Market Turmoil Stokes Fear of Big Bank Collapses

Mortgage & Real Estate

As the stock prices of the big banks cratered on Monday, particularly for Bank of America, pundits and industry observers began worrying that a second financial crisis was in the offing, including the possibility of the failure of a large financial institution.

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The banking sector suffered a triple hit as Standard Poor’s downgraded the United States’ debt rating, American International Group Inc. filed a $10 billion lawsuit against B of A, and investors continued to fear the risk exposure of big banks to the European debt crisis.

B of A’s stock price fell 20% to the spring 2009 level of $6.53, while Citigroup was down 16%, and JPMorgan Chase Co. and Wells Fargo Co. both fell 9%.

In terms of residential servicing, Wells, B of A, and JPM rank one, two and three, respectively, according to figures compiled by National Mortgage News.

On the mortgage front, the nation’s largest mortgage insurer, MGIC, lost almost half its value, falling to $1.89, though in after hours trading it was up slightly.

The rapid shift in market activity and fear over what may still come reminded many of the mood three years ago, and some speculated the next systemic failure could happen sooner than policymakers — fresh from legislative reforms meant to prepare for the next crisis — had predicted.

“We may be coming to that inflection point very soon. If you look at what’s happening to Bank of America today … it’s a very 2008 feeling right now,” said Neil Barofsky, the former special inspector general for the Troubled Asset Relief Program, and now a fellow at New York University’s law school.

B of A drew the sharpest concerns, and the SP downgrade appeared somewhat tangential to the bank’s problems. AIG’s lawsuit seeks damages for losses from faulty mortgage-backed securities. It came on the heels of news that the New York attorney general’s office is interested in nullifying a settlement between B of A and a group of other investors, potentially raising damage on the bank from mortgage buybacks.

While the bank continued to tout its high capital, the sharp spiral in B of A’s share price was an echo of how market perception pushed firms near a cliff in the financial crisis. Companies like Lehman Brothers never recovered, and others — like B of A, Citi and AIG — received huge government bailouts to stabilize. Yet under the sweeping reforms of the Dodd-Frank Act last year, the government is prohibited from such targeted aid, and instead enables the Federal Deposit Insurance Corp. — authorized by several agencies — to seize firms that cannot stand on their own.

“If B of A’s equity is losing this much value, you have to ask the question: are we getting close to that point?” said Tony Fratto, managing partner at Hamilton Place Strategies and a former Treasury Department and White House official in the Bush administration. “If B of A has another day tomorrow like today, I would say that is something Financial Stability Oversight Council needs to be thinking about. I’d be really curious to find out what their plans are.”

Fratto said that because the government now has this power, investors may be less willing to provide B of A with a capital infusion, should one be needed.

“You do have to ask this question: will it make it better or worse to use government authority to resolve a financial institution?” Fratto said. “Does that make it more likely or less likely that Bank of America can fend for itself? That’s an open question. I think it is a test and we will be watching it.”

Others said we are nowhere near that point. Unlike the height of the crisis, when many firms were largely harmed due to a rapid loss of liquidity, banks now have higher capital, liquidity and reserves.

“I don’t think we’re there at all. … We had a liquidity crisis before, and that’s what really drove changes. Now we have fear of long-term economic malaise. We have fear of credit losses turning back around, getting a little worse again. But those are different issues,” said Jefferson Harralson, a managing director at KBW Inc.’s Keefe, Bruyette Woods Inc.

Harralson said capital ratios are stronger than in 2008, and the market is closer to understanding the impact of litigation risk facing B of A and other companies.

“It’s a lot different than in 2008, one because we have a lot higher capital ratios. … Secondly, we have twice the reserves now versus then. We’ve taken on a very significant amount of cumulative losses. We’re pretty far down the path. B of A has a special type of risk that most institutions don’t have as much of, which is the litigation/reps-and-warranties risk,” he said. “I consider it very different from 2008. Versus 2008, we’re probably much farther down the path regarding litigation too. We’re starting to see settlements.”

Jerry Dubrowski, a B of A spokesman, said the company does not have plans to raise capital. He said the bank is in better shape to weather storms than it was during the crisis.

Daily Briefing | Monday, August 8, 2011

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