Tài liệu Dangerous Unintended Consequences: How Banking Bailouts, Buyouts and Nationalization Can Only Prolong America’s Second Great Depression and Weaken Any Subsequent Recovery docx

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DangerousUnintendedConsequences:
HowBankingBailouts,BuyoutsandNationalization
CanOnlyProlongAmerica’sSecondGreatDepression
andWeakenAnySubsequentRecovery
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Presentedby
MartinD.Weiss,Ph.D.
WeissResearch,Inc.
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NationalPressClub
Washington,DC

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March19,2009
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Copyright © 2009 by Weiss Research
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Jupiter, FL 33478


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MartinD.Weiss,Ph.D.,presidentofWeissResearch,Inc.,isoneofthenation’sleadingadvocatesforinvestorsand
savers,helpinghundredsofthousandsfindsafetyevenintheworstoftimes.Issuingwarningsoffuturefailures
without
ambiguityandwithmonthsofadvanceleadtime,WeisspredictedthedemiseofBearStearns102dayspriortoits
failure,LehmanBrothers(182daysprior),FannieMae(eightyearsprior),andCitigroup(110daysprior).Similarly,
theU.S.Go
vernmentAccountabilityOffice(GAO)reportedthat,inthe1990s,WeissgreatlyoutperformedMoody’s,
Standard&Poor’s,A.M.BestandD&P(nowFitch)inwarningoffutureinsurancecompanyfailures.Dr.Weissholdsa
Ph.D.fromColumbiaUniversity,andhastestifiedmanytimesbeforeCongress,providingconstructiveproposalsfor
reforminthefinancialindustry.

WeissResearch,Inc.isanindependentinvestmentresearchfirmfoundedin1971,providinginformationandtoolsto
helpinvestorsandsaversmakesoundfinancialdecisionsthroughitsfreedailye‐letter,Moneyan
dMarkets,itsmonthly
SafeMoneyReport,andotherinvestorpublications.

AlthoughTheStreet.comhasprovideddataandratingsusedinthisreport,theopinionsandanalysisexpressedhereare
strictlythoseofMartinD.WeissandWeissResearch,Inc.

Thefollowingindividualsalsocontributedtothispaper:
MikeLarson,InterestRateandRealEstateAnalyst,WeissResearch,Inc.
PhilipW.vanDoorn,SeniorBankingAnalyst,TheStreet.comRatings
Mathieu‐LouisAoun,FinancialResearchAnalyst, WeissResearch,Inc
AmberDakar,PersonalFinanceAnalyst,WeissResearch,Inc
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3
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DangerousUnintendedConsequences:
HowBankingBailouts,BuyoutsandNationalization

CanOnlyProlongAmerica’sSecondGreatDepression
andWeakenAnySubsequentRecovery
MartinD.Weiss,Ph.D.
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ExecutiveSummary
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TheFedChairman,theTreasurySecretary,andCongresshavenowdonemoretobailoutfinancialinstitutions
andpumpupfinancialmarketsthananyoftheircounterpartsinhistory.

Butit’snotnearlyenough;and,atthesametime,it’salreadyfartoomuch.
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Twoyearsago,whenmajorbanksannouncedmultibillionlossesinsubprimemortgages,theworld’scentral
banksinjectedunprecedentedamountsofcashintothefinancialmarkets.Butthatwasnotenough.
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Sixmonthslater,whenLehmanBrothersandAmericanInsuranceGroup(AIG)fell,theU.S.Congressrushedto
passtheTroubledAssetReliefProgram,thegreatestbankbailoutlegislationofalltime.Butasitturnedout,
thatwasn’tsufficienteither.
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Subsequently,inadditiontotheoriginalgoalofTARP,theU.S.governmenthasloaned,invested,or
committed$400billiontonationalizetheworld’stwolargestmortgagecompanies,$42billionfortheBig
Threeautomanufacturers;$29billionforBearStearns,$185billionforAIG;$350billionforCitigroup;$300
billionfortheFederalHousingAdministrationRescueBill;$87billiontopaybackJPMorganChaseforbad
LehmanBrotherstrades;$200billioninloanstobanksundertheFederalReserve’sTermAuctionFacility
(TAF);$50billiontosupportshort‐termcorporateIOUsheldbymoneymarketmutualfunds;$500billionto
rescuevariouscreditmarkets;$620billionincurrencyswapsforindustrialnations,$120billioninswapsfor
emergingmarkets;trillionstocovertheFDIC’snew,expandedbankdepositinsuranceplustrillionsmorefor
othersweepingguarantees;anditstillwasn’tenough.
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Ifithadbeenenough,theFedwouldnothavefeltcompelledyesterdaytoannounceitsplantobuy$300
billioninlong‐termTreasurybonds,anadditional$750billioninagencymortgagebackedsecurities,plus$100

