About a month ago I wrote a post called “The coming wave of second mortgage writedowns” the gist of which was that the big four banks Citi, JP, BofA, and Wells had a shed load of exposure to now worthless second mortgages. With many first mortgages now hopelessly underwater, it stands to reason that second mortgages on those same properties have zero value.
The big four are certainly well aware of this problem and are looking for ways to extend the wherewithal of underwater borrowers and pretend they don’t need to take losses on these loans. On paper, these companies are very well capitalized. However, in the real world, the likely losses they must eventually take on loans already on their books would probably render them insolvent.
So, what’s it all mean? Here is my nutshell view:
- Remember, the financial crisis is a byproduct of the housing bubble which was directly caused by bi-partisan government policy. It is in all politicians’ best interest to keep this fact obscured by avoiding a second wave crisis.
- The big four banks will not be allowed to fail, nor will there be more bailouts. The only course remaining is for the banks to ease into their losses gradually over the next several years by using earnings to shore up their capital base. Government regulators will not only allow, but encourage this.
- Lending will, of necessity, be constrained. This in turn, will constrain the economy.
- A lousy economy makes for lousy politics. Expect more populist outrage and scapegoating.
Bottom Line: The Great Recession won’t really end until the banks have restored their capital bases, which could take years and years. The economy will remain ugly and politics will get uglier, if such a thing is possible.