments, isn't it logical to wonder how they are doing on your own life insurance policies? How about your pension plan?

See, this is far from over. The reverberations of this Ponzi Scheme are going to travel through our economy. At the least we will see the dollar take a further hit as the Fed, on behalf of its banking owners, spreads the losses to all holders of dollar assets to essentially bailout the banks.

Welcome to our Human Resources Meeting. Sorry, the company is cutting back on healthcare benefits again. Here have another doughnut. The quarter is almost over.


Citigroup Hedge-Fund Loss Weighs on Three Banks
By DAVID ENRICH
May 20, 2008; Page C1
Wall Street Journal

The downward spiral of a Citigroup Inc. hedge fund has caused steep losses for at least three large U.S. banks that hoped it would rev up returns on a controversial type of employee life insurance.

Besides triggering a lawsuit against an insurer and brokerage firm that arranged the hedge-fund investment for Fifth Third Bancorp, the losses may pressure Citigroup to give the banks some of their money back, as it has agreed to do for individual investors. Such a bailout would be costly, because the clobbered banks sank more than $1.6 billion into the hedge fund, according to the lawsuit and people familiar with the matter.

The collapse is another headache for Citigroup's new management, led by Chief Executive Vikram Pandit, as it tries to rebound from crippling losses that stemmed partly from inadequate risk controls. Falcon's descent has caused a handful of high-level brokers to quit in frustration. Citigroup is spending $250 million to allow retail investors to exit from their positions without absorbing the fund's full losses.

Falcon also attracted major banks that invested in the hedge fund as part of their bank-owned life insurance programs. Wachovia Corp., the fifth-largest U.S. bank by stock-market value, was the most heavily exposed, with more than $1 billion invested, people familiar with the situation say. The stake represented at least 7% of the Charlotte, N.C., bank's $14.9 billion in BOLI-related assets as of March 31.

Fifth Third, of Cincinnati, sank $612 million into Falcon, according to the lawsuit the regional bank filed last month in U.S. District Court for the Southern District of Ohio. That was about a third of the bank's BOLI assets as of Dec. 31. Another regional bank also invested a sizable amount, people familiar with Falcon's operations say. The name of that bank couldn't be determined.

In such bank-owned life-insurance programs, banks buy policies on their employees. When employees die, the banks collect. Because the income is tax-free, some critics contend that BOLI is a tax shelter.

Last year, nearly 700 banks reported holding a combined $117.5 billion in their BOLI accounts, according to Michael White Associates LLC, a bank-insurance consulting firm in Radnor, Pa., and executive-benefits firm MullinTBG, of Deerfield, Ill.

In recent years, many banks have grown aggressive with their BOLI programs, putting premiums into investment vehicles that let the banks record quarterly profits -- or losses. Quarterly profits or losses are tax-free, and the policies still pay when employees die.

Falcon began stumbling last fall and by March 31 was valued at 20% of the original value, according to Citigroup documents. Fifth Third, which reaped $238 million in gains on its BOLI portfolio in a three-year period, suffered a BOLI-related loss of $177 million in the fourth quarter and a $152 million loss in 2008's first quarter.

At Wachovia, Falcon's woes caused the bank's first-quarter loss to widen to $708 million from its previously announced $393 million loss. Wachovia didn't identify the exact source when it disclosed May 6 that it had a $315 million loss on its BOLI investments, but spokeswoman Christy Phillips-Brown confirmed that it came from Falcon. She wouldn't comment on the size of Wachovia's investment in the hedge fund or whether the company plans to pursue legal action.

The market's turbulence has hurt BOLI results at other banks, too, from tiny Evans Bancorp Inc. in Hamburg, N.Y., to regional bank BB&T Corp. The Winston-Salem, N.C., bank had a loss of $15 million on its BOLI portfolio in the first quarter. Spokesman Bob Denham declined to say whether BB&T was a Falcon investor, though any future losses "will be small."

A Citigroup spokeswoman wouldn't comment on the fund's impact on banks. Citigroup has said that Falcon was marketed only to sophisticated investors.

In its lawsuit, Fifth Third alleges that Transamerica Life Insurance Co. and Clark Consulting Inc., both units of Dutch insurer Aegon NV, "utterly failed to properly manage and monitor" premiums that were invested in Falcon. Citigroup isn't named as a defendant. A Fifth Third spokeswoman declined to comment.

Cindy Nodorft, an Aegon spokeswoman, counters that Fifth Third "was free to choose from a number of investment alternatives that they were familiar with," adding that the "terms of the policy were adhered to."

Ms. Nodorft wouldn't say whether the Aegon units placed other banks in Falcon. "We continue to work closely with Citigroup as well as other financial institutions to address the developments in market conditions," she said.

Write to David Enrich at david.enrich@wsj.com2

Banks Suffer Losses on Bets on Employees Deaths

The Worst Is Still Ahead Says Meredith Whitney

Meredith Whitney drops another forecast bombshell on Wall Street. What makes it even more compelling is that it sounds like 'common sense' based on the facts as they are at present. Certainly more believable than empty assurances that 'the worst is behind us.' Where have we heard that one before?

The Fed and Treasury are going to have to take radical steps to change this, and we think outright monetization of debt to the extent that the bonds and dollar can bear will be the path of action they will take. This is where it gets interesting.