billionmoreinGSEdebt.

Totaltallyofgovernmentfundscommittedtodate:Closinginon$13trillion,or$1.15trillionmorethanthe
tallyjust24hoursago,whenthebodyofthiswhitepaperwasprinted.Andyet,eventhatastronomicalsumis
stillnotenoughforanumberofreasons:
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First,mostofthemoneyisbeingpouredintoavirtuallybottomlesspit.EvenwhileUncleSamspendsorlends
hundredsofbillions,thewealthdestructiontakingplaceatthehouseholdlevelinAmericaisoccurringinthe
trillions—$12.9trillionvaporizedinrealestate,stocks,andotherassetssincetheonsetofthecrisis,
accordingtotheFed’slatestFlowofFunds.
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Second,mostofthemoneyfromthegovernmentisstillapro
mise,andevenmuchofthedisbursedfunds
haveyettoreachtheirdestination.Meanwhile,allofthewealthlosthasalreadyhithome—inthehousehold.
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Third,thegovernmenthasbeen,andis,greatlyunderestimatingthemagnitudeofthisdebtcrisis.Specifically,

 TheFDIC’s“ProblemList”oftroubledbanksincludesonly252institutionswithassetsof$159billion.
However,basedonouranalysis,atotalof1,568banksandthriftsareatriskoffailurewithassetsof
$2.32trillionduetoweakcapital,assetquality,earningsandotherfactors.(ThedetailsareinPartIof
ourpaper,andtheinstitutionsarenamedinAppendixA.)

 WhenTreasuryofficialsfirstplannedtoprovideTARPfundstoCitigroup,theyassumeditwasamongthe
stronginstitutions;thatthefundswouldgoprimarilytowardstabilizingthemarketsortheeconomy.But
evenbeforethecheckcouldbecut,theylearnedthatthemoneywouldhavetobeforaverydifferent
purpose:anemergencyinjectionofcapitaltopreventCitigroup’scollapse.Basedonouranalysis,however,
Citigroupisnotalone.WecouldwitnessasimilaroutcomeforJPMorganChaseandothermajorbanks.
(SeePartII.)

