By Kevin G. Hall | 11 June 2008
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When financial analyst Meredith Whitney wrote in a report last October that the nation's largest bank, Citigroup, lacked sufficient capital for the risks it had assumed, she was considered a heretic. However, Whitney was proved correct: Citigroup pushed out its CEO, sought foreign investors and slashed its dividend. Her comments now carry added weight on Wall Street, and she has a new warning for ordinary Americans: The crisis in credit markets is far from over, and it increasingly will affect consumers. "In fact, we believe that what lies ahead will be worse than what is behind us," Whitney and colleagues at Oppenheimer & Co. wrote in a lengthy report last month about threats faced by big national banks, including Bank of America, Wachovia and others.
The warning is scary considering what's already behind us in the credit crisis— the resignation or firing since last August of CEOs at almost every large commercial or investment bank; the Federal Reserve lowering its benchmark lending rate by 3.25 percentage points; a Fed-brokered deal to sell investment bank Bear Stearns; and weekly auctions of short-term loans from the Fed worth billions of dollars to keep credit markets functioning. Whitney argues that the worst is still ahead because the financial tools that enabled credit to flow so freely to homeowners and consumers for most of this decade are likely to remain in a prolonged shutdown indefinitely.
"After years of inherently flawed underwriting, banks face the worst yet of the credit crisis— over $170 billion in write-downs and charge-offs from consumer loans," Whitney told McClatchy. The same kind of losses from housing may be ahead for credit extended to consumers, she said. At the heart of the nation's lending boom from 1996 to 2006 was a process called securitization. In housing, this process involved pooling mortgages for sale to investors as special bonds called mortgage-backed securities. Monthly mortgage payments were also pooled and served as the return to investors.
Securitization meant that most home loans no longer sat on a bank's balance sheet. Instead, they were sold into a secondary market, where they were sliced and diced in a process that was supposed to spread investment risk a mile wide and an inch deep. For every dollar of mortgage loans that banks kept on their balance sheets since 2000, another $7 of these loans were sold to the secondary market and securitized. This led to the industry joke that "a rolling loan gathered no loss." Risk was passed along to the next holder of the debt. Securitization added what bankers call 'liquidity', a fancy term for [[constantly renewing the amount of: normxxx]] money on hand to lend. Now, the structured finance that enabled Americans to borrow cheaply has gone away, at least in the housing market.
"With that source of liquidity removed, the sheer number of buyers who can qualify for mortgages and therefore buy homes will decline dramatically," Whitney told McClatchy. "It stands to reason, therefore, that less demand and more supply will drive home prices down well below current expectations." In addition, interest is waning in other areas of lending where securitization has also been common— car loans, credit cards, home equity lines of credit, student loans and even commercial real estate. It means that lending in those areas is growing tighter.
"There are still many areas where people aren't going to be able to do transactions that they were able to a year ago," said Sean Davys, managing director of the Securities Industry and Financial Markets Association (SIFMA), the trade association for big finance. "We do expect that it will take a significant amount of time for the market to return to any sense of normalcy. What's your reference to normalcy? It's going back several years, not just a couple of years." These other areas of lending are suffering through a buyer's strike. Investors just don't have much interest in buying anything whose underlying assets are pooled loans.
Because there are no buyers, banks are taking an accounting hit as they mark down the value of the securitized mortgages they own, and Whitney believes they'll have to do so with other types of securitized loans, such as car loans and credit card debt. That's likely to result in a large pullback in bank lending. She forecasts tighter lending standards, banks with increasingly limited capital, a growing need for banks to set aside more money to offset losses and tough new federal regulations to protect borrowers, which would reduce lending further.
If the positive side of securitization was that it let banks lend more by passing loans into a secondary market, the inverse is now true. Banks are less willing or able to lend— they collectively set aside more than $10 billion to shore up their balance sheets in the first quarter of 2008. That's meant that consumers must pay more to borrow to buy a car or fix a home, and it's harder to get loans.
"There are a lot of businesses and individuals that are going to find that their access to credit is a lot more limited than it used to be and it's a lot more expensive," said Mark Vitner, a senior economist with Wachovia, a large national bank headquartered in Charlotte, N.C. "And the reason why is the lessened ability to securitize these loans and sell them in the secondary market. That lack of liquidity is being priced into all new loans."
Higher borrowing costs are on top of tighter lending. The Whitney report estimated that by 2010 credit card issuers would withdraw more than $2 trillion in credit that they've been extending to consumers. "We're already seeing examples of people seeing their credit limits reduced," said Joseph Ridout, a spokesman for Consumer Action, a consumer rights group based in San Francisco. More troubling, he said, some banks are doubling interest rates on customers who are current on payments but considered a credit risk because of changes in their credit profile. The hikes apply to credit-card debt already racked up.
Federal Reserve Chairman Ben Bernanke worried about the state of the credit markets in a June 3 speech. Financial institutions already have taken $300 billion in write-downs and credit losses, he said, noting that "balance sheet pressures and the relatively high cost of new bank capital have reduced the willingness and ability of these institutions to make markets and extend credit." Translation: Expect less credit for consumers and businesses and higher borrowing costs. It's a bad omen for a sluggish economy struggling to stay out of recession.
Still, not everyone is so downbeat. Bert Ely, a banking consultant who was prominent during the savings and loan crisis, thinks that once the economy rebounds, banks will look a lot stronger. That's because the loans they're bringing back on their balance sheets will look better over time. "Many of the losses financial institutions have reported will essentially reverse out (and become accounting gains)… that's why large institutions have been raising capital to hang on to these securities so they don't have to sell them at what would be unrealistically high losses," said Ely. He nonetheless agreed with Whitney that "there are still some serious issues with securitization" and the credit markets are unlikely to bounce back within two or three years.
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Normxxx
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