Ready To Do It Right Yet?

The banks, that is.

XLF (the financial sector spyder) yesterday, down 16.5%.  That's impressive, but what's even more impressive is the loss in some of the components, to wit:

BAC, down 28.9%
Citigroup, down 20%
Goldman Sachs, down 18.9%
JP Morgan, down 20.7%
Morgan Stanley, down 15.9%
State Street, down 59% (!)
Wells Fargo, down 23.8%

Those are one day losses folks.  In one day anywhere from twenty percent to more than half of these firms was wiped out.  If you hold their stock, I hope you're prepared for what you see when you look online at your account.

Why did this happen?

Quite simply the market calls all bets.

Paulson, just last week, gave an interview in which he defended the TARP and said that they had "stabilized the financial system."

The market said in response:

Let me make this very clear - the market is saying very loudly that the common stocks of these firms are going to zero.  They are all functionally bankrupt, right here, right now, with their current capital structure, and have been for months.

That's the market's pronouncement as of yesterday - and as you can probably surmise I agree with it, given that I've been calling for cramdowns of the debt structure in these firms as the proper means to resolve the excessive bad debt problem for more than a year.  Such a move would inherently destroy all value in the common and preferred stock (at the same time it resolves the firm's - and the nation's - bad debt.)

Over a year ago when Bank America "decided" to take over failing Countrywide Financial I opined that Lewis would have to be a madman to close that transaction, as the retained portions of the Option ARMs they wrote were enough all by themselves to put the firm into a negative net value position - it was, in my opinion, worth less than zero.

I bought some bankruptcy PUTs on CFC at the time, believing that Lewis couldn't possibly be so stupid as to close the transaction and put Bank America at risk of either severe financial damage or even bankruptcy.

I was wrong; he did close.  Then he did the Merrill transaction, which has more irregularities than a gopher-hole filled golf course, chief among them being the apparent threat Lewis made to Treasury related to "undisclosed" Merrill asset deterioration - which appears to have been concealed from shareholders (an act that may in fact violate the law.)

CNBC has Bair on this morning claiming that "the banks are well-capitalized and solvent."  Pull the other one Sheila.  The market says you're full of crap and this sort of pumping and game-playing simply doesn't work any more.

The fact of the matter is that if you or anyone else need to come in and "buy out" assets or otherwise tamper with the banks' balance sheets they are unstable at best and broke at worst.  Only the truth - the whole truth - will stop the bleeding and distrust in the marketplace.

The market is calling "BS" the only way it knows how - it is destroying the equity value of the firms in which confidence has been lost.  The exact same thing has happened in every firm that has become subject to this problem since the crisis began, starting with Bear Stearns, then Fannie and Freddie, then Lehman and AIG.

The difference is that this time it is all the banks at once.

President Obama and Geithner (assuming he is confirmed), along with the CEOs of these firms and Sheila Bair, had better cut the crap.  Claims that "the system has been stabilized" are being challenged literally on a daily basis, the TARP funds so far disbursed are essentially gone with the share prices cratering by the minute and confidence in the system has gone to zero.  The market will not accept platitudes and lies; it wants to see clean balance sheets, as the banks over in Europe and here that started this latest round in fact were those that claimed to be clean just a few months ago, and now they have suddenly admitted to "unrealized" (and formerly hidden) losses.

Nothing beyond full disclosure and market-based accounting will fix this mess, and as noted in the previous Ticker cramdowns appear to be the only way to return capital ratios to acceptable levels.  We have tried taking equity and the money injected just got sucked into a black hole.  Only through fundamentally altering the capital ratio that comes via conversion of some (or all) of the debt to new equity, wiping out the previous equity classes, along with a fully-transparent mark-to-market accounting that is disclosed and visible to all, can this destruction be stopped.

Confidence is no longer gone in one or two firms, its gone across the entire financial sector.  There is no possible way for the government to step in and rescue all of them - not only does the money not exist but what would you have if they did?  The stock price would still go to zero (or effectively so) under those plans, and the debt structure that is the cause of the problem would remain.  Indeed, exactly that has happened already - Citibank, Bank America, Wells Fargo and the rest already got TARP money, already had equity purchased, and yet they are being systematically destroyed in the marketplace, not only hurting common shareholders but destroying the government's "value" in their preferred stock at the same time!  (That's right Mr. and Mrs. Taxpayer, this little ditty today came directly out of your pocket.  Ain't it nice?)

We are on a precipice in that Mr. Market has said "ALL IN!" to Paulson's puny little bet, and the river card has been rolled.  We're down to the showdown and unfortunately what Treasury has in the hole is 2-7 off suit, the board shows A-A-K, and Mr. Market is grinning.