A newly elected charismatic Democratic president trying to lift the country out of a terrible economic slump created by a decade of Republican excess and corrupt insider business dealings. Despite slack demand, the dollar falls hard on international exchanges and is devalued by fifty percent. A Republican minority in Congress and more importantly a Supreme Court packed with Republican appointees blocks the efforts to reform the system and alleviate the intense suffering of a large portion of the public.

A forecast? No, just a thumbnail summary of the 1930s. It doesn't have to happen this way (again). But right now it sure looks like a possibility. We still think the game plan is a hard stagflation as the most likely probability, with a big devaluation of the dollar, with a purge and a recovery after about six years. We think the Russian experience in the 1990s is a good model, but we don't have their natural resources, so we will be lifted out by something else. What? who knows. We will fall. We will get back up. There is no way for anyone to know for certain how it will happen. No one. There are too many exogenous variables.

Whatever does happen is going to hit a lot of Americans hard, very hard, because they are not expecting it and are completely unprepared. This is because they know little of history, and what they do know, they think happened on some other planet.


Credit Crisis Will Extend Into 2009, Oppenheimer Says
By Luo Jun

May 20 (Bloomberg) -- The U.S. credit crisis will extend into and even beyond 2009 as banks will write off more than $170 billion of additional reserves by the end of next year, according to Oppenheimer & Co. estimates.

``The real harrowing days of the credit crisis are still in front of us and will prove more widespread in effect than anything yet seen,'' analysts led by Meredith Whitney wrote in a research note today. ``Just as strained liquidity pushed so many small and mid-sized specialty finance companies to beyond the brink, we believe it will do the same with the U.S. consumer.''

Whitney, together with Kaimon Chung and Joseph Mack, cut earnings estimates for U.S. banks ``significantly'' due to ``strained liquidity resulting from shut down in the securitization market'' and on expectations that banks may take provisions of $88 billion in 2008 and $96 billion in 2009.

Banks and securities firms worldwide amassed almost $380 billion of writedowns and credit losses following the worst U.S. housing slump in a quarter century, according to data compiled by Bloomberg. At least $35 billion of additional writedowns included in their balance sheets weren't deducted from reported earnings, regulatory filings show.

Whitney, 38, correctly predicted on Oct. 31 that New York- based Citigroup Inc. would cut its dividend to shore up capital after mortgage-related writedowns.

Shrinking Consumer Credit

The analysts cut their estimates for 2008 earnings for Bank of America Corp., Citigroup, JPMorgan Chase & Co., Wachovia Corp. and Wells Fargo & Co. by an average of 17 percent, and reduced their 2009 estimates by 20 percent. In all, the banks earnings will be 72 percent lower than the Thomson First Call consensus forecast, Oppenheimer estimates.

Banks have become reliant on securitization markets to fund consumer lending, Whitney said. With that market shut down in the wake of the credit crunch, banks will struggle to match the funding from their own balance sheets, she added. That will remove about $3 trillion of liquidity from capital markets by the end of the year, and banks' losses will worsen as consumers will be unable to repay debt with fresh loans, she added.

``As the securitization market remains effectively closed for most asset classes, we believe more consumers will face the threat of default and banks will simply face far higher loss rates,'' Whitney said in the report.

U.S. regulators' plans to boost oversight of the credit card industry will force banks to raise borrowing rates and cut the amount of credit available to consumers. Whitney estimates about $2 trillion of credit card lines will be removed by 2010, cutting the credit available to U.S. consumers by almost half.

To contact the reporter on this story: Luo Jun in Shanghai at jluo@bloomberg.net;

Last Updated: May 20, 2008 06:38 EDT

The Shadow Exchanges Gather Their Forces

This is croney capitalism at its worst. There is one 'secret' market for big players to trade where they do not have to report the price or volume and another retail market where the small players show their cards and their orders up front. We do not have a huge problem with this as long as the trade and specific print publicly as soon as the trade is consummated. Are they? How do we know?

Still, this puts the retail investor/trader at a significant disadvantage to a few insiders who can 'see' the dark pool action, Level III quotes if you will, and use it to front run the slower and less informed retail exchanges.


Goldman, UBS and Morgan Stanley agree on dark pools
Tue May 20, 2008 9:24am EDT

NEW YORK (Reuters) - Goldman Sachs, Morgan Stanley and UBS said on Tuesday they will allow their clients to access each other's non-displayed liquidity pools, known as dark pools, in an effort to increase chances of trading orders being filled.

The agreement will allow algorithmic trading orders from each firm to tap into the additional liquidity offered by competitors' darks pools, including Goldman Sachs' SIGMA X, the largest single-broker dark pool, Morgan Stanley's MS POOL and UBS' PIN ATS.

Dark pools now account for some 10 percent of equities trading in the United States, according to New York-based consultancy TABB Group and have proliferated as investors seek to place larger orders without showing their hand to the market and risk adverse price movements.

In a statement, Morgan Stanley's managing director of electronic trading said, "These arrangements will enable us to work with trusted industry participants to deliver the same level of confidentiality our clients have come to expect from us."

(Reporting by Phil Wahba, editing by Dave Zimmerman)


Here is an earlier blog entry on the nature of these off exchange dark pools: Shadow Exchanges for the Shadow Financial System: Dark Pools