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 AIGisbig,butit,too,isnotalone.Yes,inaFebruary26memorandum,AIGmade thecasethatits
$2trillionincreditdefault swaps (CDS)wouldhavebeen thebi g eventthatcouldhavecausedaglobal
collapse.Andindeed,itscounterpartiesalonehave$36trillioninassets.ButAIG’sCDSportfolioisjust
oneofmany:Citibank’sportfolioha s $2.9trillion,almostatrillionmorethanAIG’satitspea k .JPMorgan
Chasehas$9.2trillion,or almostfivetimesmorethanAIG.Andgloba lly ,theBankofInternational
Settlements(BIS)reportsatotalof $57.3trillionincreditdefault swaps,morethan28timeslargerthan
AIG’sCDSportfolio. 
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Clearly,themoneyavailabletotheU.S.governmentistoosmallforacrisisofthesedimensions.Butatthe
sametime,themassivesumsbeingcommittedbytheU.S.governmentarealsotoomuch:IntheU.S.banking
industry,shotgunmergers,buyoutsandbailoutsareaccomplishinglittlemorethanshiftingtheirtoxicassets
likeDDTupthefoodchain.Andthegovernment’spromisestobuyupthetoxicpaperhavedonelittlemore
thanencouragebankstoholdon,pilingupevenbiggerlosses.
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Themoneyspentorcommittedbythegovernmentsofarisalsotoomuchforanother,less‐knownreason:
Hiddeninanobscurecornerofthederivativesmarketisauniquecreditdefaultswapthatvirtuallynooneis
talkingabout—contractsonthedefaultoftheUnitedStatesTreasurybonds.Quietlyandwithoutfanfare,a
smallbutgrowingnumberofinvestorsarenotonlythinkingtheunthinkable,they’reactuallyspendingmoney
onit,biddingupthepremiumsonTreasurybondcreditdefaultswapsto14timestheir2007level.Thisisan
earl
ywarningofthenextbigshoetodropinthedebtcrisis—seriouspotentialdamagetothecredit,
credibilityandborrowingpoweroftheUnitedStatesTreasury.
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Wehavenodoubtthat,whenpressed,theU.S.governmentwilltakewhateverfuturestepsarenecessaryto
sufficientlycontrolitsfinancesandavoidafataldefaultonitsdebts.However,neithertheadministrationnor
anyothergovernmentcancontroltheperceptionsofitscreditorsinthemarketplace.Andcurrently,the
market’sperceptionoftheU.S.government’screditisfalling,asanticipationofapossiblefuturedefaultby
theU.S.government,nomatterhowunlikely,isrising.


Thistrendpacksapowerfulmessage—thatthere’snofreelunch;thatit’sunreasonabletobelievetheU.S.
governmentcanbailouteveryfailinggiantwithnoconsequences;andthat,contrarytopopularbelief,even
UncleSammustfacehisdayofreckoningwithcreditors.
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5
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Weviewthatasapositiveforce.Weareoptimisticthat,thankstothepowerofinvestors,creditors,andthe
peopleoftheUnitedStates,wewillultimatelyguide,nudgeandpushourselvestomakeprudentand
courageouschoices:

1.Wewillbackofffromthetacticaldebatesabouthowtobailoutinstitutionsormarkets,andrethinkour
overarchinggoals.Untilnow,theoft‐statedgoalhasbeentopreventanationalbankingcrisisandavoidan
economicdepression.However,wewillsoonrealizethatthetruecostsofthatenterprise—the13‐digitdollar
figuresanddamagetoournation’scredit—arefartoohigh.

2.Wewillreplacetheirrational,unachievablegoalofjury‐riggingtheeconomiccycle,withthereasoned,
achievablegoalofrebuildingtheeconomy’sfoundationinpreparationforaneventualrecovery.

 Rightnow,thepublicknowsintuitivelythatakeyfactorthatgotusintotroublewastoomuchdebt.Yet,
thesolutionbeingofferedistoencouragebankstolendmoreandpeopletoborrowmore.

 Economistsalmostuniversallyagreethatoneofthegraveweaknessesofoureconomyisthelackof
savingsneededforhealthycapitalformation,investmentinbettertechnology,infrastructure,and
education.Yet,thesolutionbeingofferedistospendmoreand,byextension,tosaveless.

Thesedisconnectswillnotpersist.Policymakerswillsoonrealizetheyhavetochangecourse.

3.Whenwechangeourgoals,itnaturallyfollowsthatwewillalsochangeourpriorities—fromthebattleswe
can’twintothewarwecan’taffordtolose:Rightnow,forexample,despiteobviouslychoppyseas,the

prevailingtheoryseemstobethattheshipisunsinkable,orthatthegovernmentcankeepitafloatnomatter
howbadthestormmaybe.

Withthattheory,theymightask:“Whyhavelifeboatsforeverypassenger?Whydomuchmoreforhospitals
thatarelayingoffERstaff,forcountlesscharitiesthataregoingbroke,orforonein50Americanchildrenwho
arehomeless?WhyprepareforthefinancialKatrinasthatcouldstrikenearlyeverycity?”

