U.S. Banks Risk ‘Untold Problem’ as Muni Debt Swells
By Dakin Campbell
(Bloomberg) — Citigroup Inc., State Street Corp. and U.S. Bancorp are among U.S. banks whose municipal bond holdings have reached a 25-year high just as state budget deficits swell to $140 billion, the most since the start of the recession.
Commercial lenders added more than $84 billion to their holdings since 2003, according to the Federal Reserve, pushing total investments to $216.2 billion at the end of the first quarter. Bank regulators and ratings companies are ramping up scrutiny of banks most at risk of being forced to raise more capital should debt prices slide.
“There is a huge untold problem here,” said Walter J. Mix III, a former commissioner of the California Department of Financial Institutions who closed 30 banks during the last banking crisis in the 1990s. “The economics lead to the conclusion that there will be downward pressure on these bonds.”
At Cullen/Frost Bankers Inc., the biggest Texas lender, holdings of municipal debt exceeded Tier 1 capital, a key measure of a bank’s ability to absorb losses, by $491 million at the end of the first quarter, data compiled by Bloomberg show. For State Street, based in Boston, the holdings make up 50 percent of Tier 1 capital. U.S. Bancorp, the Minneapolis lender, has a ratio of 28 percent. It’s 11 percent at Citigroup, the data show.
Municipal Bond Yields
Default speculation and a move by investors to the safest securities drove municipal bond yields to a 13-month high relative to U.S. Treasuries in the first half of the year. Now, the Federal Deposit Insurance Corp. has asked analysts to look into the issue, according to spokeswoman Michele Heller.
The 9.5 percent U.S. unemployment rate and slump in property prices have slashed local governments’ ability to pay bills. Billionaire investor Warren Buffett, speaking at a June 2 hearing of the Financial Crisis Inquiry Commission in New York, predicted a “terrible problem” for municipal bonds. Buffett has said a U.S. state facing default may need a federal rescue.
Analysts and investors remain divided about the level of risk. Lenders hold just 8 percent of the $2.8 trillion state and local government debt market, and municipal bonds are only about 2 percent of total bank assets, according to the Fed.
‘Train Wreck’
“The open issue is whether it’s a slowly emerging train wreck,” said Jeff Davis, an analyst at Guggenheim Securities LLC, a unit of Guggenheim Partners LLC, whose executive chairman is former Bear Stearns Cos. Chief Executive Officer Alan D. Schwartz. “It’s hard to paint all general obligation and all revenue bonds with the same brush. The portfolios won’t go to zero.”
Municipal defaults are a slender risk, according to Moody’s Investors Service, which said in a February report that the investment-grade rate during the past four decades was 0.03 percent, compared with 0.97 percent for similar corporate issues. Investors eventually recoup an average of 67 cents on the dollar for defaulted municipal bonds.
While the historical default-rate risk for municipal debt is below corporate obligations, sudden declines in prices have already created losses at some banks.
Citigroup had an unrealized loss of $1.8 billion in the third quarter of 2008, when the municipal market sank 3.8 percent, the biggest quarterly decline since 1994, company filings and Bank of America Merrill Indexes show. The loss was deducted from the firm’s equity.
Citigroup
“Citi’s exposure to the municipal market is of the highest quality,” Danielle Romero-Apsilos, a spokeswoman for the New York-based firm, said in a statement. “We conduct rigorous stress tests under a variety of scenarios and are comfortable with our position.”
Citigroup had the largest municipal holdings among the biggest banks as of March 31, with $13.4 billion of state and local government bonds, according to FDIC call reports. That’s down from $13.8 billion at the end of last year. Bank of America Corp. held $8.5 billion, Wells Fargo & Co. owned $7.6 billion and JPMorgan Chase & Co. held $4.5 billion. Each accounted for less than 8 percent of Tier 1 capital, according to the FDIC.
Bank of America, based in Charlotte, North Carolina, has made “significant progress” boosting capital and reducing risk-weighted assets, spokesman Jerry Dubrowski said. The lender trimmed its municipal investments by more than $800 million in the first quarter. JPMorgan spokeswoman Jennifer Zuccarelli didn’t return a call for comment.
Wells Fargo
Wells Fargo, based in San Francisco, boosted its municipal holdings by more than $2 billion in the first quarter, data compiled by Bloomberg show. The investments are in municipalities “we know very well,” Chief Financial Officer Howard Atkins said on May 13.
