Credit Market Mayhem and the S&L Crisis: Drawing Parallels

by: Mark McQueen March 19, 2008 | about stocks: BSC / JPM / LEH    
Mark McQueen

Mark McQueen

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In the 1980s and early 90s, a collapse in the Southern U.S. real estate market trigged what’s known as the Savings and Loan Crisis. In that debacle, $151 billion of Thrifts were ultimately bailed out by the Federal Deposit Insurance Corp. Of that amount, $75 billion went to Texas-based institutions alone. The 2007 crash of the U.S. subprime mortgage market has caused the demise of an independent Bear Stearns (BSC), with the U.S. Federal Reserve agreeing Sunday to take on $33 billion of illiquid collateralized securities. Global banks have written off more than $250 billion of assets (and shareholder equity) during the past six months, with another $50 billion of write-downs still anticipated.

Oh, how history has a way of repeating itself.

Between 1980 and 1987, the concentration of real estate in the average S&L loan book grew from 13% to 26%. According to many bank analysts, Bear Stearns’ (BSC) and Lehman Brothers’ (LEH) reliance on revenue generated from packaging real estate transactions rose in a similar fashion over the course of this decade. Bear Stearns peaked as the #2 underwriter of mortgage backed securities. Lehman was #7 in the CMBS bookrunner market, for example, through much of 2007; #4 for global securitizations and #1 for private label mortgage bonds with $40 billion of underwritings in 2007 (Bear was #2).

Where are the problems today? Real estate-backed loans, just as with the Thrifts in the 80s. The Thrift industry had the benefit of FDIC deposit guarantees, and could attract individual deposits with high posted savings rates and leverage the absence of a national interstate banking network. The Thrift board turned around and lent that money to local commercial real estate developers, often advancing more than 100% of the value of the project.

Highly levered, long term loans backed by short term funding.

Sound familiar?

When the 1980s Texas oil boom corrected, the broader U.S. economy began to suffer and 1,320 different S&L institutions went under (almost 30% of all S&Ls). Over the past nine months, in excess of one hundred subprime mortgage providers have turned out the lights, with even the largest firms - GMAC and Merrill Lynch - shutting down their specialty divisions. Their crime? Lending far more money against a U.S. residential property than historical norms and prudence required.

Unlike the S&Ls, who had the FDIC playing the role of enabler by guaranteeing deposits and tacitly encouraging the growth in the commercial and industrial development markets of the 1980s, Wall Street took the lead on this recent mess by manufacturing a trillion dollar subprime industry, and then laying off that risk on a multitude of SIVs, CDOs, CLOs and whatnot.

For all of the caterwauling about the moral hazard question and the U.S. Federal Reserve’s role in taking $33 billion of risk off the hands of JPMorgan (JPM) shareholders, the “bailout” number is still a far cry from the $151 billion (pdf file) that the FDIC paid out on the S&L crisis.

A crisis that reached it crescendo just 20 years ago. Real estate was a villan then, as well. As was the lack of industry oversight. But the true shame is that it took the loss of Bear Stearns for the U.S. Fed to open the discount window to the twenty brokers that were so desperately in need of access to liquidity. It’ll come as no solace to BSC shareholders, but the rest of the U.S. financial system is now far stronger than it has been since the wheel came off last summer (see prior post “‘Panic’ sets in to the debt markets,” July 29, 2007).

The shorts have already laid off Lehman Brothers as the positive premarket trading suggests, and according to The Daily Telegraph, the Treasury Department is rumored to have sent the message to its competitors: don’t bad mouth Lehman.

The high water mark of this financial markets crisis is now behind us, and Bear will likely be the last large institution to be pushed against a wall. Which is not to say there won’t be more large writedowns, and that some financial institutions won’t need to raise more capital. The leverage ratios of many firms are still quite breathtaking, according to the Wall Street Journal:

Morgan Stanley had a leverage ratio of 32.6-to-1 at the end of last year, nearly as high as Bear’s 32.8-to-1. Lehman was leveraged 30.7-to-1, and Merrill Lynch 27.8-to-1. And the would-be rock, Goldman? It was leveraged 26.2-to-1.

