This morning Chris Whalen made some comments on CNBC that hit the nail on the head regarding the U.S. banking crisis: there is a huge wave of old-fashioned loan losses coming down the pike. The writedowns we have seen to date are largely confined to tradeable securities that must be marked to market.
There are much bigger unrealized losses sitting on balance sheets right now. $700 billion will not be nearly enough to cover these losses. If the Federal government doesn’t step in and re-capitalize the U.S. banking system with more money, we are going to suffer a major deflationary spiral as these losses are realized. The WaMu-JPMorgan transaction is an example of a best-case scenario in recapitalizing the sector. However, the government will need to get involved now proactively as opposed to waiting until crisis hits again.
Where are these losses hiding?
- Residential Property (Alt-A, Payment Option, Negative Amortization Mortgages)
- Commercial Property (Commercial Real Estate and Construction Loans)
- Leveraged Loans and High Yield Bonds (from Private Equity LBOs)
- Credit Card Receivables and Asset Backed Securities
- Auto Loan Receivables and Securitized Auto Loan Bonds
While everyone is breathing a sigh of relief about the bailout package that Congress is about to pass, we need to keep our eye on the ball. There is still much work to be done. Do not be fooled into thinking that this will be the end of it.
Most people think $700 billion is a lot of money and are angry at having to fork over this sum. However, the scope of the problem in U.S. finance is much bigger than that. The bailout of the financial services sector has just begun and we need the government to admit this to the American people and get on the case.
Ultimately, if done correctly, bailouts will cause a net loss to U.S. taxpayers that could be much less than $700 billion despite large nominal outlays. If we wait until crisis again, the losses will be greater.
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