Banks on the Brink
“If the Occupiers start chanting ‘Mark to Market,’” an attorney highly conversant with the darker workings of the Wall Street-Washington complex told me, “we’ll know they’re serious.” Such a call would quickly presage the collapse of our “too big to fail” banks, for it would highlight the fact that a huge proportion of the assets of Bank of America, Wells Fargo, JP Morgan, and Citigroup consist of loans that will never be paid back and are therefore essentially worthless. The so called “recovery” of our leading financial institutions from the post-Lehman abyss has depended on a fraudulent valuation of these assets, but stripped of the fiction, the banks are insolvent.
Not long ago, accounting rules required bank assets, such as mortgage, credit card and other loans, not to mention the securities derived therefrom, to be “marked to market,” meaning that they had to be valued on the balance sheet at what they might fetch if offered for sale on the open market. This practice, enjoined by the Financial Accountancy Standards Board (FASB), was quite popular at a time when the bubble was still inflating, propelling house prices and the mortgage backed securities they supported in a pleasingly northward direction, and naturally carrying quarterly bonuses and other good things along with them. However, such attitudes changed in a hurry once the housing bubble burst and the ratings agencies, albeit belatedly and reluctantly, began certifying that mortgage loans, as packaged and puréed into securitized instruments, were worth a lot less, or nothing at all. In 2008 therefore the banks were forced to disclose write-downs of $175 billion. By early 2009 not only were most of these institutions facing capital shortfalls that rendered them insolvent, they were close to having to admit the fact and head for the bankruptcy court.
Cries of rage and pain echoing round Wall Street were amplified in Washington DC by $27.5 million in bankers’ cash, funneled through lobbyists who focused their particular and generous attention on the capital markets subcommittee of the House Financial Services Committee. The consequences were immediate and gratifying, at least from the point of view of the banks. Hapless number crunchers from the FASB were hauled in front of the subcommittee on March 12, 2009, and harshly instructed to change their rule, fast, or the congress would do it for them. Results were immediate. Instead of having to price their assets at a realistic level, ie one where someone might buy them, banks were permitted to use “substantial discretion” in their book-keeping. “Mark to fantasy,” some called it, but suddenly Wall Street was booming again, along with bonuses. Notional profits were further bolstered by shrinking “loan loss reserves” – money put aside against a rainy day – on the balance sheets. Since all those assets were at healthy valuations again, who needed to provide for losses?
But of course the underlying reality never changed, except for the worse. Loans defaults continued their inexorable climb. Desperate to hoard whatever actual cash they did have, largely courtesy of Fed largesse, the banks eschewed anything as risky as actually lending money to businesses who might use it to give jobs to people. No one, at least in government or on Wall Street, was prepared to admit the ongoing reality of major bank insolvency.
As one clear-eyed observer of Wall Street told me earlier this week: “Bank of America earnings were out today and you need an advanced degree in bullshit to understand half of it. The whole thing is malarkey piled on crap. I don’t know how to separate the garbage from the decent and neither do (the banks). It’s the main thing that’s stopping any bank recovery, the denial and the inability or unwillingness to take their medicine.”
However, there is a way out of the morass. Congress did pass the 2010 Dodd-Frank financial reform bill. Though assiduously laced with loopholes and escape hatches, the law does contain one crucial element that would, if implemented, allow the seizure of the banks and the loans they control. That’s the part of the 2010 financial reform act that gives the FDIC the necessary authority “to liquidate failing financial companies that pose a significant risk to the financial stability of the United States in a manner that mitigates such risk and minimizes moral hazard.” It goes on to mandate that “creditors and shareholders will bear the losses of the financial company,” while management should not only be fired but also held personally liable (“bear losses consistent with their responsibility”) for the wreckage they have caused. God knows how this got past the lobbyists, but it’s on the books. Let’s use it, dismantle JP Morgan, Wells, etc. At that point the Federal Deposit Insurance Corporation would actually own all those loans that homeowners and other borrowers have been struggling to repay. The banks have been obstructing any reduction of principal by allowing subprime borrowers to refinance at affordable rates. But a government takeover, which is entirely in the administration’s power, would permit just that. As a result, homeowners etc would be able to afford their payments, with cash to spare.
Too bad it won’t happen.