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.

• Citigroup bought big stakes in a couple of Chinese banks and announced a major expansion of its presence in U.S. consumer banking.

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 run.

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 the U.S. 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.

Even 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 with bankers:

Last 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.” 

For 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.”

So 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.

But—and 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

DollarCollapse.com

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.