Friday, May 11, 2012

This Week in Bank Failures

Admitting only “egregious mistakes,” JPMorgan last night disclosed a $2 billion loss from high-risk trading. The actual size of the loss is unknown, but $2 billion is a careful estimate. Banks typically take on trading risks in difficult times to try to make up for deficits in other parts of the balance sheet. JPMorgan has made a fortune in presumably high-risk trading over the last few years, so yesterday’s $2 billion dollar loss is probably not actually a mistake, but just the inevitable downside of an ongoing pattern of risk-taking. When the stock market turns downward, as it must eventually, all of the very large banks and insurance companies will have losses to report.

People were already trying to revive the idea of shrinking the too-big-to-fail banks before the JPMorgan news came out. It gains extra impetus from the worry that JPMorgan or another bank might trade away its remaining capital the way AIG did in 2006. A measure that would have restricted the size of banks was shouted down in the Senate two years ago, but new measures being considered in Congress appear to target only the four or five largest banks. Some are talking of actually breaking up the banks, by creating an auction-style mechanism for dividing up the assets among several new companies. There is also talk about setting a fixed limit on how much a bank can borrow — if a bank exceeded that limit, its management would be removed and it would be placed in conservatorship until its debts were brought under control.

Bank of America acknowledged this week that it is looking at ways of putting mortgage subsidiary Countrywide Financial into bankruptcy. The statement comes in the same week as reports of a bankruptcy at the mortgage unit of Ally Financial (GMAC), though that filing never did occur. In either case, the bankruptcy of a subsidiary has to be approached warily. In theory, a corporate subsidiary can go bankrupt without doing any further financial harm to the parent company — that is the essential intention of the corporate form of a business — but much depends on the details of contracts and the way they are handled in bankruptcy.

Deutsche Bank will pay $200 million to settle charges resulting from sloppy handling of mortgages at its mortgage subsidiary MortgageIT. In order to resell mortgages, the bank routinely told the FHA that borrowers had the financial ability to repay mortgage loans. Yet it may have known that this statement was often not true, as it was especially eager to resell mortgages whose borrowers were in financial distress. The government has lost $400 million so far on those loans.

Bank of America’s revelation about a possible Countrywide Financial bankruptcy came at the Bank of America annual meeting. The bank and city officials were worried about protestors showing up at the meeting, but the predicted throngs never materialized. Instead, there were fewer than 1,000 relatively quiet picketers outside. Bank of America did not close its annual meeting as Wells Fargo had done two weeks ago, but amid the chaos of the extra security, some 100 shareholders, a group that included bank employees and institutional shareholders, were unable to gain access to the meeting.

Bankia, formed in 2010 from the seven Spanish regional savings banks hit hardest by the real estate decline, is looking more and more like a “bad bank.” Its executive chairman resigned on Monday. On Wednesday, Spain decided to take control of the bank by converting its bailout bonds into stock. Bankia has the largest real estate loan portfolio, not a happy market position in a country seeing a California-like decline in real estate values. Bankia raised capital in the stock market last year, but the stock has lost most of its value in less than a year, and further stock sales are probably impossible.

Today Spain announced a tepid series of financial measures, smoke and mirrors the government claims will protect banks from their bad assets. Spain’s optimistic tone about its train wreck of a banking system is beginning to remind economists of what happened in Ireland, where political leaders refused to recognize the scale of the problems in the banks until a series of bailouts and guarantees had brought the government to the point of financial collapse. In Spain, regulators this week announced new loan loss provision requirements, but for only a small fraction of real estate portfolios. It is easy to imagine why: if the full problems were put on the books, the country as a whole would be insolvent. Unlike Ireland, Spain is too large, too isolated, and too idle to rescue. Spain is hampered mainly by a slow economy, one that anywhere else would be considered a depression. Only half of workers are fully employed and one fourth, in any given week, are not employed at all, yet the public has so far resisted reforms that would expand employment.

A banking crisis in Spain could have troubling implications for the Americas and the westernmost countries in Europe, where many of the giant banks are Spanish-owned. Or, the overseas operations could stave off a collapse. Santander in particular continues to earn a respectable profit in U.S. and Latin American even as its domestic operations hope to break even.