State Street, the second-largest independent custody bank, owned $6.2 billion of state and local government debt at the end of March, the data show. State Street is “very comfortable” with its portfolio and has had no material credit issues, spokeswoman Carolyn Cichon said. At Minneapolis-based U.S. Bancorp, which owned $6.6 billion of municipal bonds, spokeswoman Jennifer Wendt also declined comment.
Cullen/Frost, which says it’s the only one of the 10 biggest Texas banks to survive the 1980s savings-and-loan crisis, is “extremely comfortable” with the municipal investments, CFO Phillip Green said in a July 1 interview.
$1 Billion in Bonds
The 142-year-old lender, based in San Antonio, bought $1 billion of municipal bonds in the 12 months through February, Green said that month. Most were issued by Texas school districts and insured by the state’s Permanent School Fund guarantee program, he said in last week’s interview.
Municipal debt gained 2 percent in the second quarter underperforming Treasuries by 2.7 percentage points, according to Bank of America Merrill indexes. In 2009, state and local government debt rose 14.5 percent.
U.S. states are likely to face $140 billion in cumulative budget gaps in the coming year, according to the Center on Budget and Policy Priorities. Last year, 187 tax-exempt issuers defaulted on $6.4 billion of securities, the most since 1992, according to data from Distressed Debt Securities in Miami Lakes, Florida.
“It’s a market where it’s clear that the underlying fundamentals are lousy,” said Michael Aronstein, chief investment strategist at Oscar Gruss & Son Inc., a New York- based brokerage. “People can say fundamentals don’t matter but I’ve been doing this for 32 years. They do.”
–With assistance from Dunstan McNichol in Trenton, New Jersey and William Selway in Washington, D.C. Editors: Alec McCabe, David Scheer.
To contact the reporter on this story: Dakin Campbell in San Francisco at dcampbell27@bloomberg.net
To contact the editor responsible for this story: Alec McCabe at amccabe@bloomberg.net.
Downsizing the big banks: A long-term solution
The hundreds of billions in rescue funds needed to support banks — and the trillions in implicit subsidies — has brought the question of appropriate institutional size to the forefront of regulatory reform. Not surprisingly, FDIC Chairwoman Sheila Bair and Federal Reserve Chairman Ben Bernanke favor measures collectively intended to limit the size of banks in the future, Bloomberg News reports.
Options include raising capital ratios as a bank increases in size, accelerating the increases in fees paid to the FDIC, and lowering the cap on the percentage of nationwide deposits any one bank can take. Overall, the goal is to have “financial disincentives for size and complexity,” according to Bair. Complexity encompasses untraditional banking activities, such as the proprietary trading that drove Goldman Sachs’ (GS) hugely profitable quarter, as well as investing in structured financial products.
There’s no doubt that the majority of large banks took on more risk than they could handle during the last few years. Scale can be helpful in banking, but it can also mean that improper activities are occurring because management’s oversight is less effective. A trillion dollar-plus balance sheet can hide a lot of bad assets and hidden risks. As the too-big-to-fail debate rages on, the real goal is how to avoid a bank that is too-big-to-rescue.
If it seems absurd that the current raft of bailout programs could need to be repeated one day in such a larger size as to be impossible for the U.S. government to finance, consider what’s happening in the financial system now. As certain banks go under (like Washington Mutual) and others are absorbed (like Wachovia) — the result is greater concentration of banking assets under the survivors. I’ve argued elsewhere that this is both a natural and healthy part of market cycles. However, if the government is implicitly supporting existing large banks — keeping them around in the hopes that they can help clean up the mess by taking over other failed institutions — then all bets are off.
The current working plan of regulators and the Treasury Department is to increase concentration in the banking system, but it’s a near-term patch job and the exact opposite of what’s necessary long-term. Promoting stability means promoting an environment where the failure of one does not lead to a potential failure of all, and that’s tough to do when the top handful of financial institutions have huge balance sheets and extensive counterparty entanglements with each other. If that means creating a well-defined line between the dealings of regulated banks and unregulated investment banks or hedge funds, then that discussion should be on the table.
Luckily, America hasn’t yet been confronted with a financial crisis “fix” that exceeds its capacity to borrow. But to ensure that doesn’t happen in the future, institutions need to be appropriately sized so that they aren’t crucial enough to create the hope for financial help when times get tough.
James Cullen edits and writes at CollegeAnalysts.com. He is the vice president of the Boston College Investment Club, which owns shares of GS, but he has no personal position in the stocks mentioned above.
