American Republic Online

If any of you took the time to read my post on the FDIC, here’s a follow up.  A case study:

National City (NCC) is the bank Elizabeth and I used when we lived in IL, and it is trading around $5 now, down from about $40 last April. 

Now, part of the wonders of our modern capital economy is that financial companies borrow money (either through depositors or by issuing bonds, etc) and then lend it out at a higher rate – the essence of banking, right?  Well, how long do you think a bank can stay in business borrowing money at a 7% rate, and loaning it out at 14%?  A pretty long time right?  Well, what if they are borrowing at 14% and then lending it out at 7%?  That’s the rate that investors are demanding for National City’s debt: 14%.  

Consider this: last quarter NCC lost about $1.76 billion (almost $20 million a day).  Even though they raised about $7 billion in April with an equity issuance, they basically used it to pay down their debt. 

Let me ask it a different way: how much money would you loan to someone if their business is set to lose (at least) 7% on its transactions?  How long would you expect that business to remain viable (solvent)?  Indeed, in order to stay afloat they will have to start selling either assets or more equity.  Again, how much money would you invest in said company?  (BTW: given the hesitation towards buying financial paper “assets,” what is one of the main real assets of a local/regional bank?  You guessed it: real estate.)  Needless to say, I’m glad we no longer bank there.

Case #2:

Fannie Mae and Freddie Mac are goners.  John Mauldin reminds us that their capitalization (total # of shares x stock price) is about $7 billion and $3 billion, respectively.  So you could buy both companies for about $10 billion.  (By comparison, Google is about $147 billion.)  Whether you think that is cheap or expensive certainly depends on your point of view.

If only that was it. 

Fannie Mae has over $21 billion in preferred shares outstanding (Freddie about $14 billion).  Guess who owns most of the preferred shares.  Banks and pension funds bought them as safe, steady streams of income. 

“[Fannie and Freddie] back $5.2 trillion in mortgage securities. As an aside, that means even a 1% loss from foreclosures would mean a $50 billion portfolio loss. Care to make an over/under wager on a 1% loss by this time next year? I don’t think I would want the under… By the way, Congress and bank regulators encouraged banks to buy preferred shares by giving them special status and tax breaks.” (This was, no doubt, the result of the hundreds of millions in campaign contributions both Fannie and Freddie gave them, which in turn was spurred by the desire to increase options for company executives.)

There are, of course, other issues in both cases (like billions in subordinated debt), but figured I’d spare you the details, and focus on the meaty, obvious stuff.

Closing thoughts: 

Fannie and Freddie will be nationalized before next summer, probably even the end of this year. 

I wonder if Jim Collins still considers Fannie Mae a “Great” company?