Monday, July 14, 2008

A Regional Bank Collapse: No Moral Hazard Here

The charts above show price changes for the S&P 500 Index (SPY) and seven major regional banks: Bank of America (BAC); Comerica (CMA); Fifth Third Bank (FITB); SunTrust Bank (STI); KeyCorp (KEY); Wachovia Bank (WB); and National City Bank (NCC). The top chart displays the percentage changes from Friday's close to the end of trading today, Monday. The bottom chart shows year-to-date percentage changes for the issues as of Monday's close.

To say that the regional banks are underperforming the broad, large cap market would be a massive understatement. As a group, as tracked by the regional bank ETF (KRE), they were down over 8% today alone. Bank of America was down 7% today; National City was down over 27%.

Year to date, the group sports 50+% losses, with National City now down over 80% on the year.

As I noted in today's Twitter comments, it's become clearer that Federal bailouts will be designed to protect the functioning of the financial system, not to bail out shareholders. We've heard a fair amount of anguished commentary regarding the "moral hazards" introduced by possible bailouts of investment banks and Government Sponsored Enterprises (GSEs, such as FNM, FRE). Well, take a good look at the charts above. That's what a crisis of confidence free of moral hazard looks like.

Will depositors respond calmly to the collapse in share values among their banks? After Sen. Schumer's disclosure of problems at IndyMac Bank, depositors chose to vote with their feet, leaving the bank and precipitating its seizure by regulators. An eye-opening statistic reported in today's Wall St. Journal indicates that, at the nation's banks, "the percentage of uninsured deposits has doubled since 1992, climbing to about 37% of the nation's $7.07 trillion in deposits at the end of the first quarter...". In the wake of continued bank weakness and the realization that funds thought secure may not fall within FDIC insurance limits after all, we may see depositors as well as shareholders flee from the financial hazards that accrue in the absence of moral ones.


Krish Rathi said...

Dr Brett,
lot of people would flee from these financial institutions and there could be major withdrawals as we have already been witnessing in the form of equity investment withdrawals. In my opinion, this has been not only a result of fundamental issues with the structure but also because of the domino effect as supports are withdrawn be it in the form of loan refusals or in the form of lack of buying interest, etc. The real point I am trying to come to is every time we have come to such junctures in the history, I feel like what bails us out in the next new thing. Sometimes it is a new asset class bubble or sometimes it is a new life transforming innovation and sometimes it is a combination of both like the internet bubble of early 00s. I am not saying anything new here ..but merely recrystallizing some of the observations with a that aha moment feeling. I feel in the next one to three years, we will witness the next new thing. Could it be alternative energy or could it be the unwired electricity or could it be just another asset bubble caused by recent rate decreases that take months to come into effect? Who knows. I am myself betting long term on alternative energy plays.

Great post as always and thank you provoking me to reflect and articulate my thoughts.

JessicaYogini said...

In the case of the GSEs, the shareholders may be left out to dry, but the real moral hazard is about making those holding securities issued by the GSEs whole, even if the market itself would not do that.
I believe that for the GSEs, the bond holdings are one or two orders of magnitude greater.

Bryan said...

Hi Brett, It's always hard to see how a crisis in a sector will play out and which companies will be the winners and losers. If savers with the weaker regional banks do start to withdraw their money they will need somewhere to put it. The stronger national banks may be the winners here. Mattress manufacturers might do well too?

bruce said...

There's been no run on any of the others. Maybe that's because Sen Schumer hasn't "disclosed" anything about them. Do you think the shareholders should be thanking Chuck?

Johan Lindén said...

regarding your twitter post:

"SEC to fight short selling of financials
By Joanna Chung in New York

Published: July 15 2008 21:31 | Last updated: July 15 2008 21:31

US regulators will take emergency action to stop abusive short-selling of stock in financial institutions such as mortgage financiers Fannie Mae and Freddie Mac and investment bank Lehman Brothers.

Christopher Cox, Securities and Exchange Commission chairman, told legislators on Tuesday that the agency would issue an emergency rule to stop so-called “naked” short-selling of shares in significant financial entities. The SEC will also consider new rules to extend those trading limits to the rest of the market."

Is this for real????? I swear it wasn't April fool's day when I checked my calender this morning!

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