Fed Documents Fuel Concerns About Expanding Central Bank’s Role
By DAMIAN PALETTA
WASHINGTON — Documents unearthed by congressional investigators reveal disagreements among senior Federal Reserve officials about how to handle Bank of America Corp.’s acquisition of Merrill Lynch, fueling concern on Capitol Hill over giving the central bank even more power to regulate the financial system.
Federal Reserve
The glimpse inside the regulatory machinery provided by emails, memorandums and handwritten notes show a Fed that wrestled with how tough it should be on Bank of America, one of the biggest U.S. banks. It also shows Fed officials questioning more broadly their response to the financial crisis months earlier.
In December, Bank of America approached top U.S. officials about abandoning a deal, forged in the heat of the crisis, to buy investment bank Merrill Lynch. In the end, the government arranged a $20 billion rescue package for the bank to cover growing losses at Merrill.
In between, the documents show areas of disagreement within some of the Fed’s 12 regional reserve banks.
The Federal Reserve Bank of Richmond, where supervision of Bank of America’s parent company is based, pushed for a tougher approach than other regulators, emails suggest. Bank of America officials appealed more than once to the Fed’s Washington headquarters to intervene.
Bank of America CEO “Ken [Lewis] may also raise his favorite perennial issue — that is, is the Richmond supervisory team on the same page as the [Fed] Board,” Fed governor Kevin Warsh wrote in an email Dec. 30 to Fed Chairman Ben Bernanke and other senior officials. “Richmond staff was on our call today, but prior to the call, it sounds like they may have threatened a little more than ideal…”
On Jan. 10, Fed General Counsel Scott Alvarez wrote to Mr. Bernanke and others that Richmond Fed President Jeffrey Lacker was raising some issues over the final deal. Mr. Lacker wanted the entire Federal Open Market Committee to vote on any loan to Bank of America.
Mr. Bernanke responded at 2:01 a.m.: “Thanks. If we are nimble we can manage this.”
Whether or not Mr. Bernanke threatened Mr. Lewis’s ouster over the rescue remains a source of contention. Mr. Lewis suggested in testimony to New York Attorney General Andrew Cuomo that the Fed chief did just that. Mr. Bernanke has denied making such a threat to Mr. Lewis.
On Jan. 16, just days before government aid for the deal was supposed to be announced, Federal Reserve Bank of Boston president Eric Rosengren sent Mr. Bernanke an email saying that the Fed shouldn’t dismiss too hastily the idea of tossing management at Bank of America.
Mr. Rosengren suggested such a shake up might be necessary, “particularly if we believe that existing management is a significant source of the problem.”
Mr. Bernanke, at a contentious hearing Thursday, defended the Fed against suggestions it had been too lenient with management.
“The supervisory process is not a onetime thing. It’s an ongoing process, and in an ongoing supervisory process, we have made demands of the Bank of America on terms of their board and management,” he told Rep. Dennis Kucinich (D., Ohio).
The documents reveal Fed officials questioning the central bank’s response to the financial crisis even before negotiations began on the effort to aid Bank of America’s acquisition of Merrill Lynch.
“At this point I have [the] sense that the hearts and minds war in Iraq was handled better than it has been in this crisis, particularly within the Fed system,” wrote Meg McConnell, a top Federal Reserve Bank of New York official, on the day the House of Representatives voted down the Bush administration’s first financial-rescue package, sending the Dow industrials down almost 800 points.
The Obama administration earlier this month proposed giving the Fed powers to oversee and examine the largest companies in the financial system.
The disclosures could bolster the central bank’s argument that it needs more power to manage future crises. One reason for the government’s lurching response last year, officials say, was that it didn’t have the needed tools.
The Fed has been dealing with a steady stream of criticism from Republicans. Democrats have recently joined in, and the disclosures being aired through the congressional inquiry have put the central bank on the defensive.
Write to Damian Paletta at damian.paletta@wsj.com
Fed’s specter could steer GE Capital revamp
By Scott Malone – Analysis
BOSTON (Reuters) – The possibility of the Federal Reserve gaining regulatory authority over General Electric Co’s hefty finance arm could influence how the company restructures that business.
Jeffrey R Immelt GE
When President Barack Obama this week unveiled his proposal for the most sweeping overhaul of U.S. financial regulations since the 1930s, he proposed the central bank oversee not just banks but “other large firms that pose a risk to the entire economy in the event of failure.”