Theanswerwillbe:Becausewehavenootherchoice;becausethat’sawarwecanandwillwin.Itwillnotbe
veryexpensive.Wehavetheinfrastructure.Andwe’llhaveplentyofvolunteers.

4.Rightnow,ourlong‐termstrategiesandshort‐termtacticsareinconflict.Wetrytosquelcheachcrisisand
kickitdowntheroad.Thenwedoitagainwitheachnewcrisis.Meanwhile,fiscalreformsaretalkedupin
debatesbutpushedoutintime.Regulatorychangesaremappedoutindetail,butunderminedinpractice.
Soon,however,withmorereasona
ble,achievablegoals,theoryandpracticewillfallintosynch.

5.Insteadoftryingtoplugourfingersinthedike,we’regoingtoguideandmanagethenaturalflowofa
deflationcycletoreapitssilver‐liningbenefits—areductioninburdensomedebts,astrongerdollar,alower
costofliving,ahealthierworkethic,anenhancedabilitytocompeteglobally.

6.We’regoingtobufferthepopulationfromthemostharmfulsocialside‐effectsofaworst‐casescenario.
Thenwe’regoingtostepup,bitethebullet,paythepenaltyforourpastmistakes,andmakehardsacrifices
todaythatbuildafirmfoundationforaneventualeconomicrecovery.Wewillnotdemandinstant
gratification.Wewillassumeresponsibilityforthefutureofourchildren.

6

7.Wewillceasethedoubletalkandreturntosomebasicaxioms,namelythat:

 Thepriceistheprice.Onceitisestablishedthatouroverarchinggoalistomanage—notblock—natural

economiccycles,itwillnaturallyfollowthatregulatorscanguide,ratherthanhinder,amarket‐driven
cleansingofbaddebts.Themarketpricewillnotfrightenus.Wecanuseitmoreuniversally tovalueassets.

 Alossisaloss.Whetherinstitutionsholdassetorsellassets,whethertheydecidetosellnoworselllater,
iftheassetisworthlessthanwhatitwaspurchasedfor,it’saloss.

 Capitaliscapital.Itisnotgoodwill,orotherintangibleassetsthatareunlikelytoeverbesold.Itisnottax
advantagesthatmayneverbereaped.

 Afailureisafailure.Ifmarketpricesmeanthatinstitutionshavebiglosses,andifthebiglossesmeanall
capitalisgone,thentheinstitutionhasfailed.

8.Wewillpro‐activelyshutdowntheweakestinstitutionsnomatterhowlargetheymaybe;provide
opportunitiesforborderlineinstitutionstorehabilitatethemselvesunderaslimdietoflow‐risklending;and
givethesurviving,well‐capitalizedinstitutionsbetteropportunitiestogainmarketshare.

KansasCityFederalReservePresidentThomasHoenigrecommendsthat“publicauthoritieswouldbedirected
todeclareanyfinancialinstitutioninsolventwheneveritscapitallevelfallstoolowtosupportitsongoing
operationsandtheclaimsagainstit,orwheneverthemarketlosesconfidenceinthefirmandrefusesto
providefundingandcapital.Thisdirectiveshouldbeclearlystatedandconsistentlyadheredtoforallfinancial
institutionsthatarepartoftheintermediationprocessorpaymentssystem.”Weagree.

9.Wewillbuildconfidenceinthebankingsystem,butinaverydifferentway:Rightnow,bankingauthorities
aretheirownworstenemy.Theypainttheentirebankingindustrywithasinglebroadbrush—“safe.”But
whenconsumersseebigbanksonthebrinkofbankruptcy,theirresponseistopainttheentireindustrywith
analternatebroadbrush—thattheentirebankingindustryis“unsafe.”Topreventthatoutcome,wewill
challengetheauthoritiestoreleasetheirconfidentialCAMELSratingsoneachbankinthecountry.Andto
restoresomeriskfordepositors,wewillaskthemtoreversetheexpansionofFDICcoveragelimits,bringing
backthe$100,000capfo
rindividualsandbusinesses.


