Thursday, December 3, 2009


In an effort to get out from under the watchdog eyes of the federal government Bank of America is re-paying $45 billion in TARP bailout money. Sounds like great news, huh? The "road to recovery" others will argue. Well, hang on to your wallets. It's all smoke mirrors ...

BofA is saying that they will use $26.2 billion of its own money, and $18.8 billion in raised capital (for a total of $45 billion), to pay down what they borrowed from the Troubled Asset Relief Program (TARP). Where have they gotten the $26.2 billion? This is especially a good question since they were moving toward financial Armageddon after purchasing the very toxic Merrill Lynch just 9 months ago. BofA is getting the money from at least three developments:




I'll take each one in turn.

BofA, like all other FDIC-backed financial institutions, has reduced the amount of money they are putting aside for a rainy day (blue line on the chart; called Coverage Ratio). As The Pragmatic Capitalist points out (in "The Bank Profit Mirage"), this means that if things go bad in some client accounts banks will have less money to deal with the problem than they did before the market collapsed last year. How do we know this? Because the FDIC keeps track of this stuff. Again, look at the Blue Line on the chart.

But then it gets really bad. Every time somebody decides that they can't make payments on a home loan or a small business loan it becomes a non-performing loan. Look at the red line on the chart (Non-Current Loans & Leases). As you can see, things aren't going well for American debtors these days. When BofA (or any bank) decide they can't squeeze any more money out of a debtor they simply write the account off as a loss (or a "charge-off"). Things aren't going well here either. Look at the green line in the chart (Loan Loss Reserves).

You don't have to be a rocket scientist to see things aren't going well for FDIC-insured banks.

Most institutions are supposed to have money to cover accounts they anticipate will go bad. After last year - and given current economic conditions for Middle America - you would think that banks would be putting billions more into the Blue Line (Coverage Ratio, to cover anticipated losses). They're not. Instead of using billions as operational (rainy day) funds they're shifting them over to their bottom line and calling it a "profit."

And just like that, it looks like banks are doing better. See how easy that is?

In a few words, BofA is taking billions out of it's rainy day fund at precisely the time that they should be putting more into it. My guess is that they're confident that their current market bets will continue to pay-off because of government guarantees in other (non-TARP) areas. Here's why.

I'll try and make this as simple as possible. The once toxic derivatives, and other market garbage, that Merrill Lynch, Goldman Sachs, and AIG (among others) had were suddenly cleansed. Because of the federal government's bailout money, the Federal Reserves gurantees and credits, and the Treasury Department's intervention, well over $5 trillion in watered stock, bad assets, and toxic securities were pretty much cleaned up by the U.S. government. I previously wrote about this in my "Iron Maiden" posts.

These financial cleansing activities by the Federal Reserve and the Treasury Department covered at least $1.9 trillion for new lending and $4.8 trillion for troubled asset purchases. They also explain why Goldman Sachs, Merrill Lynch, AIG, etc. were suddenly made "profitable" to the point that they could pay out 100 cents on the dollar. Everything they thought was toxic was suddenly turned into gold.

In a few words, banks are profitable because the American taxpayer has made them profitable through Federal Reserve and Treasury Department trillion dollar guarantees. If our financial institutions, like BofA, were really doing fine they would pay back the TARP money and then ask the Federal Reserve and the Treasury Department to rescind their trillion dollar guarantees. But they can't. They need the guarantees to make money off the toxic assets they're still flushing out of the system. This is not a sign of recovery.

As I pointed out two posts ago one of the reasons financial institutions are starting to see profits is because they've gone back to the same derivative markets that helped get us into this mess. Rather than making loans to small businesses and entrepreneurs (who take longer to pay off) financial firms like BofA are betting on making a quicker buck on derivative contracts. This "recovery" strategy - as any half-wit should see - is only working because of the trillion dollar Federal Reserve guarantees and Treasury Department interventions.

Gambling with a continuous stream of the House's money does not make you a success ... no matter how much you make. In fact, it should make you the butt of the gambling den's jokes. But that's not the case for America's financial institutions. They actually believe they're the ones making things work.

The additional $18.8 billion that BofA says it will use to pay it's TARP loan back will come from selling more of it's stock. This means BofA will dilute the value of current shareholder stock in order to raise capital. This is not good news for their shareholders. But the goal isn't to appease shareholders today. It's to get the U.S. government off of its back so that BofA

At the end of the day, that anyone buys into the idea that the major financial institutions are healthy is dumbfounding. Toxic assets were spun into gold by the U.S. government. Money (or "profits") used by BofA to pay back the federal government is really operational capital that should be used for the rainy day around the corner. Instead, BofA, like other financial institutions, is banking on the Fed's trillion dollar guarantees to make anticipated losses whole. But this is understandable. Federal Reserve trillion dollar guarantees don't have TARP-like conditions attached to them (thank you Tim Geithner and Ben Bernanke).

Finally, that BofA and other financial institutions continue to bet on interest rate and foreign currency derivative markets - which have been made whole by government money - should be a red flag. The fact that the media wants to talk about the "recovery" of BofA, instead of asking why they're so healthy, tells me one thing: We've learned nothing from the previous years of smoke & mirrors.

Stay tuned.

- Mark

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