Last weekend was the biggest so far in bank failures, from the Thursday night takeover of Washington Mutual followed to the report of a takeover of Wachovia and moves of a similar scale in Europe.
Billions for Banks in Europe
Fortis was the largest bank in Benelux and appeared close to collapse before the governments of Belgium, the Netherlands, and Luxembourg agreed to take a 49 percent stake in the company and restructure it. The Fortis story and similar news around Europe says that European banks have been hurt significantly by the collapse of the derivatives bubble based in the United States.
Iceland took over its third largest bank, Glitnir. The government paid 600 million euros for a 75 percent share in the bank, which had 3 billion euros in assets. Glitnir also operates a bank in Luxembourg and has offices in at least five other countries, with a significant presence in Norway.
Germany issued an emergency credit line to Hypo Real Estate Holding AG, which was hurt in part by bad loans for luxury and commercial real estate in Germany.
Then on Monday morning, the United Kingdom effectively nationalized Bradford & Bingley, a large mortgage lender that had mainly been hurt by mortgages on rental properties in Britain. Real estate values have fallen so much that many property owners are collecting too little in rent to pay their mortgage payments. The government took over the bank’s £50 billion loan portfolio and paid £18 billion on the sale of the bank’s branches and deposits to one of Europe’s largest banks, Banco Santander of Spain. Santander will pay less than £1 billion.
The 4th Largest Bank in the U.S.
Then in the United States, the Federal Deposit Insurance Corporation (FDIC) did not take over Wachovia, yet it and Citigroup came to a financial interpretation of Wachovia that allowed me to conclude that Wachovia was on the verge of collapse. Wachovia’s stock had fallen by three fourths since the beginning of the year as Wall Street lost confidence in its prospects. The FDIC provided a guarantee of Wachovia’s loan portfolio to Citigroup, which agreed to pay a purchase price of $2 billion — a token purchase price of $1 per share. Citi agreed to accept only the first $42 billion of losses on Wachovia’s $312 billion loan portfolio. Those losses could occur almost immediately, if the look of Wachovia’s recent financial statements is any indication, so the deal would likely have cost U.S. taxpayers $50–100 billion, in spite of the FDIC’s optimism about Wachovia. Regardless, the guarantees were necessary in order to avoid putting Citi’s own future in doubt.
By Friday morning, Wachovia had changed its mind, announcing that it instead would be acquired by Wells Fargo. Wells Fargo agreed to pay $15 billion in a stock swap and would complete the deal without government assistance. It is a surprising premium price for a company that recently had a market capitalization of $10 billion and whose book value excluding goodwill is surely much less than the $38 billion it reported at the end of June.
Wachovia was formed in a merger in 2001 and with subsequent acquisitions was the fourth largest bank in the United States. Predecessors of Wachovia include CoreStates, First Union, World Savings Bank, SouthTrust, and other large and small banks. Most of the predecessor banks were available because they were experiencing operating difficulties, and Wachovia stabilized them mainly by putting stronger operational systems in place. The combined Wachovia had a troubled loan portfolio of its own by 2006, and it compounded its troubles by acquiring Golden West. There was already a hint of Golden West’s real estate loan troubles, and analysts worried that the deal was too top-heavy and could lead to Wachovia’s collapse. Indeed, Wachovia’s combined loan portfolio quickly wiped out its profits, with no turnaround on the horizon.
Wachovia was also in trouble for possible collusion in identity theft. In April, it paid $144 million to settle a federal probe. It did not admit wrongdoing and might have lost its banking license if it had done so or had been convicted of even a slight involvement in the series of thefts. It fired its CEO a month later.
Wells Fargo was recently listed as the 6th largest bank in the United States, about three fourths the size of Wachovia, so is it large enough and stable enough to neutralize the troubles of Wachovia’s balance sheet? The answer appears to be no. At least on the surface, this is just another troubled, top-heavy merger in the long series of mergers that created Wachovia. An additional $75 billion loss from Wachovia’s loan portfolio would wipe out the stockholder equity of the combined company, and Wells Fargo has real estate exposure of its own and will surely take losses from its own portfolio as real estate values decline further. Because of this scenario, it seems possible that the Federal Reserve Bank could intervene, or that Wells Fargo shareholders could file suit to block the acquisition, which otherwise is expected to close around the end of the year. Citi may have something to say about it too, but that is likely to be little more than bluster to try to persuade the markets that Citi is still financially strong enough to get into this kind of argument.
The combination of Wells Fargo and Wachovia makes good sense geographically and in terms of market position, and there are other reasons to hope the combination could somehow work. The loan losses will not all hit at once, giving Wells Fargo time to raise the capital it needs. The combined bank can look for cost savings, and as both banks have relatively high cost structures, it ought to be able to cut costs in various operational areas. Still, it has to survive the economic turmoil of next year to get any of these benefits, and if things keep going the way they have been, it may have to scramble to stay above water.
The Wall Street Bailout Tog-of-War
Washington’s high-risk Wall Street bailout plan, which some supported in the mistaken hope that it might improve the financial condition of banks and stop the recent run of bank failures, was voted down in the House on Monday amid the largest demonstration of public opposition to a government initiative since the Vietnam War. As one hint at the size of the opposition, the House web site was effectively unavailable during afternoons for the entire week, as it was overwhelmed by inquiries. The Senate, which traditionally has been more sympathetic to the concerns of Wall Street, passed a souped-up version of the bill Wednesday evening. On Friday, the bill returned to the House, where it passed by a narrow margin. President Bush rushed to sign it into law.
For banks, the biggest item in the plan is a temporary increase in FDIC coverage, normally $100,000, to $250,000. The Senate added this provision in the hope that it would slow down any runs on banks that may be coming this winter. Yet the bill did not provide any additional FDIC funding, so it seems unlikely to improve depositors’ confidence in their bank deposits.
The heart of the plan a sort of collection agency in the Treasury Department. This is supposed to improve the liquidity of banks so they will start lending again, yet most of the money will not go directly to banks, but to brokerages, mutual funds, and other financial corporations. If the plan works at getting banks to lend more, the increased lending could lead banks to fail faster, unless the banks can find a way to steer around the loan losses that have piled up at alarming rates for the past two years. Even in the optimistic scenarios of banking industry insiders, it may take two years for the additional liquidity to trickle down to consumer loans.
In the end, the public lost, and Wall Street won. And I have a feeling many of the people on Wall Street will be playing “Take the Money and Run” on their car stereos as they get their bailout money out of the United States and into a more stable foreign currency as fast as they can.