But the crisis of confidence has passed. It's time to exhale and get back to work at Wellington Financial LP, lending money to high quality companies looking for True Growth Capital. “All” we have left to worry about now is the depth and breadth of the U.S. recession.

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This article has 6 comments:

  •  
    Mar 19 02:56 PM
    If you see this as a light at the end of a tunnel, I sure hope you have a flash light and some extra batteries. The only benefit to the "average JOE" is a remote possibility that this just might be positive sign in an otherwise negative climate...Does it have legs ? I think not.
    I know when I pull up to the pump, go grocery shopping,and tell the family there's no chance of a vacation this summer I really don't care
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  •  
    Mar 19 03:05 PM
    Nice article. And it was especially good of you to point out the leverage firms have dug themselves into, as many still do not realize that virtually every US bank has excessive leverage. The unwinding process is just beginning. Will we see many more situations like Caryle before it's over. I think to compare the current meltdown to the S&L crisis is a huge understatement. Already, the losses due to mortgage-related writeoffs have exceeded $200 billion. Finally, together with the European Central Banking System, the total amount of cash released to banks in less than a year as a result of the subprime debacle is in excess of $1.2 trillion. In order to provide adequate liquidity over the next year, I estimate another $1-$1.5 trillion will be needed in order to keep banks solvent. In total, I am expecting direct losses due to the real estate-banking meltodown of $600-$800 billion.
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  •  
    Mar 19 04:12 PM
    You fail to mention the Real estate run up in the northeast in the 1980's and the subsequent failure of the third largest bank in Boston - Bank of New England in the early 90's. It was also a time when Collateralized Mortgage Obligations were developed. Back then they were almost impossible to value and the models were extremely primitive. Sounds eerily familiar to me.
    Reply | Link to Comment
  •  
    Mar 20 12:19 AM
    The FRB are idiots for trying to save these banks. Thank goodness for them, that the American taxpayers are bigger idiots.

    The US Dollar Index traded at 76.156 less than a month ago. Due to the Feds' slash and burn policies, it was 71.198 yesterday.

    That is a 6.5 percent drop in the value of all US currency. Given there is about $820 billion dollars of U.S. currency in circulation, that means that $53 billion dollars in wealth was destroyed for the sake of Lehman (a $30 billion company) and Bear, which for all intents and purposes is on life-support anyway. I don't even know where to start in calculating the loss in value of hard assets that are also valued in US Dollars.

    Get ready for massive inflation, because once again, we all pay so that a greedy few large investors don't lose their assets.

    Its better to stop messing with policy, and allow investors to take their medicine, than ruin an entire economy.
    Reply | Link to Comment
  •  
    Mar 20 01:06 AM
    "The high water mark of this financial markets crisis is now behind us" How can you possibly know this? The housing market still has a long way to fall and that's going to cause further huge losses. What happens if Uncle Ben runs out of rabbits to pull out of his hat?
    Reply | Link to Comment
  •  
    Mar 21 08:12 AM
    It is unfortunate that We Never Seem To LEARN:always confusing cause and effect. In so doing we never discover the real culprits and therefor, we never find out the real causes and so the stage is always set for a repeat of the exact same crisis some 15 to 20 years hence.
    CONGRESS is already holding hearings in an attempt to asses blame and divert attention away from the real culprits; Congress itself.
    Both during the S&L debacle as well as today It was Congress the President and the FED that basically coerced the mortgage lenders to make those ridiculous Zero Down abnormally Low interest rates Liar loans all in the name of Fairness in achieving the American Dream (Buying Votes). To compound the error we had the illustrious Greenspan encouraging everyone to use ARM's when 5% 30 mortgages were available. The S&L problem was also caused by Congress when like today ; in the name of fairness they eliminated the Usuary Laws as well as the S&L interest rates advantage in conjunction to creating massive inflation: As they are doing today.
    Until we do a proper investigation and bring the real causes to light the exact same problems will re-occure every 20 years or so until we create a Real 1930's type depression.
    This leaves two questions. #1 Will we be able to avert Depression this time? and More importantly How and Who is going to investigate congress?

    Dr. Aubie BaltinAubie Baltin
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