Friday, November 6, 2009

Is Our Whole Banking System Catastrophically Insolvent?

A good friend on mine works for a real estate consulting firm in NYC. One of his deals is evaluating a client's investment in an insolvent commercial property. The deal has $110 million bank loan funded by Bank of America. My friend said the property is worth $30-40 million. What I found interesting, and which confirms that banks are not even close to marking their assets properly, is that my buddy said that B of A is carrying the loan on its books at the full $110 million.

I just did a "drive-by" on B of A's latest 10-Q. It has $2.1 trillion in assets, not including cash. It is reporting $257 billion of shareholder equity. Now, BAC is over-marking the above-referenced asset by 70%. Assume across all of its assets, BAC is being generous in its marks by only 10%. This exercise implies that a true mark-to-market of BAC's balance sheet would wipe out BAC's shareholder equity.

Is this unrealistic?  I think, if anything, my analysis errs in the favor of BAC. Why? BAC has $159 billion of home equity loans on its books. We know that, in general, most home equity loans are probably worth nothing. Let's say BAC's are worth 50 cents on the dollar (this is generous). That adjustment alone would reduce BAC's book value by nearly $80 billion.

The bank has a loan loss reserve of 3.8% of its $914 billion in loans.  But the charge-off ratios for residential mortgages and credit cards (not including commercial r/e) was 4.73% in the latest quarter for mortgages and 12.9% for credit cards. Clearly, BAC is unequivocally under-reserving for the purposes of managing earnings and mainting its vital capital ratios.  And we know that the banks are undeniably stretching out their declarations of delinquencies, defaults and charge-offs. 

My point here is that between the home equity loans and the anorexic loan loss reserve, I can demonstrate that BAC's shareholder equity is overstated by at least 50%.  I haven't bothered addressing the larger balance sheet items of residential mortgages (a large portion of which come from its acquisition of Countrywide, which we know was the goliath of toxic mortgage lending) and commercial loans.  Imagine what a realistic assesment of those items would do to BAC's book value.

Then there's the off-balance-sheet toxic waste (like SIV's, CDO's, VIE's and derivatives). I said I did a "drive-by" on BAC's latest 10-Q, meaning I spent a couple hours digging through the footnotes looking for the obvious accounting exploitations the bank used to pervert its accounting presentation.  I wanted to show that Bank of America is technically insolvent. If someone wanted to spend the time dissecting the derivatives disclosures and special purpose financing vehicles, I'm sure it could be shown that Bank of America would collapse tomorrow without the Federal Reserve and taxpayer support tossed its way (please note, most of the Fed support has taxpayer guarantees - you can thank Paulson, Geithner and Bernanke for that goody tossed at the banks).

This whole exercise was started after my "catch up time" phone call with one of my best friends from NYC. After I got off the phone I realized that I had just received an inside look at how distorted the book value of just one of BAC's non-menial commercial loan assets was. Based on this simple analysis, I truly believe that if we could do an accurate forensic accounting at all the big banks, especially Goldman, JPM and Citi, it could be shown that they are all fraudulently overvaluing their assets and thus catastrophically insolvent.


  1. Yes, and so the question is, what financial chicanery with FASB come up with this year (last year's FASB 157) so the banks and their auditors can sign off something that won't put the CEO/CFO in jail under Sar-Box?


  2. As long as banks and General Electric for that matter, had to follow "Mark to Market" accounting they were spiraling into Bankruptcy. As soon as "Mark to Fantasy" rules were adopted, everybody became profitable and solvent...and nobody has mentioned "Mark to Market" ever since.

    It stinks to high heaven but the reality is that Banks are sitting on paper that is essentially worthless after having looted the banks of the hard currency used to issue the paper. I always thought that counterfeiting was illegal. Guess it just depends on your point of view.

    Henry M. Galt

  3. It's always nice to hear a credible piece of anecdotal evidence, but I think quite a few know that "The banks are insolvent." The question is what, if anything, will force this realization out into the open.

    Friday, for example, the share market was set to break down badly, but some entity was intervening against that outcome. In a market that is routinely interfered with, Friday was extraordinary. I would remind readers that the present economic circumstances, vis a via unemployment, exceed the stress test boundaries. We should be collapsing badly, and yet we aren't. Something must give, but what and when?

  4. Edwardo, it is my belief that our markets will stay like this, and the fraud, corruption, and wealth theft by the elitist bankers/politicians, until the Fed ulitmately prints the currency into worthlessness. That is what happened in Weimar Germany. The currency eventually collapsed under the sheer weight of its enormous supply.

    What does this mean? It doesn't mean the dollar has no value in this country. It has value by legal decree. BUT, it means the rest of the world no longer will take dollars in exchange for goods and services. This is already happening all over Europe on a micro-basis. Eventually OPEC will stop taking dollars. That movement took another step, I would argue, when the Saudis announced they were no longer going to use the NYMEX WTI contract to index the price of oil. Eventually the dollar will have no value outside the the U.S. borders. Until then, we're going to continue seeing more of the same out of Washington and Wall street, only it will become more and more mind-blowing. Notice how quickly the appointment of that 29 yr old zit-popper from Goldman to head the SEC's enforcement activities has disappeared from public purview...

