Tuesday, January 19, 2010

Banking 101

There have been a couple of inquiries as to how the banks can be in position to pay huge bonuses again if things are so shaky.

Well, this is where it gets a bit complicated. The banks are poised to pay big bonuses on their trading operations. The average stiff working at a Bank of America branch isn't buying a place in the Hamptons, but the traders that gamed the system in 2009 to book massive profits will get PAID this year.

How healthy are the banks? This is where I diverge from the mainstream. Most feel that trading success has solidified the banks and provides a strong base for future growth. Everyone seems to have forgotten the massive book of business that is still at risk. Both Alt-A loans and second mortgages are in real trouble. We've kicked the can down the road by not requiring banks to reflect these asset prices at their market price but rather "whatever the bank wants to tell us". In layman's terms imagine you bought a house for $100k and a year later it was worth $75k. You have a $25k paper loss. If you were a bank you should recognize that loss (and later report a gain if it regains value). These hidden losses at the banks are in the hundreds of billions of dollars. The hope is that we can keep these losses from bubbling to the surface until the economy recovers. I'm not optimistic that they can.

Finally, regarding the loan modification programs consider this chart....
On the surface this looks like a big improvement as we cut the median monthly payment by over $500 for those that participated in the loan modification program (I'd argue that if you couldn't afford your mortgage, you should lose your house but I'm a cold hearted SOB).
However, note line 2. AFTER MODIFICATION the mortgage payment still represents 55% of GROSS INCOME. Given that taxes, social security, etc take close to 30% of the average persons pay the modifications are actually showing that the mortgage payments will be close to 75% of after tax income. There is no way that plan can succeed, in my opinion.

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