That was a reference to troubled insurer American International Group, which has received roughly $180 billion in government bailout money. But GE investors said the label could just as easily apply to the U.S. conglomerate’s finance business, a major commercial lender.
“I could definitely see that potentially becoming an issue if companies like GE and their finance arms came under more scrutiny,” said Perry Adams, vice president and senior portfolio manager at Huntington Private Financial Group in Traverse City, Michigan, which holds GE shares.
The Fairfield, Connecticut-based company is already working to scale back GE Capital, which has faced a sharp drop in profit through the recession and is a major reason for the 58 percent drop in GE shares over the past year, a sharper decline than the 30 percent slide of the Dow Jones industrial average.
Finance had accounted for half of GE’s profit in 2007, but Chief Executive Jeff Immelt said he plans to downsize the unit so that in the future the world’s largest maker of jet engines and electricity-producing turbines would rely on it for just 30 percent of earnings.
Last year GE Capital earned $8.6 billion, about one-third of the corporate total, and executives said in March it could earn $2 billion to $2.5 billion this year if the conditions envisioned in the Fed’s base case for the economy pan out.
GE aims to reduce its reliance on investments including real estate and on consumer finance, instead focusing more on financing GE products and other heavy equipment.
‘POUND OF FLESH’
While Obama did not name GE Capital, investors said it could easily come in for more federal oversight.
“Anybody who got aid of some sort, whether it was direct or indirect, probably is going to find that the government is going to extract their pound of flesh, have more regulation just because they don’t want to do that again,” said Peter Klein, senior portfolio manager at Fifth Third Asset Management in Cleveland, Ohio, which owns GE shares.
GE did not seek capital under the Troubled Asset Relief Program, but it did participate in Washington’s Commercial Paper Funding Facility and issue debt backed by the Temporary Liquidity Guarantee Program.
GE Capital has braced for more government oversight, but is waiting to see how it will be affected, said spokesman Russell Wilkerson.
“We have anticipated and planned for increased regulation of financial institutions and are supportive of the broad themes of addressing systemic risk and increased transparency,” Wilkerson said. “However, many elements of the administration’s proposal are new and bear further scrutiny.”
Given that the company is already working to downsize its finance arm, it may choose to exit businesses that will face substantial new regulations, investors said.
“What happens with regulation, obviously, is the returns come down,” Klein said. “All things being equal, it will find less pleasure in being a regulated entity, and there may be less emphasis on GE Capital.”
BANK WITHIN FIVE YEARS?
During the worst of the credit crisis last year, GE officials considered seeking a bank holding company charter, which would have given them access to the Fed’s lending window but also would have subjected them to more regulation. They ultimately opted not to seek a federal charter.
But under the new regulatory framework, the company may need to become a bank holding company within the next five years, wrote Goldman Sachs analyst Terry Darling, in a note to clients.
That is not necessarily a bad thing for GE investors, who in March watched the shares fall briefly below $6 — about half their current level — as Wall Street worried that GE Capital contained a “time bomb” or some sort of massive liability that investors did not know about.
GE executives responded by holding a day-long investor briefing where they reviewed GE Capital in great detail, in a bid to assuage Wall Street’s anxiety.
“We believe the ultimate outcome is unlikely to be perilous for GE shares,” Goldman’s Darling wrote. “A strong (GE Capital) is in the best interest of the economic recovery the government is trying to foster.”
(Reporting by Scott Malone, editing by Matthew Lewis)
Prez targets finance system
Seeks to prevent Wall St. abuses
President Obama’s plan to overhaul the nation’s financial regulatory system received support yesterday from key Massachusetts congressional members who said changes are long overdue.
Saying America had allowed a “culture of irresponsibility” to grow within the financial industry, Obama proposed giving the Federal Reserve more regulatory powers and creating a new consumer watchdog agency to review new financial products peddled by firms.
“This was a failure of the entire system,” Obama said at a White House event, referring to last fall’s near collapse of the nation’s financial system. “An absence of oversight engendered systematic, and systemic, abuse.”
U.S. Rep. Barney Frank (D-Newton), chairman of the influential House Financial Services Committee, said the plan is an important step toward overhauling the regulatory system. He predicted Congress will have a bill on Obama’s desk before the end of the year.
Frank, who has parted with the administration over some issues, said there will be changes to Obama’s plan, but he said Democrats agree with the “fundamental” thrust of the package.
