In previous episodes of
“Banks and Bubbles” we witnessed Bank
of America buying a huge credit card company at the peak
of the consumer credit cycle and Wachovia plunging into California mortgage
lending just as the state enters a housing depression. Huge,
crazy deals, these, the kind of financial debauchery that
tomorrow’s historians will cite when discussing the mass delusion that
prevailed at the end of the world’s greatest credit bubble.
But apparently the keg’s not empty and the party’s still going. In the
past few weeks:
• Bank of America bought U.S. Trust, to vault to the top of the
private banking heap.
• Wachovia accelerated its push into
“high-growth” markets like California.
bought big stakes in a couple of Chinese banks and announced a major
expansion of its presence in U.S.
Citigroup's story is the
most telling. According to a recent BusinessWeek
article, the bank’s disgruntled shareholders
are pressuring Citi management rev up its growth
rate—and management agrees.
“The concerns are perfectly legitimate," says [CEO Charles
“Chuck”] Prince. "People are saying 'Do something!' They
want to know how long is this guy going to take?"
Not to worry: “Investors will be happy to hear that Prince is dropping
hints that he's revving up the deal engine again. He laments that for the
past three years he had to stay out of the market and focus exclusively on
making existing operations more profitable. ‘We're getting ourselves
back on the playing field,’ he said, noting that most of the
acquisitions will be in foreign markets. There's already chatter in London that he's eyeing
Lloyds Bank or BNP Paribas.
Here in the U.S.,
consumers are Prince's target, says BusinessWeek.
“If we don't grow consumer, the whole place has modest
growth,” he says. Prince is planning big branch expansions in locations
where many customers of the company's Smith Barney brokerage business live,
hoping to sell them bank products. In Boston,
for instance, Citi is planning to build 30 branches
next year as a service to 30,000 Smith Barney clients. If it's successful, Citi will roll out new branches in Philadelphia and a half-dozen other cities.
And some, at least, in the
financial community think this is a good idea. "We are impressed by [Citi’s] organic growth efforts, including 785 new
branches year-to-date," said one analyst.
So what’s wrong with this picture? First, history teaches that at the
peak of a long credit cycle the best most banks can hope for is survival. Borrowers
will default, assets will shrink, and margins will narrow. The only question
is by how much. So an astute banker would be hunkering down right about now,
selling off risky loans and tightening lending criteria. And such a
bank’s investors, if they had any sense (common or historical), would
be applauding management’s attempt to maximize the bank’s
long-run returns by doing what it takes to actually be around in the long
Instead, Citi and the other big banks are compelled
by the logic of public markets and their own executives’
empire-building compulsions to pile into whatever sector promises growth in
the next few quarters. That’s the only possible explanation for buying
a European bank when Europe’s
demographic and financial trends are heading off a cliff. As for expanding
consumer side of the business, this chart is all you need to handicap the
prospects of another decade of booming car and home equity loans.
with all the pressure on banks to keep growing, you’d think at least
some of them would be willing to choose prudence over expediency. That so few
do means something else must be going on. That something is securitization. Here’s
a riff on the subject from a real
estate developer friend who spends a lot of time
year, I dined with head one of Wall streets largest commercial mortgage
banking operations (we’ll call him Harry). Harry had the personal
objective of making his mortgage department the largest on Wall Street in
originating commercial mortgage debt. After a few glasses of wine and
some prompting on my part he confessed that underwriting terms on mortgages
had become as easy as in the Savings & Loan era. I was curious as to why
his bank was taking on these increased risks. “We’re not taking
on significant risk with commercial mortgages,” said Harry. “Only
the temporary risk of securitizing them and finding buyers. It ends up not
being the bank’s money because I pool these mortgages, after which they
are sliced and diced, rated by agencies and sold to yield-hungry investors. My
bank only holds the average commercial mortgage for 45 days.”
Harry, real estate has entered a kind of golden age. He’s just shoveling this paper out the door, to these hedge funds
and German and Chinese and insurance companies that are chasing yield. They’re
looking at default history and going “what’s the problem?” They’re
not looking at the catastrophic event, at what happens when the imbalances
unwind. For the most part the people buying this debt haven’t been
through a real bear market. When you have to eat what you kill it’s
different. This time around we’ve allowed the banks to become killing
machines and sell the meat everywhere.”
there’s our answer. Credit card loans, mortgages and all the rest are
no longer the banks’ problems, because it’s no longer their
money. They do the deals, collect their fees, and move on. Because they no
longer have a stake in these loans actually being paid back, they see little
risk—at least no mortal risk—in churning out as much paper as the
market will bear. So the question becomes, how much more can the market take?
Who knows, really. It’s a big world with a lot
of dollars sloshing around.
I know I’ve been saying this for a couple of years—it sure feels
like the end is near. Home foreclosures have doubled or tripled in formerly
hot markets. A flat yield curve is squeezing bank loan margins (though for
now they’re making it up through trading and mergers and acquisitions).
And hedge funds—lucrative customers of the money center
banks—are starting to die spectacularly. Add it all up, and the result
is a party that’s about to end, producing a long list of bankrupt
lenders and busted stocks. In the interest of full disclosure, I
recently bought more LEAPS puts on Citi and JP
Morgan Chase, and am now short just about all the big U.S. banks. Can’t wait for the keg to run dry.
By : John Rubino
November 20, 2006
John Rubino is co-author, with GoldMoneys
James Turk, of The Coming Collapse
of the Dollar and How to Profit From It (Doubleday, December 2004),
and author of How to Profit from the
Coming Real Estate Bust (Rodale, 2003) and Main Street, Not Wall Street (Morrow, 1998). After earning a Finance MBA from New York University,
he spent the 1980s on Wall Street, as a Eurodollar trader, equity analyst and
junk bond analyst. During the 1990s he was a featured columnist with
TheStreet.com and a frequent contributor to Individual Investor, Online
Investor, and Consumers Digest, among many other publications. He now writes
for Fidelity Magazine, CFA, and Proto.