Friday, May 30, 2008

S&L Crisis vs. Current Crisis

I have been talking about an expected wave of bank failures for quite some time, most recently in Too Late To Stop Bank Failures. Recently I was asked to compare the current crisis to the 1980's S&L Crisis in regards to to whether or not this crisis will be worse.

By sheer number of failures the S&L crisis will dwarf what's coming hands down. Here is a chart from MarketWatch that tells the story.

However, numbers alone are not the proper way to measure things.

A proper focus must include an analysis of the magnitude of the failures, who will be affected by those failures, and what actions the Fed might have at its disposal to handle the situation.


Let's start with a look at bank consolidations. Following is a history of just one bank, courtesy of Mr. Practical :
Roll Up

Here's an incomplete list of former financial institutions that now comprise what is known as JPMorgan (JPM):
  • Bank One
  • Chase Bank
  • U.S. Trust
  • Manufacturer's Hanover Trust
  • Chemical Bank
  • First Chicago
  • National Bank of Detroit
  • First U.S.A
  • Bear Stearns (BSC)
Of course there are thousands of smaller financial institutions that have been rolled up into this behemoth. Many of us believe that the last and most famous "acquisition� was really a bail-out of JPMorgan, the deal in reality injecting some $50 billion of capital into this amalgamation of finance.

So what you say? Well I think as we watch bank after bank (Royal Bank of Scotland(RBS) this morning as an example) take recurring �one-time� write-offs we can begin to see just what a ponzi scheme this has been over the years. Banks book loans, mark them up in value, and show the difference in profits. They've done the same thing with the phantom book value these deals present when consummated. Over the last few decades banks have not really made any money; they have merely been a conduit for the Fed to create massive credit. The U.S. money supply is now over 99% debt.

The ponzi scheme is unwinding and investors continue to be gullible. Those that bought Citigroup (C) on its dilutive stock offering are now over 20% in the red. The implications are vast. Risk is high.
The failure of Bear Stearns alone is enough to counterbalance hundreds of what really amounts to branch failures during the S&L crisis.

From the MarketWatch article: "During the late 1980s, banks in Texas couldn't open a new branch in another county without forming a new commercial bank. That meant there were lots more lenders in the state when the S&L crisis struck. So when a bank failed, "40 of its other banks failed on the same day," Cassidy recalls."

Today there are some huge banks and brokers at risk. Wachovia (WB), Washington Mutual (WM), Lehman (LEH), Citigroup (C), Morgan Stanley (MS), Merrill Lynch (MER), Countrywide Financial (CFC) , Keycorp (KEY), Fifth Third (FITB), and Regions Financial (RF) for starters.

That list looks ominous if not preposterous. Yet two years ago if someone said Bear Stearns and Countrywide would fail and that Citigroup, Morgan Staley, Lehman and others would need repeated capital infusions from Dubai, Singapore, and China they would have been laughed off the street.

For more on regional bank failures please see Charge-Offs Hammer Banks.

The Fed will likely act to prevent Citigroup from going under, but I do not believe Citigroup will survive in its current form. I said that last summer while Chuck Prince was still a "dancing fool".

Not every bank and broker in the above list will fail, but I am quite sure that some of them will. Others will be rescued by "shotgun marriage" just as the Fed orchestrated a rescue of JPMorgan by allowing it to take over the Bear.

Who Is Affected

Looking back at the S&L crisis, I do not recall knowing anyone who was directly affected. This mortgage crisis (credit crisis really) runs far deeper. Ridiculous lending standards compounded by consumer greed and Fed micro-management of interest rates are causing millions of foreclosures.

In the wake, tens of thousands of self-employed real estate agents have not had any income for months on end, the originate to securitize model is dying, and mortgage rates are not dropping in spite of massive rate cuts by the Fed. Unemployment is poised to soar which means still more foreclosures are coming. REOs are piling up on bank books. What was largely an institutional crisis in the 1980's is now a huge consumer crisis as well as a huge institutional crisis.

Fed's Inability To Counteract Crisis

In the 1980's the consumer was not tapped out. Today's consumer is so tapped out that many are walking away from their homes. Others are voluntarily choosing bankruptcy. The Fed can add liquidity now, but it cannot dictate where it goes. This poses a huge problem for the serial bubble blowers at the Fed because from a jobs creation standpoint, housing was the bubble of last resort.

No matter what the Fed does now, it is not going to spur jobs creation. On the other hand, Fed action may further stimulate commodity speculation, the very last thing the Fed wants. I talked about this in Commodities Speculation Symptom Of Larger Problem.

Furthermore, what was a US crisis in the 1980's is now a global problem. Property bubbles are busting in the US, Spain, Ireland, Australia, Canada, and other places. What was a US S&L crisis before is now an international credit bubble crisis.

And the popping of this bubble could not have happened at a worse time. Boomers are entering retirement en masse, and many have been counting on increases in the value of their home and the stock market to see them through. What boomers need is one thing, what they are going to get is another.

For more on the demographic problem, please see US and Canada Demographic Time Bomb and Pink Slips Hit Older Workers.

Finally, the Fed is facing additional problems of a falling US dollar, global wage arbitrage, and an economy at the mercy of hundreds of trillions of dollars worth of derivatives with suspect counterparties. Those derivatives dwarf the entire world's economy. This is all happening at a time when the world is increasingly less dependent on the US and is therefore less likely to bend to every whim of the Fed.

The Fed has attempted to counteract these problems with an alphabet soup of lending facilities. However, the Fed Is Not King Midas.

The root cause of this mess is the Fed itself and fractional reserve lending. The Fed created this mess, with help from Congress. If you prefer, Congress created this problem by creating the Fed. Whichever way you prefer it, the Fed and especially Bernanke are not going to fix it. Instead they are going to attempt to increase their power, disguised as a need for still more regulation. If you have not yet done so, please consider the Fed Uncertainty Principle.

Add it all up and the upcoming bank crisis is going to be far greater than what happened in the 1980's even though the number of failures will be far smaller.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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