After $1tn Cost of Housing Collapse, America is Now Bracing Itself

After $1tn Cost of Housing Collapse, America is Now Bracing Itself for the Credit Card Bill

By © Guardian News & Media 2008

US banks start preparing as accounting changes bring credit debt onto the balance sheet
The $326bn rescue of Citigroup was, some investors hoped, a turning point. It prompted a concerted rally on Wall Street last week as shareholders were reassured that the US authorities would not allow another major bank to collapse.

The Dow Jones gained more than five straight days for the first time in more than a year; the S&P 500, considered a barometer of the domestic economy, had its best week in 34 years.

"The government pretty much came out and said it would not let Citigroup fail and it was not going to wipe out the equity holders either," said Pri de Silva, analyst at Credit sights, the Wall Street research group.

Then, on Monday, came the rout. US recession was confirmed and the Dow showed its second largest fall this year.

The question now is how resolute is the government's determination to soak up the cost of holding up the system. With recession under way, analysts fear more home loans, credit card debt and even private equity deals will go bad.

"The worry is that unemployment will rise and people will not be able to service their consumer borrowings as well as their mortgage," says Brian Gendreau, an investment strategist with ING Investment Management in New York.

The cost so far to nationalize mortgage providers Freddie Mac and Fannie Mae and fund the troubled asset relief program (Tarp) for recapitalising banks is more than $1tn.

"The problem is bigger than anybody has admitted so far," warns Nariman Behravesh, chief economist at forecaster IHS Global Insight. "The government is going to have to do more. The Tarp will have to be expanded and the Federal Reserve might have to become the lender of first resort."

The assumption markets appear to have made last week, that the US authorities will step in, will have alarmed any US taxpayer who read a note last week by Meredith Whitney, the Wall Street analyst who predicted the near-collapse of Citigroup.

The Oppenheimer & Co analyst estimates the $110bn of Tarp funds drawn by Bank of America, Citigroup, JP Morgan, Wells Fargo, Goldman Sachs and Morgan Stanley will be consumed by further write downs and replenishing reserves endangered by yet more bad loans. The banks are forecast to incur $44bn in impairment charges and credit-card-related provisions in the final quarter this year.

"Overall we do not believe these capital raises will spur meaningful growth for the industry," she wrote in a note, titled "Gobble Gobble" in allusion to banks' appetite for government capital.

If she is right, more capital needs to be pumped into the system, hence the $800bn poured into mortgage and consumer credit markets last week. With the economy forecast to contract by 4% this quarter and unemployment expected to rise from 6.5% to 9% by next year, credit needs to start flowing immediately.

Accounting changes in the US next year mean all credit card debt will have to be brought onto balance sheets. That spells trouble for Bank of America, Citigroup and JPMorgan, which hold more than half of their credit card debt outside their profit and loss accounts, according to Oppenheimer & Co.

"It will require the banks to use up a meaningful portion of their Tarp capital to build reserves for credit card losses in 2009," says Whitney, who believes the three major banks might need to devote between 20% and 42% of their newly raised capital to credit card debts.

It raises the question whether the $178bn in new capital raised by the six big banks so far is enough. Of that, $110bn came from the Tarp and it was supposed to encourage banks to resume lending to consumers, but that is possible only if the consequences of the past decade's loan spree have been addressed in full. "We believe much of this capital will be diverted to plug holes on the balance sheet," says Whitney.

There is $350bn left in the Tarp but will even that be enough? Whitney warns that other off-balance sheet debts held by the big banks, as well as credit card loans, will also have to start coming back on to the accounts by the end of next year. Yet more capital will have to be held against those debts to protect customers' savings.

Including credit card debts, Citigroup is exposed to $1.2tn of off-balance-sheet debt, JP Morgan to $735bn and Bank of America to $73bn. Not all of it will be dumped back on to profit and loss accounts but Whitney warns her estimates do not include off-balance-sheet mortgages. "We are unclear what the magnitude of that will be."

Last week's optimism is giving way, once again, to uncertainty.

Fall cuts

Main financial services job losses since beginning of September:

Sept 1 Commerzbank 9,000

Sept 13 GMAC 5,000

Sept 26 HSBC 1,100

Oct 3 UBS 2,000

Oct 10 Barclays 3,000

Oct 21 National City Corp 4,000

Oct 23 Goldman Sachs 3,300

Oct 28 Credit Suisse 500

Oct 30 American Express 7,000

Nov 7 DBS Group 900

Nov 14 Fidelity 1,700

Nov 14 RBS3,000

Nov 17 Citigroup52,000

Nov 20 Bank of New York Mellon Corp 1,800

Dec 1 J P Morgan Chase 9,200; Credit Suisse 650; HSBC 500; Bayern LB 5,600