Althoughthesestepsmayhurtindividualbanksintheshortrun,itwillnotharmthebankingsysteminthe
longrun.Quitethecontrary,whenconsumershaveareasontodiscriminaterationallybetweensafeand
unsafeinstitutions,andwhentheyhaveamotivetoshifttheirfundsfreelytostrongerhands,theywill
strengthenthebankingsystem.

IammakingtheserecommendationsbecauseIamoptimisticwecangetthroughthiscrisis.Oursocialand
physicalinfrastructure,ourknowledgebase,andourDemocraticformofgovernmentarestrongenoughto
makeitpossible.Asanation,we’vebeenthroughworsebefore,andwesurvivedthen.Withallourwealth
andknowledge,wecancertainlydoitagaintoday.

Butmyoptimismcomeswithnoguarantees.Ultimately,we’regoingtohavetomakeachoice:Theright
choiceistomakesharedsacrifices,letdeflationdoitswo
rk,andstartregeneratingtheeconomicforcesthat
havemadetheUnitedStatessuchagreatcountry.Thewrongchoiceistotaketheeasywayout,trytosave

7

mostbigcorporations,printmoneywithoutbounds,debaseourdollar,andultimatelyallowinflationto
destroyoursociety.

Thiswhitepaperismysmallwayofencouragingyou,withdataandreason,tomaketherightchoicestarting
rightnow.

8

Introduction

Withinfewerthan18months,theU.S.governmenthasspent,loaned,guaranteedorcommittedan
astronomicalsumof$11.6trillioninanall‐outattempttobailoutfailingcompanies,saveWallStreetfroma

financialmeltdown,andpreventaneconomicdisaster.Yet,despitetheseHerculeanefforts,American
householdshavelost$12.9trillioninwealth,millionsarelosingtheirjobs,andtheeconomyissi
nkingintoa
depression.

Thebailoutsarenotworking.Andsixmonthsago,inourwhitepaper,“Proposed$700BillionBailoutIsToo
Little,TooLatetoEndtheDebtCrisis;TooMuch,TooSoonfortheU.S.BondMarket,”weexplainedwhy.

Wearguedthat

1. The$700billionrequestedbytheBushadministrationundertheTroubledAssetReliefProgram(TARP)
torescuethenation’sbanksandotherfinancialinstitutionswouldbevastlyinadequatetocoverthe
probablelossesinAmerica’svastcreditmarkets.

2. TheburdenofsuchmassiverescueswouldmakeitincreasinglyexpensiveanddifficultfortheU.S.
governmenttosellitsbonds.
1


Today,inthehalf‐yearthathaselapsedsinceourpaper’spublication,anabundanceofnewevidencemakesit
plainlyevidentthatourfirstargumentwas,ifanything,understated.Meanwhile,strongerevidencevalidating
oursecondargument—regardingpotentialU.S.governmentfundingdifficulties—isjustbeginningtocome
tolight.Inthispaper,weprovideupdatedandexpandedresearchonbothissues:

Weestimatethedimensionsofthedebtcrisis,includingthenumberofU.S.banksandthriftswebelievetobe
atriskoffailure,atotaltallyoftheirassets,andthenamesofeach.

WeexplainthethreattotheTreasurybondmarkets,showinghowdifficultitcouldbecomefortheU.S.
governmenttorefunditsmaturingdebts—letalonefinanceitsbulgingdeficits.


Andweprovidenewrecommendationsforavertingaworst‐casescenario.Bankfailuresandadepressionare
nottheendoftheworld.Providedthecrisisismanagedproperly,itsmostdamagingimpactscanbeavoided
andlong‐termbenefitswillaccru
e.


1
Inour2008paper(availableat />theanalysisofTheStreet.comratingswithourownevaluationofderivativesandotherrisksoflargeinstitutionswhichwefeelare
notadequatelycapturedbytheTheStreet.comratingsmodel.Inthispaper,forthesakeofbetterclarity,weprovideTheStreet.com
listbasedontheCallReportdataandaseparate,shorter,listbasedonWeissResear
ch’sanalysisofderivativesandotherrisks.


