The Next Looming Bank Crisis: De-Leveraging

Big Banks have another major crisis growing beneath the surface!

Banks are again on the verge of a damaging financial crisis and will plead for help from taxpayers despite it being the product of their own greed. Financial institutions are horrible corporate citizens.

As if the Big Banks, after being saved by the taxpayers, the Federal Reserve, and FASB (Financial Accounting Standards Board), didn't have enough to worry about with the ongoing foreclosure nightmare that could possibly cost them billions of dollars, another problem is brewing that is not being talked about.


Huge banks still have huge problems masked by TARP, the Fed's quantitative easing, FASB's change of Mark to Market accounting, and changes as a result of FinReg passed by Congress.

Bank's problems include: questionable foreclosure procedures, defaulting mortgages, the repurchase of toxic assets, investors demanding recourse for fraudulent securitized instruments, a potential change in FASB rules forcing aggressive markdowns, and exposure to the European crisis.

Each element, on its own, could change the landscape of banking and plunge us into another financial crisis. The convergence of any two, especially with the uncertainty of the foreclosure mess, could destroy the banking system.

Is the banking system really that fragile?

Yes it is! Despite several quarters of reported profits, including some that were phenomenal, banks are on thin ice -- with cracks that could turn into fissures at any time.

This looming crisis is already affecting banks' earnings and may be a problem that we have not yet been told about.

Prior to Gramm/Leach/Bliley -- the Financial Services Modernization Act -- banks made money by lending to their customers and collecting a fair interest by providing funding for auto loans, personal loans, and credit cards. They made money when borrowers repaid the outstanding loan. But that business model changed in 1999 when President Clinton signed the Gramm Bill into law.

Banks immediately saw an opportunity to make fast money by betting their depositors' money on riskier ventures and investments. They began leveraging those bets, committing more money to even riskier deals.

In promoting their utopian economy, banks lured naive customers into ever-increasing debt. The new path to prosperity. That lasted for several euphoric years.

Then... Utopia began to crumble. Over-leveraged consumers, unable to keep up with their newfound lifestyles, began defaulting under the burden of too much debt. Banks feeling the pain of their collapsing model were being pulled into the abyss they had created.

Years of pushing higher credit limits, of stimulating an overheated housing market and passing the paper onto unwitting investors with false promises and unprofessional expectations, began to fall apart.

Defaults on real estate, credit cards, and a sundry of other loans soared causing huge losses at banks and other financial institutions.

It was not surprising, given historical examples, that it failed.

In order to make up for the damage caused by their greed, banks began to raise interest rates, many of them to usurious levels, and add fees to offset losses in their core business. They began to lower credit limits and lines of credit hoping to quell the rising problems of too much credit and too much debt. And they stopped lending, hoarding cash out of fear of continued losses due to the declining economy.

Those moves have proven to be the wrong direction for banks as well.

Greed has created tunnel-vision in the financial services industry. Their myopic shift from providing a service to becoming a cash generating machine is backfiring on them. Their focus on gambling and new exotic instruments instead of taking care of their core business will be their eventual downfall.

What they didn't anticipate in their efforts to satisfy their newfound hunger was the reaction of their clients; clients burdened by excessive debt and a hardened resolve to relieve the pressure. That strong desire to de-leverage and the depth of that conviction has caught Big Banks by surprise.

Consumers have been reducing revolving credit for nearly two years. It is steady and unabating -- declining by billions each month -- and appears to have become the new economy.

In September consumers reduced revolving credit by $8.3 billion as reported on the NASDAQ Economic Calendar on Friday, November 5, and have been doing so for 20 straight months. In the past 11 months revolving credit declined by $75 billion (which I arrived at by adding every report from Nov '09 till the Sept. '10 report), and, including non-revolving credit, consumer credit has declined by 6.6 percent, to $2.58 trillion, since the July 2008 peak.

Strapped consumers are holding back from using their cards while paying down debt. They're opting to purchase with cash, which is beginning to put pressure on card issuers and other financial institutions.

It will soon, if it hasn't begun already, cost banks and lenders more to service debt than they collect on the outstanding debt.

There's a fear that a dramatic decline in the markets combined with continued declines in banks' core business will lead to another catastrophic financial crisis.

The Fed has used all of its tools to stave off Depression and taxpayers are loathe to bail the banksters out of another greed induced failure.

This time the banks are on their own -- and it will be fatal.