naked capitalism

I don’t mean to sound as if I am hectoring Shahien Nasiripour, since he has doggedly and successfully broken quite a few banking stories when he was at Huffington Post, which lead the Financial Times to snatch him up. That’s tremendous validation for a young reporter.

However, the conventions of reporting (and it may reflect FT style preferences) are having two unfortunate side effects on his latest article about the so-called 50 state attorney general settlement. The first is that his new piece has the unfortunate effect of making the deal seem more alive than it is. This process is beginning to remind me of the Vietnam peace talks, which dragged on for years and made progress only when the US decided to throw in the towel and used the negotiations to wrap it decision to leave in “Peace with Honor” packaging.

The second is that the story is organized around one new tidbit, and you learn much later in the story that it means less than it seems, and another tidbit mentioned in passing seems just as important as the one featured prominently.

Shahien got his hands on a memo from the Illinois attorney general which breaks a settlement of $17 billion (not $20 billion as generally rumored) down among the bank miscreants. Perhaps the reduction in total size is the result of some big states dropping out (more on that shortly), From the Financial Times:

Bank of America would pay $7.8bn…JPMorgan would pay $3.8bn, while Wells could pay about $3.5bn, according to people familiar with the document. Citigroup would be asked to pay about $1.4bn and Ally Financial, which is 73.8 per cent owned by the US Treasury, would pay $860m.

Now of course, all these numbers, and the fact that the two sides are meeting Friday makes it sound like the deal is moving along, right? Think twice.

First, this is one state’s back of the envelope breakdown. Not only has no other state agreed to it, Illinois isn’t even necessarily on board with it:

People familiar with the Illinois document warned that it did not represent the states’ position, just one agency’s view of where things stood.

Second, as we’ve said before, there is still no agreement (and no news of further progress) on the big divisive issue, which is what sort of release the banks get for their dough. That is tantamount to saying “I want to spend $10,000 to go somewhere” and having no idea of either where you are going or what the mode of transport is.

The article says California wants principal reductions and is meeting with banks separately, which is a pretty strong signal that they are out of the talks, along with New York, Delaware, Nevada, Massachusetts, and Minnesota. That is pretty significant and is in contradiction to the impression conveyed by the piece, that the negotiations are moving apace.

Finally, the article mentions that:

About 80 per cent of the settlement figure, earmarked for the federal government, could be used to fund another round of debt and payment reductions for struggling US homeowners, people with knowledge of the Illinois document said. That would be split between principal reductions on first-lien mortgages and junior liens; payment forbearance for unemployed borrowers; and short sales, blight remediation and transition assistance for homeowners to move into rentals.

The remainder, about $4bn-$4.4bn in cash, could be designated for the states, which then would divide the proceeds to fund a variety of programmes, including assistance to borrowers. About half that amount could be used to pay up to $2,000 to an estimated 1.1m aggrieved borrowers who allege they were harmed by improper practices.

80% to the Federal government? I wonder if this is based on an acute calculation of how little a state AG can get an look like a hero at home. Presumably the total would be allotted to the participating states in some manner (number of foreclosures or defaults?). Take 20% of $17 billion and divide it by 45 states. You get an average of $75 million. That is chump change relative to the damage done. It doesn’t even begin to cover the recording fees evaded through the use of MERS (the city of Dallas estimates that they are at least $58 million and could be as high as $100 million. Some of that liability may redound to the banks as originators and packagers).

On a different front, just as banks are coming under more attack, Moody’s signaled its doubts that Uncle Sam will be there when banks need them most. Moody’s downgraded Bank of America’s long term debt rating by two grades, from A2 to Baa1 and its short term debt rating by one notch. It lowered Citi’s short term debt rating one notch, from Prime1 to Prime2 and affirmed its long term debt rating. It kept Wells’ short term debt rating in place and cut its long term debt rating from A1 to A2.

Like the downgrade of the US, the concern is political. As the Bank of England’s Andrew Haldane explained in his paper, The $100 Billion Question, rating agencies score banks on both a stand alone basis and with the assumption of government support:

Table 2 looks at this average ratings difference for a sample of banks and building societies in the UK, and among a sample of global banks, between 2007 and 2009. Two features are striking. First, standalone ratings are materially below support ratings, by between 1.5 and 4 notches over the sample for UK and global banks. In other words, rating agencies explicitly factor in material government support to banks.

Second, this ratings difference has increased over the sample, averaging over one notch in 2007 but over three notches by 2009. In other words, actions by government during the crisis have increased the value of government support to the banks. This should come as no surprise, given the scale of intervention. Indeed, there is evidence of an up-only escalator of state support to banks dating back over the past century.5

As the New York Times noted:

The downgrades were driven by Moody’s conclusion that the federal government was less likely to step in and provide support for a faltering big bank the way it did after the 2008 collapse of Lehman Brothers, when Washington executed a series of actions including capital infusions and credit guarantees to halt the spreading panic…

While Moody’s said it “believes that the government is likely to continue to provide some level of support to systemically important financial institutions,” the agency added that the government “is also more likely now than during the financial crisis to allow a large bank to fail should it become financially troubled.”…

“Now, having moved beyond the depths of the crisis, Moody’s believes there is an increased possibility that the government might allow a large financial institution to fail, taking the view that the contagion could be limited,” the firm said in a statement. Even so, Moody’s said it doubted whether a global financial institution could be liquidated “without a disruption of the marketplace and the broader economy.”

It sounds as if Moody’s is confirming our conclusion of months ago, that a Dodd Frank resolution is not going to be the pretty, surgical event that the FDIC fantasizes it will be, and a combination of undue confidence in an untested scheme plus political pressures against bailouts will lead the authorities to hazard trying to resolve a really big bank.

In some ways, this downgrade reflects the very real possibility of an Obama loss. Geithner or a like minded successor (Jamie Dimon, eek) would be particularly attentive to the pet needs of the banking industry and would continue the “No more Lehmans” policy if at all possible. But a Republican who came in with meaningful Tea Party support might well consider it a badge of honor to let a big bank fail. And we may have the opportunity to see how that plays out sooner than we’d like.