9

PartI
TheFDICGreatlyUnderstatestheNumberand
AssetsofU.S.BanksCurrentlyatRiskofFailure

Financialfailurecanappearinmanyforms.Sometimesthecompanyfilesforbankruptcyvoluntarily;
sometimesit’sboughtout,bailedoutorsimplyliquidated.Nomatterwhatthefinaloutcome,forthe
purposesofthispaper,weconsideritafailure.

Toflagpotentialfailuresinthebankingsystem,theFederalDepositorsInsuranceCorporation(FDIC)maintains
a“ProblemList”ofbanks,oftenusedbythepublicandpolicymakerstogagetheseverityofthebankingcrisis.
Andinitsmostrecentrelease,
2
theFDICreportedthat

 ItsProblemListgrewduringthefourthquarterfrom171to252institutions,thelargestnumbersincethe

middleof1995.

 ThetotalassetsofinstitutionsontheProblemListincreasedfrom$115.6billionto$159billion.

 Comparedtoayearearlier,thenumberofinstitutionsonthelistrose232percent,whiletheirtotalassets
surgedbyasurprisinglysharp623percent.

TheFDICdoesnotdisclosethenamesoftheinstitutionsonitsProblemList.However,thereisabundant
evidencethatitunderstatestheriskofbankfailuresintheU.S.byawidemargin,asfollows:

First,itwaswidelyreportedthatoneofthelargestbankstofailin2008,IndyMacBankofPasadena,California,
withassetsof$32billion,wasnotontheFDIC’sProblemList,evidencethatthelistisnotcapturingthe
broaderthreatstotheU.S.bankingsystem.

Second,severallargeinstitutions,eachofwhichhasassetsmanytimeslargerthanthe$159billiontallyofthe
FDIC’sProblemList,weretroubledenoughtoreceivelargeemergencyinjectionsofTARPfunds.Therefore,it’s
obviousthattheyarealsonotontheFDIC’slist.

Third,astatisticalratingsmodelconceptuallysimilartothoseusedbyfederalregulatorsforidentifyinghigh‐
riskbanksgeneratesalistofinstitutionsatriskoffailurewhichwebelieveismorecomprehensiveand
accuratethantheProblemListmaintainedbytheFDIC.

ABriefHistoryofSomeStatisticalRatingsModelsforBanksandThrifts

Theba
nkingregulators havedeve lopedamethodologyforflaggingtroubledbanks,curr entl ycalledCAMELSrat ings,
whichev alua tecapitaladequacy,ass etquality,manag ement,earnings,liquidity,and sensitiv itytomark etrisk .

Theresultsofthismodelarenotpublished.However,inthe1980s,whentheofficialCallReportdatabecame
morereadilyavailabletothepublic,independentresearchfirms,suchasVeribancofMassachusettsandT.J.

HoltandCo.ofConnecticut,developedratingsmethodologiesthatwerebasedconceptually(albeitnot


2
QuarterlyBankingProfile,FourthQuarter2008,availableat />
10

mathematically)ontheFed’sCAMELSratings.Subsequently,actuarialstudiesperformedonboththeT.J.Holt
andVeribancratingsdemonstratedaconsistentpatternwhereby

 virtuallyallinstitutionsthatsubsequentlyfailedhadreceivedalowratingmonthsearlier;

 few,ifany,institutionswithahighratingfailedwithinayea
raftertheratingswerepublished.

Althoughnotalllow‐ratedinstitutionssubsequentlyfailed,thefailurerateoflow‐ratedinstitutionswasvery
high,validatingourviewthattheyareatriskoffailure,especiallyinadeeprecessionordepression.

In1987,WeissResearchpurchasedtheHoltbankratingsdatabaseandquantitativemodels,incorporating
elem
entsofitsownqualitativebankratingsmethodologyandpublishingtheseunderthebannerofWeiss
SafetyRatings.

