Changin' Times in Financials

I've been writing this blog for two days and have yet to finally complete it. Dick Bove, one of the best and most well respected analysts covering the banks at Ladenburg Thalmann emailed me on Monday morning about the two small regional banks that failed. We exchanged emails about the severity of the situation and also about the importance of the housing bill and a rescue plan for Fannie Mae and Freddie Mac.

Here are some excerpts of those emails.

----- Original Message -----

From: Richard X Bove

To: Glick, Alexis

Sent: Mon Jul 28 11:02:22 2008

Subject: RE: Bank Closings

Alexis,

During the first banking crisis in the post war period (1987 to 1993), the United States under then Treasury Secretary Nicholas Brady did a study of the industry and concluded in very simple terms that American banks were too small (Citibank was the 22nd largest in the world) and that there were too many of them. It has been the policy of the government since that time to get rid of as many of these banks as possible (you will not find a public statement on this but call Jim Leach in Iowa if you doubt it). So, yes at some point there will be 3,500 banks or less.

The FDIC is crucial but so few banks are about to fail or stated differently the amount of bank deposits at risk is so small that the FDIC resources are not likely to be endangered.

Richard X. Bove

________________________________

From: Glick, Alexis

Sent: Monday, July 28, 2008 10:52 AM

To: Richard X Bove

Subject: Re: Bank Closings

Dick,

This is excellent. Should I then assume that all of this is being taken out of context? Also do you think we will be sitting here one year or five years from now talking about 3,500 institutions? More consolidation where the % of assets wind up with a smaller group of banks. Also isn't the FDIC crucial here? If they can prove that they have enough funding to prevent losses if and when banks fail.

Alexis

----- Original Message -----

From: Richard X Bove

To: Glick, Alexis

Sent: Mon Jul 28 07:29:33 2008

Subject: Bank Closings

Alexis,

I noticed the comments on Fox this morning concerning bank closings and the article in the NY Times about bank lending.

I thought you might be interested in a couple of statistics:

1. In 1983 there were approximately 14,500 banks in the United States. Today there are roughly 7,200. This means that every week for 25 years 6 banks have been merged out of existence or shut down for other reasons. Over the six years period in the last banking crisis from 1987 to 1993, 9 banks were eliminated every week.

2. The top 5 banks in this country represent 52% of the industry’s assets. Banks with over $20 billion in assets are 70% of the industry. The smallest 6,000 banks in this country have fewer assets in aggregate than Citigroup.

3. Year-over-year bank loans to businesses are up 17.7% this is 70% higher than at the same time last year.

------------------------------------------------------------------------------------------

Dick makes so many important points. First of all, everything must be put in context. Second of all, the banking world is getting smaller and will continue to do so. When I pressed Dick on the motivation behind the move to rescue Fannie Mae and Freddie Mac he said the following:

"The key thought I would have is that if the FNM/FRE bailout sticks, the deficit doubles (obligations of the U.S. government). This should drive the dollar lower and the interest rates/costs to taxpayers higher. It makes it absolutely impossible to avoid a tax hike no matter who is elected President or who controls the Congress. It is actually critical for FNM/FRE to be broken up as soon as is feasible. My guess is that a system similar to the Federal Home Loan Bank system will be put in place in 12 to 18 months – i.e. 12 regional banks are created that are owned by the local financial institutions and they buy out the current FNM/FRE debt. These banks take over the secondary market function performed by FNM/FRE. It may sound far out but seven months ago or before the Barney Frank program was created I wrote a very similar proposal and it was reviewed by the President. He rejected it out of hand and is now doing exactly what we suggested for housing. So it is possible that this 12 district idea may see the light of day also."

Dick is on vacation but I wonder what he would have said about the covered bond announcement Monday. Four of the best known commercial banks announced a plan to issue covered bonds. What are covered bonds? They're actively used in other countries but essentially they're prime mortgages pre-packaged or high quality securitized debt that must sit on the balance sheet -- not the asset backed mortgages or sub-prime mortgages that caused us to get into this problem in the first place but mortgages backed by solid buyers / owners.

Why would the Treasury announce this on the Monday following the passage of the housing bill over the weekend? It's simple. The Treasury and the Fed are trying to create a back stop for mortgages much like Fannie Mae and Freddie Mac. The banks need business and institutions, whether they are pension funds or mutual funds, who will purchase their debt for two reasons. One, as a source of revenue and two, as a way to access liquidity so that they can lend more money to homeowners.

What is the Treasury, Fed or FDIC doing? They're saving their rear end. Excuse my French! How? They need Fannie Mae and Freddie Mac to originate mortgages but they cannot fully rely on them when some say they are insolvent and when they have two missions that contradict one another. One mission, originate loans and implicitly back mortgages so that other banks can give loans to potential home owners and two, de-leverage or write down loans that have filled their balance sheets with junk. Dick said in the above note that 12 banks would assume the duty of FNM and FRE on Monday morning. Monday afternoon the Treasury paved the way for 4 banks to begin doing that. I'm not a fortune teller but this was right on the money.

One other point about Merrill Lynch's announced write down and capital raise: Thain has a credibility issue. Twelve days ago he said MER was well-capitalized. What happened in 12 days? I'm not one to point fingers, but I would guess that he is not a very popular guy on Wall Street or on Main Street. Yes, the market was on fire last yesterday. Ironically, Charles Payne was emailing me all day in 50 point fonts because I said earlier in the morning on The Opening Bell that we could very well be up 300 points today.

Merrill wrote down the junk on their books to 22 cents on the dollar. This mark-to-market accounting is killing them and everyone else. Merrill threw in the towel and may have forced the hands of everyone else. Citi, Lehman, UBS, JPM, Morgan Stanley......anyone with exposure to these CDO's will now have analysts attaching a 78% loss on that paper. Not good and yet the market reacted favorably. What John Thain, the CEO of Merrill Lynch, did yesterday, is say you want a price, here it is. It's not the price he wanted but now we have a value, a mark-to-market value for today that the entire street can mark their paper at. Is it the right price? Could they have held out longer? Did they pull the trigger too soon? Perhaps.

Come gather 'round people
Wherever you roam
And admit that the waters
Around you have grown
And accept it that soon
You'll be drenched to the bone.
If your time to you
Is worth savin'
Then you better start swimmin'
Or you'll sink like a stone
For the times they are a-changin'.

Come writers and critics
Who prophesize with your pen
And keep your eyes wide
The chance won't come again
And don't speak too soon
For the wheel's still in spin
And there's no tellin' who
That it's namin'.
For the loser now
Will be later to win
For the times they are a-changin'.

Come senators, congressmen
Please heed the call
Don't stand in the doorway
Don't block up the hall
For he that gets hurt
Will be he who has stalled
There's a battle outside
And it is ragin'.
It'll soon shake your windows
And rattle your walls
For the times they are a-changin'.

Come mothers and fathers
Throughout the land
And don't criticize
What you can't understand
Your sons and your daughters
Are beyond your command
Your old road is
Rapidly agin'.
Please get out of the new one
If you can't lend your hand
For the times they are a-changin'.

The line it is drawn
The curse it is cast
The slow one now
Will later be fast
As the present now
Will later be past
The order is
Rapidly fadin'.
And the first one now
Will later be last
For the times they are a-changin'.

BOB DYLAN’S “THE TIMES THEY ARE A_CHANGIN’.”