Safehaven | Any Objective Review Shows That the Big Banks are Simply Too Big for the Safety of this Country

The title just about says it all. The only thing missing is that it doesn't tell you that the banks that are too big to ensure financial stability are still getting bigger, and riskier. Before we go on, let's get a few things established for those who have not followed me regularly. Note to avoid redundancies: If you have not read me regularly, I suggest you peruse the "Credibility" side bar below. If you have not followed my recent banking articles over the last few weeks, then continue below. If you have been hanging off of my every word, then skip down to the "Break'em up, and break'em up now!" section, otherwise please read on. I strongly believe that the content of this article can change many a perception of the big banks in this country, and hopefully alert many to the risks that have been concentrated therein, even after the meltdowns that we have had to suffer at the collapse of Lehman Brothers and Bear Stearns. Things have not only not gotten better, they have gotten worse! Forward this article (or a summarized version of it) to your local congressman, senator, regulator or investment advisor, and ask them to respond to the assertions herein.

Credibility

When I have sounded the alarm in the past, it made sense to take notice. Look at who has failed over the last two years, and what I have said publicly, months before each failure.

Is this the Breaking of the Bear?: On Sunday, 27 January 2008 I made it very clear that Bear Stearns was in a fight for its life and was in explicit risk of failure. Most sell side firms has a buy on this stock at $185, and it had an investment grade rating from all of the big ratings agencies. We all know what happened two months later.

"Is Lehman really a lemming in disguise?": On February 20th, 2008, I made the proclamation that Lehman was hiding significant losses on its balance sheet. We all know what happened 7 months later. It had an investment grade rating from all of the big ratings agencies.

At the inception of this blog, I warned about nearly all of the homebuilders as well as issuing explicit insolvency proclamations on the monoline insurers when they had AAA rating and were trading in the $60 dollar range. We all know how that story ended...

I also warned about the more generalized life/P&C insurers when they had AAA ratings and were thought to be healthy. They have since converted into a bank to run to the government for TARP funds and aid. SeeIn case you haven't forgotten, I'm still bearish on the life insurance industry and scroll down for the relevant links.

The current regional bank failures were called out in the spring of 2008 with the advent of the Doo Doo 32 list. They shortly started dropping like flies. See As I see it, these 32 banks and thrifts are in deep doo-doo! and "The Doo Doo 32, revisited". Prior to this, in 2007, I made it clear that Washington Mutual and Countrywide were probably done for, see Yeah, Countrywide is pretty bad, but it ain't the only one at the subprime party... Comparing Countrywide to its peer.

The list of timely and relevant warnings can actually go on for some time. As a matter of fact, after sounding the alarm on commercial real estate exactly two years ago, and singling out the granddaddy of all commercial real estate failures a full year in advance (General Growth Properties was called out and shorted on this blog in November of 2007 as a general foreclosure case while it was the 2nd largest commercial mall owner in the country trading above $60, it filed for bankruptcy a year and a half later - see If only more rich heiresses read my blog for a full chronology).

In early March, I commented that I was preparing for a violent and aggressive bear market rally and sold off all of my profitable and in the money positions to prepare. Little did I know the extent to which I would be correct. I was actually "too right" and severely underestimated the depth and breadth of the market price increases to follow. So, what happened? I'll put it bluntly, government intervention, market manipulations and shenanigans. A picture here from "The Folly of US Financial Political Games" is worth a thousand words...

Long story, short - stock market prices have become totally detached from their fundamentals. This has a bifurcated meaning though. On one hand, this means momentum investors have outperformed over the last two quarters. On the other hand, markets always revert to fundamentals. and the longer this goes on, the stronger (and potentially more profitable) that reversion will be.

I have started to take a close look at those big banks that have benefited immensely from the large dollops of government welfare that has been distributed on the taxpayers dime, and potentially what is behind the secrets that the Fed and the Treasury have been attempting to hide from the public. The results have been illuminating, indeed. Please read, or re-read these in order before we move on.