Inits1994study,InsuranceRatings:ComparisonofPrivateAgencyRatingsforLife/HealthInsurers,
3
theU.S.
GeneralAccountabilityOffice(GAO)reviewedtheWeissratingsscale(fromAtoF)anddeterminedthata
WeissSafetyRatingofD+orlowerdenotesinstitutionsthatare“vulnerable”tofuturefinancialfailures.
Further,thehighpercentageofcompaniesratedD+orlowerthatsubsequentlyfailedagainvalidatedthe
generalaccuracyofthatdesignation.AlthoughtheGAOwasreferringtoadifferentindustry(lifeandhealth

insurers),theWeissratingsscalewasdesignedtoconveythesamesignificanceacrossvariousfinancial
industries,includingcommercialbanks,savingsbanks,andsavingsandloanassociations.

In2006,theNewYorkmediafirmTheStreet.compurchasedtheWeissRatings,nowcalledFinancialStrength
Ratings.However,TheStreet.comratingsscale(AthroughF)isthesameastheearlierWeissratingsscale,
whiletheratingsmethodologyhasremainedvirtuallythesameaswell.

Now,forthepurposesofthispaper,TheStreet.comhasprovidedalistofallrateddepositoryinstitutionswith
aFinancialStrengthRatingofD+(weak)orlower.
4
Andbasedonthebackgroundcitedabove,webelievethe
listisbothmorecomprehensiveandmoreaccuratethantheFDIC’s.
5
Fromthelist,WeissResearchfindsthat:

 1,372commercialandsavingsbanksareatriskoffailurewithtotalassetsof$1.79trillion(AppendixA).

 196savingsandloanassociationsareatriskwith$528billioninassets(AppendixB).

 Insum,atotalof1,568banksandthriftsareatriskwithassetsof$2.32trillion.That’s6timesthenumber
orinstitutionsand15timestheassetsofbanksandthriftsontheFDIC’sfourthquarter2008ProblemList.

 Giventhedeteriorationinbanksandintheeconomyreportedbythe FDICandtheCommerceDepartment,
itislikelythatmorebanksandthriftswillbeaddedtothelistoncefourthquarterratingsbecomeavailable.



3
AvailableinpdfimageformatprovidedbytheGAOat />4
TheStreet.com’sdatasourcesaretheFederalFinancialInstitutionsExaminationCouncilCallReportandtheOfficeofThrift

Supervision’sThriftFinancialReportsforthethirdquarterof2008,asprovidedbyHighlineFinancial,Inc.,withreferencetothe
fourthquarterCallReportsstrictlytodeterminewhichbankswerestillinbusinessaty
earend.
5
TheopinionsexpressedhereregardingTheStreet.comratingsareexclusivelythoseofMartinWeissandWeissResearch.

11

TheprecisedifferencesbetweentheFDIC’smethodforflaggingproblembanksandthemethodusedhereare
notknown.However,theaggregateresultsshouldmakeitclearthatthemagnitudeofthebankingtroublesin
theU.S.todaycouldbefargreaterthanwhattheFDICispubliclyrecognizing.

12

PartII
U.S.CommercialBanksHaveTakenMassive,
OftenUnquantifiable,RisksinTheirDerivativesHoldings

Thecollapseofmajorfinancialinstitutionssince2008hascomeasashocktobothWallStreetand
Washington.Butnearly15yearsago,theU.S.GovernmentAccountabilityOffice(GAO)explicitlywarnedof
thispossibility.OnMay18,1994,inalandmarkstudy,FinancialDerivatives,ActionsNeededtoProtectthe
FinancialSystem,
6
itstatedthat:

1. Derivativestradinginvolvesexposuretofivedifferentrisks:

(a)creditrisk,definedas“thepossibilityoflossresultingfromacounterparty'sfailuretomeetitsfinancial
obligations”;


(b)marketrisk,“adversemovementsinthepriceofafinancialassetorcommodity”;

(c)legalrisk,“anactionbyacourtorbyaregulatoryorlegislativebodythatcouldinvalidateafinancial
contract”;

(d)operationsrisk,“inadequatecontrols,deficientprocedures,humanerror,systemfailure,orfraud”;and

(e)systemrisk,achainreactionoffinancialfailuresthatcouldthreatenthenationalorglobalbanking
system.

