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Is this the quarter when banks finally admit all of their problems?
On Jan. 15, Citigroup (C, news, msgs) announced it would take an $18.1 billion write-down on its portfolio of subprime mortgages and other risky debt, and the bank cut its dividend 41%.
With other banks following suit -- Merrill Lynch (MER, news, msgs) reported $16 billion in write-downs and other charges two days later, and Wells Fargo (WFC, news, msgs) delivered similarly huge losses -- will they throw everything, including the kitchen sink, into their losses? That kind of quarter always marks the bottom in a crisis like this.
Nah. The banks and other financials have more losses from the subprime-mortgage mess on their books that they haven't yet confessed. Worse, the mortgage debacle has spread to other types of debt, with banks and other financial companies reporting mounting losses in their credit card and auto loan portfolios. And worst of all, the next big leg of the crisis -- the one I think will mark the true bottom -- has just started.
As the economy slows, the default rate is rising for corporate debt, especially for the high-risk, high-yield corporate debt called "junk" by many of us. That's opening a Pandora's box of potential write-downs that could dwarf the losses in the mortgage market.
If that's true, it would push off the kitchen-sink bottom until the second or third quarter of 2008, depending on how bad the economy gets and how long it stays in the dumps. (See my Dec. 28 column, "Don't count on a 'normal' recession.")
A brief history of bubbles
It's not surprising that it will take so long to work through this mess, if you remember how it all began. The current crisis is yet another in a string of financial bubbles -- the tech bubble that burst in 2000, the housing bubble that burst in 2007 and the debt-market bubble that's bursting now. Behind each bubble stands a global flood of cheap money created by:- Central banks running their printing presses to fend off economic slowdowns or financial-market crashes.
- A weak yen that let traders and speculators borrow for almost nothing in Japan in order to buy stocks and bonds in other markets.
- A huge surge of exports from countries such as China determined to hold down domestic consumption.
- Soaring oil prices that gave oil producers billions of dollars to invest somewhere.
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All of those dollars chased a limited supply of real assets and traditional stocks and bonds, bringing down returns just as a falling dollar and signs of inflation lowered real returns more. Everyone wanted something as safe as U.S. Treasurys that paid more than Treasurys.
Everyone wants to believe in magic
Wall Street obliged by packaging and then slicing debt backed by mortgages, so that even the riskiest mortgages could earn a safe AA or AAA rating from Standard & Poor's, Moody's (MCO, news, msgs) or Fitch. It performed the same magic with credit card debt, with auto loans and finally with corporate debt -- even the riskiest kind, called high-yield because it pays out a higher dividend to compensate for its higher risk. It's known as junk because in hard economic times it can become worthless. (See my Aug. 10 column, "How Wall Street got into this mess.")Everyone wanted to believe that Wall Street's magic worked. Investors from Citigroup to the Hillsborough County Public Schools in Florida (exposure: $573 million) bought in. The more investors who bought in, the more of these new products Wall Street could sell and the more money it was willing to lend to home builders, home mortgage lenders and credit card companies; to the savings and loans and banks that created the raw materials (mortgages, credit card debt, auto loans) that Wall Street needed to manufacture its products; and to the hedge funds and structured investment vehicles that bought what Wall Street produced.
It worked out just fine until reality stuck a pin in the bubble. It turns out that you can't lend more and more money to less- and less-qualified home buyers without driving up the number of borrowers who pay late or can't pay at all.
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Jubak's Journal: WaMu deal in the works?JPMorgan Chase reserved $2.3 billion against rising loan losses in the fourth quarter. That looks good compared with an $18 billion write-down at Citigroup. Now, MSN Money's Jim Jubak says, the buzz is that JPMorgan could buy Washington Mutual. But is that a good idea?
On Jan. 9, Countrywide Financial (CFC, news, msgs) reported that the foreclosure rate on its 9 million mortgages had climbed to 1.44% in December, double the 0.7% rate of December 2006. The delinquency rate had climbed to 7.2% of unpaid balances, up from 4.6% in December 2006. The rates were the highest ever for Countrywide, which entered the mortgage business in 2002.
Within a week, as bankruptcy rumors swirled around Countrywide, Bank of America (BAC, news, msgs) agreed to acquire the company for $4 billion.
Damage goes beyond mortgages
But the cause of this mess stretched far beyond any problems specific to the mortgage sector, so the damage wasn't limited to that part of the debt markets. On Jan. 10, for example, American Express (AXP, news, msgs) announced that credit card debt at least 30 days past due had climbed to 3.2% of its portfolio from 2.9% in the third quarter, and write-offs of bad debt had climbed to 4.3% from 3.7% in the same period. In 2008, American Express expects write-offs to average 5.1% to 5.3%.Rate this Article
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