NYU economics professor and head of RGE Monitor Nouriel Roubini said today the latest stock rally will be short lived for many reasons and that banks like Citi, BofA and JP Morgan Chase saying they’re profitable is not exactly true—because the fine print is that they are profitable “before provisions for writedowns.” Below is the excerpt regarding why banks are not really profitable like most headlines have been saying.
Finally, regarding the fourth optimistic argument – that banks stocks are oversold, that most banks will be profitable in 2009 and that most banks are not insolvent – it is worth considering both what we have been writing previously and some additional points.
First, notice that it with policy rates – Fed Funds – at 0%, with massive quantitative easing, with credit easing allowing banks to dump toxic assets on the Fed balance sheet and with a new government program that allowed banks to borrow at riskless rates almost $200 billion dollars at medium term maturities the Fed and the Treasury are heavily subsidizing banks and other financial institutions. Second, in its latest incarnation – the TALF – now even hedge funds will be able to borrow – up to a trillion dollars – at government rates – and leverage their investments 20 times to purchases new ABS issued by banks and reap a nice spread over LIBOR with very limited risk (effectively investors in TALF will at most make a zero return on the investment in the bad state of the world and make a high return – 15-20% annualized – if all goes well). With policy and borrowing rates equal to zero or close to zero for banks and broker dealers their intermediation margins are obviously positive as lending rates are much higher. But this is a direct huge subsidy of the financial institutions that is being paid by savers that are now earning 0% or close to 0% on $10 trillion of bank deposits. Third, add to this massive subsidy various forms of government forbearance – fudging by regulators on the true valuation of illiquid and toxic assets, parking illiquid assets in level 3 “lala land” of valuations, easing of capital requirements, using AIG to bail out its counterparties to the tune of $160 billion and, soon enough, suspension of mark to market accounting – and you get other cosmetic plastic surgery on the earnings and writedowns by financial institutions. Fourth, with many of the prime broker and prop trading players gone out of business or significantly shrunk the remaining players are having much larger margins; add to that using public money borrowed at 0% rate to engage into risky and leveraged prop trading activity and you get – for a while – nice profit margins. For a while as the experience of Merril Lynch – where one individual FX trader alone allegedly lost $400 million in trading – shows the risk of such speculative activities now financed by Uncle Sam. Fifth, the government has already committed $9 trillion dollars of bailout funds to the financial system and already disbursed $2 trillion of that amount. Without such support – that has taken the form of at least 12 separate new and unorthodox support programs – most financial institutions in the US would already be literally fully under and bust.
So it is no wonder that Citi, Bank of America and JP Morgan can argue that they will be making this year a profit “before provisions for writedowns”. That is the most important caveat: while operational margins can be positive if you borrow at 0% and lend at much higher rates, the actual P&L and balance sheet of banks and broker dealers depends also on writedowns. And delinquencies, charge-off rates and writedowns are rising rapidly as both the loans and securities are showing mounting losses given the worsening of the economic recession. Losses are spreading from subprime to near prime and prime mortgages; to commercial real estate; to credit cards, auto loans and student loans; to leveraged loans and corporate boans; to industrial and commercial loans; to loans to real estate developers; to muni bonds and sovereign bonds of emerging markets and European economies where sovereign spreads are rising; and to the entire alphabet soup of credit derivatives that securitized these loans and mortgages (MBS, CMBS, CDOs, CLOs, CMOs, CPDOs, ABS, etc.). So for the major banks to argue that they are profitable before provisions on losses is a joke: such losses are now officially over $1.2 trillion globally (and $900 billion for US financial institutions) and they will be at least $2.2 trillion (according to the conservative estimates of the IMF and of Goldman Sachs) and as high as $3.6 trillion according to the peak time estimates of such losses according to our most recent study.
And according to independent analysts of the financial system – Meredith Whitney, Chris Whalen – charge off rates on loans – let alone additional losses on securities – are rising at alarming rates: they are already at levels twice as high as in the 1990-91 recession and they will soon enough – given recent trends be much higher double further. So, regardless of whether you got smarter management or not (i.e. it does not matter if you are JP Morgan and run by someone as brilliant as Jamie Dimon) the macro picture trumps any other bank-specific factors (the loan book of JP Morgan is as exposed to residential and commercial mortgages, consumer credit and other loans as any other major bank): i.e. with the unemployment rate going above 9% in 2009 and highly likely to reach 10% in 2010, with GDP growth likely to be 1% or lower in 2010, with home prices likely to fall – conservatively – at least another 15%, with commercial real estate rents now falling about 40 to 50% and valuation bound to fall 30 to 40% then losses on any category of banks loans and mortgages and consumer credit will sharply rise over time; and losses on the assets that securitized these loans/mortgages will increase over time.