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Comments by Christopher Whalen
American Enterprise Institute
October 6, 2010
Is the Subprime Crisis Over?
• No. The improvement in bank loan default rates
is a mirage. The use of loan modification to make
bad credits appear “current” is an economic
fraud perpetrated by Washington that is already
becoming apparent via foreclosure moratoria.
• Mounting cash flow stress on all lenders is
reaching crisis levels. Non‐payment by borrowers
and mounting foreclosure backlogs are creating
the conditions for the collapse of some of the
largest U.S. banks in 2011.
Chart 1: Efficiency
• First stage of the banking crisis involved stress on
liquidity due to market contagion. TARP, the Fed, FDIC
responded with liquidity and debt guarantees.
• The second stage involved stress on capital via charge‐
offs and loan loss reserves, both of which drove banks
into record levels of loss.
• The third stage of the banking crisis involves
degradation of bank operating efficiency as
restructuring accelerates, expenses rise and lenders
involuntarily become non‐operating REITs.
1984Q1
1984Q4
1985Q3
1986Q2
1987Q1
1987Q4
1988Q3
1989Q2
1990Q1
1990Q4
1991Q3
1992Q2
1993Q1
1993Q4
1994Q3
Source: FDIC Quarterly Bank Profile
1995Q2
1996Q1
1996Q4
1997Q3
1998Q2
1999Q1
1999Q4
2000Q3
2001Q2
2002Q1
2002Q4
2003Q3
2004Q2
2005Q1
2005Q4
2006Q3
2007Q2
2008Q1
2008Q4
2009Q3
2010Q2
Efficiency: Banks > $10b Assets
40.0%
45.0%
50.0%
55.0%
60.0%
65.0%
70.0%
75.0%
Chart 2: Net Interest Income
• Many on Wall Street believe that net interest
margin or NIM among U.S. banks is at record
levels. They are right, but not in the way that
many investors and analysts expect.
• Unfortunately, measured in dollars, the NIM of
the banking industry has been cut by a third over
the past three years due to the Fed’s zero interest
rate policy. Banks are literally dying from lack of
yield on assets due to the Fed’s ZIRP.
1984Q1
1984Q4
1985Q3
1986Q2
1987Q1
1987Q4
1988Q3
1989Q2
1990Q1
Total interest income
1990Q4
1991Q3
1992Q2
1993Q1
1993Q4
Source: FDIC Quarterly Bank Profile
1994Q3
1995Q2
1996Q1
Total interest expense
1996Q4
1997Q3
1998Q2
1999Q1
1999Q4
2000Q3
2001Q2
2002Q1
2002Q4
2003Q3
2004Q2
2005Q1
Net Interest Income
2005Q4
2006Q3
2007Q2
2008Q1
2008Q4
2009Q3
2010Q2
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
180,000
200,000
Chart 3: Non‐Interest Income
• In 2005‐2007 period when the subprime frenzy
peaked, non‐interest revenue for U.S. banks
reached a record $80 billion. Expenses,
conversely, were muted as defaults disappeared,
but are now growing rapidly.
• Since 2007, the non‐interest revenue of all U.S.
banks has fallen by over $10 billion. Non‐interest
expenses at U.S. banks will continue to increase
due to residential and commercial foreclosures.
1984…
1984…
1985…
1986…
1987…
1987…
1988…
1989…
1990…
1990…
1991…
1992…
1993…
1993…
1994…
Source: FDIC Quarterly Bank Profile
Total noninterest income
Total noninterest expense
1995…
1996…
1996…
1997…
1998…
1999…
1999…
2000…
2001…
2002…
2002…
2003…
2004…
2005…
2005…
Non‐Interest Income
2006…
2007…
2008…
2008…
2009…
2010…
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
Chart 4: Exposure at Default (EAD)
• U.S. banks continue to shrink their unused credit lines to
limit exposure to default. The shrinkage in EAD is also a
function of slack demand for credit in a deflating economy.
• The combinations of still‐record default rates and rising
servicing costs related to foreclosures is making banks
hyper‐cautious about credit. The muddle along policy of
Obama and Geithner = no net credit growth.
• Chart on the following page shows unused credit lines for
BAC, C. JPM and the large‐bank peer group created by The
IRA Bank Monitor. Note all have greatly reduced EAD.
0
50
100
150
200
250
300
Mar‐00
Jul‐00
Nov‐00
Mar‐01
Jul‐01
Nov‐01
Mar‐02
Jul‐02
Nov‐02
Mar‐03
Jul‐03
Nov‐03
Source: FDIC /IRA Bank Monitor
Mar‐04
Jul‐04
Nov‐04
Mar‐05
BAC
Jul‐05
Nov‐05
Mar‐06
Jul‐06
Nov‐06
Peer Avg
Mar‐07
Jul‐07
Nov‐07
Mar‐08
C
Jul‐08
Nov‐08
Mar‐09
Jul‐09
Exposure at Default (%)
JPM
Nov‐09
Mar‐10
Conclusions (1)
• The U.S. banking industry is entering a new period of crisis
where operating costs are rising dramatically due to
foreclosures and defaults. We are less than ¼ of the way
through the foreclosure process. Laurie Goodman of
Amherst Securities predicts that 1 in 5 mortgages could go
into foreclosure without radical action.
• Rising operating costs in banks will be more significant than
in past recessions and could force the U.S. government to
restructure some large lenders as expenses overwhelm
revenue. BAC, JPM, GMAC foreclosure moratoriums only
the start of the crisis that threatens the financial
foundations of the entire U.S. political economy.
Conclusions (2)
• The largest U.S. banks remain insolvent and must continue
to shrink. Failure by the Obama Administration to
restructure the largest banks during 2007‐2009 period only
means that this process is going to occur over next three to
five years – whether we like it or not. The issue is
recognizing existing losses ‐‐ not if a loss occurred.
• Impending operational collapse of some of the largest U.S.
banks will serve as the catalyst for re‐creation of RFC‐type
liquidation vehicle(s) to handle the operational task of
finally deflating the subprime bubble. End of the
liquidation cycle of the deflating bubble will arrive in
another four to five years.
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