The dirty laundry must soon be aired(ZT)

Just How Much Trouble Are The Big US Banks In?
FN Arena News - August 27 2007

By Greg Peel


Historybooks are already being updated to include the supposed stroke ofgenius which was the Fed's lowering of the discount rate two Fridaysago. In making this move, and not immediately slashing the cash rate,observers have suggested Fed chairman Ben Bernanke's reputation hasbeen elevated to "rock star status". Only a higher being could havecalmed the waters so decisively as Bernanke has done.


And inwhat has been heralded as a symbolic show of support for the move, lastweek four of America's biggest investment banks - JP Morgan, Citigroup,Bank of America and Wachovia - strode purposefully to the discountwindow and each borrowed US$500 million. It is too coincidental thatthey all borrowed the same amount, so analysts have suggested thesefour were trying to make a point to others struggling in the creditcrunch that there should really be no stigma attached in having toaccess a lender of the last resort facility.


But just how symbolic really was the gesture?


Fortunemagazine's Peter Eavis has picked up on what he finds a very disturbingaddendum to the four bank story. It was Wednesday when the banks tappedon the window, but it has come to light that on the Monday the Fed sentletters to both Citigroup and Bank of America in which it agreed tobend key banking regulations in order to help the two out. Theregulations amount to just how much a federally-insured bank (such asCitibank) can on-lend to its brokerage affiliates (such as CitigroupCapital Markets).


While once upon a time the banks weresimply not allowed to lend any money to their trading and brokingdivisions, at the risk of deposit holders, a more recent regulation hasallowed lending of up to 10% of capital. Citibank and BA are now ableto lend up to US$25 billion a piece, and if you quantify this againstCitibank that's a whopping 30% of capital.


So it appearsthat the banks set up this exemption - which has been deemed onlytemporary by the Fed, although no end date has been mentioned - justbefore they made their "symbolic" borrowings. Maybe the symbolism wasin fact masking some darker reality.


Eavis assumes that JP Morgan would also have sought the exemption, but received a firm "no comment" from management.


TheFed did comment however, dismissing the temporary relaxing of the rulesas a way to expedite the infusion of liquidity into the greaterfinancial system in "the most rapid and cost effective manner possible".


Ifyou recall that this whole credit mess really started when Bear Stearnsannounced that one of its hedge funds had gone from US$6 billion toworthless on the back of unsaleable mortgage securities, then $25billion each to Citi and BA is rather disturbing.


What Eavissuggests is that the Fed is in crisis management while trying tomaintain a calm exterior. The discount window move, as opposed to aknee-jerk cash rate cut, is seen as testament to this. But perhaps wecan envisage the metaphoric duck gliding gracefully while its feet arefuriously paddling. One thing that will come out of this move, notesEavis, is that the Fed is going to implore its regulatory arm tosharpen up its oversight of bank balance sheets. Thus banks will haveto mark their dud exposures down to realistically levels a lot fasternow.


The month of September is traditionally the time whenthe US financial sector starts announcing pre-third quarter profitresults. Throw in the September 18 date for the next FOMC ratedecision, and we have the potential for a lot more volatility ahead.Hedge funds and investment banks can't hold on forever marking CDOs andother assets at inflated valuations in the hope the credit market willbounce back. The dirty laundry must soon be aired, and there is littleto suggest it will be only slightly soiled.


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