    As for showing what's really going on using anectdotal evidence. Where else are you seeing numerical examples backed up by real life data? Meredith whitney isn't doing it. Dick Bove? ROFLMAO. I am not seeing any research put out anywhere that shows actual data gleaned from 10-Q's showing how and why these bank balance sheets are bullshit. Reggie Middleton is doing good work, but he doesn't have an actual piece of proof from the field like I just got yesterday. It's easy to say that the banks are insolvent. But showing why with proof from the inside is another matter. My friend's accounting is real proof. The Fed and Geithner and the banking industry are doing everything within their power to hide all proof.

    Eventually - impossible to say when - the sheer force of the money supply and the fraud will cause some kind of event. Don't even want to begin to speculate what that will look like but I have a feeling I could lay out a good general outline of what to expect...

  5. Dave,
    great write up and your last comment was so spot on I cannot add anything!

  6. I agree, the Weimar outcome becomes more likely with each passing day. And yes, it is well nigh impossible to acquire absolute proof showing that the banks are holding assets on their books that bear no relationship to what they would sell for at market. But I would argue we do not need to know the details, because we know that mark to market has been abandoned by the banks.

    All we will find out if we ever see "the books" is just how radically distressed they actually are. They are all insolvent, but some are probably more desperately so than others.

  7. Tell ya what Edwardo

    We know the bank books are completely fraudulent. What I'd REEEAAALLLLY like to see is where all the gold really is. The Comex, the LME, HSBC custodian gold, JPM custodian silver and First and Foremost, the U.S. Government's SUPPOSED 8100 tons. I'd bet all my money, my dog's life, my skis, my new road bike and both of my testicles that most of the 8100 tons is mythical.

  8. Dave,
    I dug up some cool old cartoons that you may like to check out.

  9. If you take the math a step further, you will find that the amount by which the banks are insolvent is approximately the amount injected into them as subsidies. So, everything's cool. In a weird way. But yes, the banks are alive by virtue of an accounting fiction. And not much more.

  10. Dave in Denver said...
    "...until the Fed ulitmately prints the currency into worthlessness. That is what happened in Weimar Germany."

    Yes, and 8 or 9 years later they got their reward for that from the Nazies : they killed them off.

  11. Dave,

    Is your precious metals fun open to new investors? If it is, how can I find more inforamtion about it?


  12. @Anonymous:

    email me at and I'd be happy to give you more information on my fund.


  13. Not to be a downer as I do believe they (like all banks) are valuing the assets at more than they are worth but how would your buddy know what BofA is carrying it for on their books ? That would not be public info (for a particular mortgage) imo. It would have to come from someone at BofA who has access to their accounting info.

  14. ok not trying to be a smart-ass

    there are many that are aware about bank balance sheet issues - after all thats why the accounting rule change was introduced this year

    but honestly - and this is more of a philosophical question, forget about free markets etc - let's just suppose if banks were forced to mark to market, and the truth came out,

    who would benefit?

    because ultimately this would be financial armageddon, and forget about ETFs backed by gold or other commodities, and any other financial instrument. how would one access your gold in a vault of a financial institution if there was a run on that institution?

    the counterparty risk contagion would be so serious that every major financial institution would fail to honour its contracts (that would include the prime broker that lent you your stock for that short) and bear in mind this would also include any kind of automated electronic payments system that one would use for asset transfer

    so in reality, no one would benefit apart from the egos of certain Roubini-esque types

    it's a shame we're in the mess we're in. but let's try to keep financial armageddon at bay

  15. Dave "House passes $1 trillion mandatory health insurance bill."

  16. So it's not just me with that weird sensation that there is major manipulation afoot? I've never seen a stock market so utterly divorced from the economic realities of the culture in which it resides.

  17. @Werner

    A blood thirsty psychopath? Tell me I'm wrong.

  18. Shall we all start to think a little further down the road? It seems there is common agreement in these threads that some one or more events of an "Armageddon" magnitude and significance are going to occur. There is no timing estimate nor any evidence that the events will be synchronous. Can we start discussing what may happen once those watershed events occur? For example, what will the common man's intuitive concept of "trust" be in the paper currency in his pocket; in the bricks and mortar behind the logo of his "bank"; the monetary, national accounts and employment statistics that may be issued to assuage public panic; his response to "green shoots"; etc. As OldSouth has put it, the market is now a disconnect from the main street marketplace. So, should we recognize that as an index or a proxy it is no longer incorporating the national and personal economic risk(s) perceived by of the bank-using population-at-large? In which case, shall we cast off NBER, Fed, Treasury, Conference Board, D&B, Moody’s, WSJ, etc. etc. (and your choice of other oracles of economic faith)? I’d like to hear how we suppose our personal daily lives will be lived once there is a collapse. I’ve already stocked upon bullets. They solve nothing. I would like advice on how I should handle the day-to-day guns ‘n butter decisions in a post-Armageddon world.