Banking System in Trouble?

The United States Banking System has shown strength and resiliancy since recovering from the September 11 terrorist attacks in New York and Washington. One can see this strength in looking at the charts of moneycenter banks during the fall of 2001. These companies provide many financial services other than banking but we'll call them banks for convenience.

  
  

We will use the stock price as a proxy for general confidence in these and other banks for their current and future health.

The charts show strength from September 2001 through their peaks around the beginning of January 2002 except for JP Morgan. JP Morgan had a few problems with Enron late in 2001 which probably accounted for their relative weakness compared to the others. For more on JP Morgan's problems, I refer you to two articles by Adam Hamilton: "The JPM Derivatives Monster" and "JPM Derivatives Monster Grows". written in 2001.

A look at the first two charts after May shows an acceleration to the downside culminating in new 52-week lows. The Merrill Lynch chart started weakening in April, probably due to the Eliot Spitzer investigation. I don't recall the reason for Goldman's relative weakness but it has been in a slide up until this week which happens to be an options expiration week.

One could think that their recent declines in stock price has to do with Wall Street ethics problems that have been making the rounds in the United States and around the world lately. Citigroup has it's problems with its own Eliot Spitzer email investigation.

But a look at charts in the auto loan, subprime credit card, insurance, mortgage insurance and banking businesses in a more general context shows considerable weakness acrosss a variety of financial services companies.

Auto Loans

  
  

These are pretty ugly charts though there seems to be a bit of a rebound in the last two.

Credit Cards

  

Ouch! Capital One just plain fell out of bed. At least Metris and MBNA fell gracefully before falling off a cliff. Hope you weren't holding any of these.

Government Sponsored Enterprises

  
  

The first two broke down around the middle of June. Aggie broke down late May. One could argue that these charts are similar to the S&P 500 and are just following the indexes down. Some money market funds invest in Fannie Mae and Freddie Mac. I personally avoid these funds where possible.

Mortgage Insurance

  

These two companies have had a pretty vicious fall. Are there concerns about mortgage delinquencies?

Insurance Companies

  
  

Just some insurance companies for balance.  John Hancock insures a variety of things and also provides other financial services. Renaissance, Max and Everest provides insurance and reinsurance.

Banks

  
  
  
  
  
  
  
  

A casual look at the charts should indicate that there are a lot of crash charts here or charts that
could potentially crash in the near futire.

Student Loans

  

Some told me that some students he knows that graduated in 2002 took a look at the job market and decided to go for Graduate School and more loans.

Mortgage Companies

  
  
  
  
  

Kind of a mixed bag for the mortgage companies but the ones that aren't bad at the moment arecertainly signalling caution ahead.

Theories for the gloom

• Conflict of interest investigations. These certainly are a factor for those bank that do investment banking and provide analyst services but those are a small percentage of the banks here.
• Expectations of rising delinquencies. One would expect this where unemployment and underemployment is rising. Our residential real estate markets are in a spectacular bubble right now given our current state of easy money [low interest rates, low down payments, securitization of loans]. There could be concerns that the bubble will pop resulting in mortgage defaults with PMI companies left holding the bag.
• Expectations of higher interest rates. Banks could be playing the spread game where they are lending long-term and borrowing short-term and pocketing the difference. This works fine when short-term interest rates are low but could be a problem if short-term rates rise. It is widely expected that Fed Chairman Alan Greenspan will endeavor to keep short-term rates low though it is possible that he will be forced to raise rates to defend the weakening dollar. Some spread game players may use derivatives to hedge their risk to rising short-term rates. One has to hope that the counterparty to the derivatives is financially healthy.
• Foreigners withdrawing money from our credit markets resulting in higher interest rates. Foreigners hold a lot of our debt instruments and could start repatriating money currently in long-term investments in our various debt markets resulting in higher interest rates. Higher long-term interest rates could kill the housing market resulting in default and delinquency problems that could hurt banks and mortgage insurers. It's unclear to me if the current spread game can keep low rates down. Certainly the risk involved in the spread game would go up in the event of short-term rate hikes.
• Higher potential risk for property and liability coverage for the insurers. Always possible in these turbulant times.
• The prospects of a weaker economy. Reported GDP and some better economic and industry reports have led some to believe that the economy is growing and that markets will have spectacular second-half 2002 growth. Some have pared back their enthusiasm and companies reporting Q2 results are quite cautious about the second half of 2002 and are starting to look to 2003 for profits recoveries. Some companies have announced large layoffs along with their Q2 corporate results. Companies generally resort to layoffs as a last resort as the money spent to recriuit and train along with the employee's experience is lost.
• Delinquencies may push banks to tighten lending standards thereby popping the real estate bubble. The popping of this bubble would lead to lower prices and could trigger foreclosure clauses on mortgages. Houses are so leveraged today that owners, with little or negative equity could just turn over the keys to the bank and leave them holding the bag with a property worth less than the loan value.
• Could just be overall market weakness but valuations for the banking sector tend to be fairly reasonable with Price/Earnings ratios typically in the teens.

Concerns for the future

• If you're holding these companies, a portfolio review might be in order.
• A banking liquidity crisis would probably be met with a flood of liquidity from The Fed. This has been the approach taken with past financial crises. This flood of liquidity could result in import inflation if foreigners decided that dollars weren't worth as much due to the increase in the supply. There would be deflation if the buibble popped but it's possible that The Fed could try to counter that with monetary inflation. The readers at Gold-Eagle understand the implications of a big liquidity pump and know how to act accordingly.
• The FDIC is an insurance fund but its resources aren't unlimited. Banks that borrow from depositors with FDIC insurance that then lend out to the subprime arena could tax the FDIC fund requiring a taxpayer bailout.
• There may be the possibility of bank closures or the banks shutting off your credit cards abruptly. I believe that there is an example of this right now with one of the subprime credit card companies.

Conclusions

• These charts are pretty scary looking and could portend major dislocations in our financial systems.
• One should consider the ramifications of these charts but not panic any interpretation.

Disclaimers

• I may hold long or short positions on some of the companies mentioned here.
• This isn't investment advice. Be sure to do due diligence when considering investment actions.
• Opinions here are mine and are not guaranteed to be true, correct or useful.

Michael Moy
July 22, 2002  Email: mmoy@yahoo.com