U.S. Sen. Edward M. Kennedy (D-Mass.) and Rep. William Delahunt (D-Quincy) won a major victory when Obama agreed to create a new Consumer Financial Protection Agency, something the two Bay State pols have pushed for in recent months.
“The plan announced by the president today will protect consumers and investors by restoring much of the regulatory oversight of our financial system that has been systematically dismantled in recent years,” said Delahunt.
But business leaders and Republicans didn’t like most of the proposals.
David Hirschmann, president of the U.S. Chamber of Commerce’s capital markets center, said the president’s plan adds an extra layer of red tape without really fixing the problems that led to last year’s Wall Street meltdown.
“We can’t simply insert new regulatory agencies and hope that we’ve covered our bases,” he said.
U.S. Rep. Scott Garrett (R-N.J.) said the president’s plan could create a cycle of more bank bailouts.
“It perpetuates what we’ve had in the past, said Garrett,” a member of Frank’s Financial Services committee.
The financial industry, including some of Boston’s most powerful mutual-fund companies, have been wary of too much government intervention in the sector, fearing their interests might be hurt.
Article URL: http://www.bostonherald.com/business/general/view.bg?articleid=1179683
US push to overhaul banking worries some
/business/general/view.bg?articleid=1179686
Mortgage rates dip, remain below 5%
http://www.boston.com/business
WASHINGTON – Rates on 30-year mortgages inched downward this week, remaining below 5 percent for the 10th-consecutive week and just above record lows.
Mortgage finance giant Freddie Mac said yesterday average rates on 30-year fixed-rate mortgages dipped slightly to 4.82 percent this week, down from an average of 4.86 percent last week.
The record low of 4.78 percent was recorded on the weeks of April 2 and April 30. Freddie Mac’s survey dates to 1971.
Low rates have sparked a surge in refinancing activity. The Mortgage Bankers Association said its index of application volume climbed 2.3 percent last week from a week earlier.
Applications to refinance existing loans made up nearly 75 percent of all applications.
To revive the economy, the Federal Reserve has cut its key interest rate to a record low near zero and is expected to hold it there well into next year.
The Fed at its meeting in March launched a $1.2 trillion economic revival effort. It agreed to starting buying up to $300 billion worth of government debt over the next six months and to boost purchases of mortgage securities and debt from Fannie Mae and Freddie Mac.
At the April meeting, some Fed policy makers said additional purchases “might well be warranted at some point to spur a more rapid pace of recovery,” according to documents released Wednesday.
Qualifying for a loan, however, is still tough. Lenders have tightened their standards dramatically over the past year.
The average rate on a 15-year fixed-rate mortgage fell to 4.5 percent this week from 4.52 percent last week, according to Freddie Mac. 
Boston.com
The Associated Press
AP sources: Obama wants Fed to be finance supercop
By Anne Flaherty, Associated Press Writer | May 9, 2009
WASHINGTON –The Federal Reserve could become the supercop for “too big to fail” companies capable of causing another financial meltdown under a proposal being seriously considered by the White House.
The Obama administration told industry officials on Friday that it was leaning toward making such a recommendation, according to officials who attended a private one-hour meeting between President Barack Obama’s economic advisers and representatives from about a dozen banks, hedge funds and other financial groups.
Treasury Secretary Timothy Geithner and other officials made it clear they were not inclined to divide the job among various regulators as has been suggested by industry and some federal regulators. Geithner told the group that one organization needs to be held responsible for monitoring systemwide risk.
“Committees don’t make decisions,” said Geithner, according to one participant.
Officials from the Treasury Department and National Economic Council, which hosted the meeting, told participants that the Fed was considered the most likely candidate for the job, according to several officials who attended or were briefed on the discussions.
The administration officials said a legislative proposal would likely be sent to Capitol Hill in June with the expectation the House Financial Services Committee, led by Rep. Barney Frank, D-Mass., would consider the measure before the Independence Day recess.
The officials requested anonymity because the meeting had not been publicly announced and they were not authorized to discuss it.
A Treasury Department statement provided to The Associated Press on Friday confirmed Geithner’s position that he wants a “single independent regulator with responsibility for systemically important firms and critical payment and settlement systems.”
A spokesman said Geithner also is open to creating a council to “coordinate among the various regulators, including the systemic risk regulator.”
The Fed itself hasn’t taken a position on whether it should have the job, although Chairman Ben Bernanke has said the Fed would have to be involved in any effort to identify and resolve systemwide risk.
© Copyright 2009 The New York Times Company
