Here we go again - another banking disaster on the cards

By Jonathan Weil

Ask anyone what the most immediate threats to the global financial system are, and the obvious answers would be the European sovereign-debt crisis and the off-chance that the US won't raise its debt ceiling in time to avoid a default.

Here's one to add to the list: the frightening plunge in Bank of America's stock price.

At US$9.85 a share, down 26 per cent this year, Bank of America finished on Thursday with a market capitalisation of US$99.8 billion. That's an astonishingly low 49 per cent of the company's US$205.6 billion book value on June 30.

As far as the market is concerned, more than half of that book value is bogus because of overstated assets or understated liabilities or a combination of the two.

That perception is a dangerous situation for the world at large, not just the company's shareholders.

The risk is that with the stock price this low, a further decline could feed on itself and spread contagion to other companies, regardless of the bank's statement this week that it is "creating a fortress balance sheet".

It isn't only the company's intangible assets, such as goodwill, that investors are discounting.

Consider Bank of America's calculations of tangible common equity, a bare-bones capital measure showing its ability to absorb future losses. The company said it ended the second quarter with tangible common equity of US$128.2 billion, or 5.87 per cent of tangible assets.

That's about US$28 billion more than the company's market cap. Put another way, investors doubt Bank of America's loan values and other numbers, too, not just its intangibles.

So here we have the largest US bank by assets with an US$8.8 billion quarterly loss - its biggest ever - and the people in charge of it have a monstrous credibility gap, largely of their own making. Once again, we're all on the hook.

As recently as late last year, Bank of America still said none of the US$4.4 billion of goodwill from its 2008 purchase of Countrywide Financial had lost a dollar of value.

Chief executive officer Brian Moynihan also was telling investors the bank would boost its penny-a-share quarterly dividend "as fast as we can".

Both notions proved to be nonsense.

The goodwill from Countrywide, one of the most disastrous corporate acquisitions in US history, has now been written off entirely.

And, thankfully, Bank of America's regulators in March rejected the dividend plans, in an outburst of common sense.

Last fall, Bank of America also was telling investors it probably would incur US$4.4 billion of costs from repurchasing defective mortgages that were sold to investors, though it did say more were possible.

Since then the company has recognised another US$19.2 billion of such expenses, with no end in sight.

The crucial question today is whether Bank of America needs fresh capital to boost its balance sheet.

Moynihan emphatically says it doesn't, pointing to regulatory-capital measures that would have us believe it's doing fine.

The market is screaming otherwise, judging by the mammoth discount to book value.

Then again, for all we know, the markets might not be receptive to a huge offering of new shares, even if bank executives were inclined to try for one.

We can only hope Bank of America's regulators are tracking the market's fears, and have contingency plans should matters get worse.

Yet to believe Moynihan, there's nary a worry from them. Asked by one analyst during the company's earnings conference call this week whether there was any "pressure to raise capital from a regulatory side of things," he replied, simply, "no".

If that's true, the banking regulators should share blame with Moynihan for the present mess. It would be impossible for any lender to have too much capital in the event that Europe's debt problems, for example, morph into another global banking crisis.

It's also hard to believe Bank of America has enough capital now, as the market doesn't believe it.

There are undoubtedly plenty of brave investors who trust the numbers on the company's books and see a buying opportunity. Perhaps they'll even be proven right.

But there's more at stake here than whether Bank of America's shares are a "buy" or a "sell".

The main thing the rest of us care about is the continuing menace this company and others like it pose to the financial system, knowing we never should have let ourselves be put in the position where a collapse in confidence at a single bank could wreak havoc on the world's economy.

Here we are again, though. Curse the geniuses who brought us this madness.

- Bloomberg

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