As can be garnered from the links above, I posit that big banks have (with the complicit assistance of the US government) amassed a concentrated pile of risk that easily will bring down our financial system if ignited. Listen, when 5 banks have 96% of the notional value of derivatives in the world, there is simply too much concentration in the system. THEY MUST BE BROKEN UP! Plain and simple. Let's look at this from a simplified perspective. I have 100 people in a room, and I give them each one gallon of gasoline, each. Each gallon of gasoline represents one unit of risky assets which has both a potentially lucrative energy store and the propensity to burst into flames as well, dependent on how it is handled and the surrounding conditions. If one where to walk into the room and somehow threaten any group of 2, 5 or 10 or even two dozen of those people with a match or flame (akin to the recent credit meltdown), the risks are still distributed enough where the risk can be considered manageable, albeit quite dangerous as well.

Just imagine if one were to move 96 gallons of this flammable gas to just 5 people (who were attempting to horde all of the potential energy) in one very small corner of the room! Would someone who doesn't want to get badly burned consider the risks those 5 people cause to the whole population excessive. Just imagine if a match was thrown in to the side of the room where those 5 people stood!!! That is what we currently have in our banking system in regards to derivatives on and off balance sheet. Hey, it gets even worse. As you will learn as you read on, several members of that group of five are holding those 96 gallons of gas with handles made of tinder, kindling and matches!!!

The biggest financial institutions, you know - those that were "too big to fail" - have swallowed their fallen brethren, hence have become too big to survive, particularly if there was actually any prudent concept of too big to fail in the first place. We started with 5 bulge bracket investment banks there were basically the backbone of the shadow banking system. The shadow banking system was a practically unregulated, gray market of credit and risk. There are only two bulge bracket firms left, and they were forced to become commercial banks (in name only, and I warned about this risk explicitly in each and every one of those banks, months before their downfall/conversion to commercial banks in name only). In actuality, they are simply large, government (read as taxpayer) insured/endorsed hedge funds:

I now posit that the already dangerous moniker of "too big to fail" has already morphed through the magicks of moral hazard into "too big to let survive intact". The biggest of these banks are literally smoking time bombs that will make the Lehman failure look like a kindergarten show and tell session.

We have looked at notional value of derivatives, gross fair value of derivative (before netting) and net fair value (after netting) for leading players in the "alleged" commercial banking industry and have compared them across various metrics.

* Includes both trading and non-trading derivatives
** Notional value of derivative for GS is sourced from OCC report and pertains to 1Q09
All data pertain to latest 10-Q (June 30, 2009)

Needless to say, we will be following up with a revamped report on the "riskiest bank on the street" soon.

For those who don't speak banking parlance, tangible equity is the actual "spendable" capital that you have on hand to cover events that you would actually need money for. It excludes intangible nonsense that cannot be spent. What this means is that if Morgan Stanley's or HSBC's derivative portfolio moves a few percentage points againt them, theoretically (and actually) their equity can be totally wiped out. Now, what are the chances of that happening? Well, do you see that long list of dead companies in the "credibility" side bar above? Why don't you ask them? Oh yeah, you can't can you? That's because the infallible experts that worked there didn't think their excessive leverage and risk taking would turn againt them in such a fashion as described above as well. Not to worry, these "too big to fail" banks have the cusioning of the US taxpayer to save them if they fall. You know, the currently 10% unemployed US taxpayer!

I find it absolutely amazing that this country could justify breaking up a telephone company (Ma Bell, ala AT&T) yet allow these monstrosities of unproductive financial risk to grow even bigger and threaten the entire world, not once but twice, with their extreme levels of concentrated esoterica.

One would think that smaller banks and the associated banker's associations would scream bloody murder since they are being surcharged for risks by the FDIC (see More on the FDIC as a Catalyst...) that most couldn't even afford to take in the first place - the risks that were purposely borne by the big banks. The risks that are still being expanded by the big banks. For instance, Goldman makes nearly all of their profits through trading like a risky hedge fund (VaR is shooting through the roof, despite getting exemptions from accurate VaR reporting from the regulatory authorities), yet is protected by the FDIC, has access to the Fed window and pays one of the smallest percentages of its revenues into the FDIC insurance pool. The smaller banks are being hit so hard by these insurance charges that they are losing over 13% of their gross revenues to it, despite the fact that thay are not doing anything near as risky as proprietary trading. You guys need to speak up and defend yourself against the big boys. Hey, use this article as a lobbying tool if you have to, but do something are you will soon no longer be in existance, wiped out by the re-emergence of the dinosaurs!