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Banking issues are clearly resurfacing in recent months as the sovereign debt crisis flares up again and the mortgage fiasco in the U.S. comes to light.  In addition, there is a very serious risk that a housing double dip will exacerbate all of these problems.  Several reports in recent weeks support my theory that housing prices are indeed set to decline further in 2011.  There are additional risks, however, and Christopher Whalen believes that many of these issues are in fact being exacerbated by the Federal Reserve itself.  In a recent presentation he highlighted why he believes the next US banking crisis is right around the corner and why the Fed is in large part to thank:

  • 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, gross interest revenue ofthe banking industry has been cut by a third over the past three years due to the Fed’s zero interest rate policy. Banks, savers are literally dying from lack of yield on assets due to QE/ZIRP.

  • In the post WWII period, Fed interest rate cuts resulted in significant reduction in average mortgage borrowing costs for households ‐‐ until 2008, when mortgage rates implied by the bond market fell significantly but households were not able to refinance.
  • Fees charged by Fannie Mae and Freddie Mac, and a mortgage origination cartel led by the big four banks (BAC, WFC, JPM, C),  are now 4‐5 points on new origination loans vs. less than 1 point during housing boom.  Huge subsidy for largest zombie banks effectively blocks refinancing by millions of households.
  • These fees, which can add up to 7 to 10% of the face value of the loan, raise mortgage rates to borrowers by hundreds of basis points. Banks and the housing GSEs, however, saw significant benefits in declines in funding costs thanks to low fed funds rates.


  • For banks and investors, one of the biggest opportunities for gain is to invest in the stronger regional banks that are acquiring troubled or failed institutions.  Resolution results in losses, but also creates value for investors and society.
  • Acquiring failed banks from the FDIC is extremely attractive for existing banks, which tend to get preference from regulators in failed bank sales.  Attractive pricing, lack of legacy liabilities key positives for investment thesis.
  • Another way for investors to exploit the bank restructuring process is to purchase troubled assets.  So far, Fed QE and ZIRP are enabling banks to resist selling bad assets.
  • In addition, the FDIC, NCUA and other agencies are issuing RMBS and CMBS securities with government guarantees that offer attractive yields compared with Treasury debt.


  • The U.S. banking industry entering a new period of crisis where operating costs are rising dramatically due to foreclosures and loan repurchase expenses.  We are less than ¼ of the way through foreclosures. The issue is recognizing existing losses ‐‐ not if a loss occurred.
  • Failure by the Bush/Obama to restructure the largest banks during 2008‐ 2009 period only means that this process is going to occur over next three to five years–whether we like it or not.   Lower growth, employment are the cost of this lack of courage and vision.
  • The largest U.S. banks remain insolvent and must continue to shrink until they are either restructured or the subsidies flowing from the Fed, Fannie Mae/Freddie Mac cover hidden losses.  The latter course condemns Americans to years of economic malaise and further job losses.

Source: Institutional Risk Analytics

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