2. Over‐the‐counter(OTC)derivativestradingataffiliatesofsecuritiesandinsurancecompaniesare
unregulatedandgrowingtoorapidly.

3. Justfivemajorsecuritiesfirms,threeinsurancecompaniesandsevencommercialbanksaccountforthe
overwhelmingbulkofthederivativestrading.

4. “IfoneoftheselargeOTCdealersfailed,thefailu
recouldposeriskstootherfirms—includingfederally
insureddepositoryinstitutions—andthefinancialsystemasawhole.”

5. “Financiallinkagesamongfirmsandmarketscouldheightenthisrisk.Derivativesclearlyhaveexpanded
thefinanciallinkagesamongtheinstitutionsthatusethemandthemarketsinwhichtheytrade.Various
studiesoftheOctober1987marketcrashshowedlinkagesbetweenmarketsforequitiesandtheir
derivatives.Accordingtothosestudies,pricesinthestock,options,andfuturesmarketswererelated,so
thatdisruptionsinonewereassociatedwithdisruptionsintheothers.”

6. “TheconcentrationofOTCderivativesactivitiesamongarelativelyfewdealerscouldalsoheightentherisk
ofliquidityproblemsintheOTCderivativesmarkets,whichinturncouldposeriskstothefinancialsystem.
BecausethesamerelativelyfewmajorOTCderivativesdealersnowaccountforalargeportionoftrading
inanumberofmarkets,theabruptfailureorwit

hdrawalfromtradingofoneofthesedealerscould

6
Availableat />
13

underminestabilityinseveralmarketssimultaneously,whichcouldleadtoachainofmarketwithdrawals,
possiblefirmfailures,andasystemiccrisis.”(Italicsareours.)

7. “ThefederalgovernmentwouldnotnecessarilyintervenejusttokeepamajorOTCderivativesdealerfrom
failing,buttoavertacrisis,theFederalReservemayberequiredtoserveaslenderoflastresorttoany
majorU.S.OTCderivativesdealer,whetherregulatedorunregulated.”

InresponsetotheGAO’s1994warningsabove,thefinancialindustry’sresponsewasbothaudibleandcaustic.
MajorWallStreetfirmspushedbackwithconcertedlobbyingeffortstoblockanyregulatorychangesatthe
pass,while“ChickenLittle”accusationswereleveledattheauthors,Congressionalrequestersofthestudy,
andanyindependentfirm,suchasWeissResearch,thatmadeforecastsbasedonitsconclusions.
7


Theindustry’sprimaryargumentindefenseofderivativeswasthattheyhelpedtoreduceriskthrough
hedging,andthateachderivativespositionwasgenerallybalancedagainstoffsettingpositions.However,
manylargefinancialinstitutions—suchasBearStearns,LehmanBrothers,MerrillLynchandtheAmerican
InsuranceGroup(AIG)—wentfarbeyondhedging,transformingtheirderivativesdivisionsintomajorprofit
centersbasedonspeculativetrading.Moreover,theydidnotadequatelyprotectthemselvesagainstdefaults
bytheirtradingpartnersoranticipatetheseverityofthesystemriskstressedbytheGAO.

Subsequently,asdetailedintheGAO’sfollow‐upreport,FinancialDerivatives:ActionsTakenorProposed
SinceMay1994,
8

some,mostlycosmetic,changesweremade.Buttheydidnothingtoslowthemeteoric
growthoftheveryinstrumentsandpracticesthattheGAOidentifiedasposingthegreatestthreatsto
financialinstitutionsandthefinancialsystem.Specifically,

 Inits1994study,theGAOreported,“Thebestavailabledataindicatethatthetotalvolumeofworldwide
derivativesoutstandingasofyear‐end1992wasatleast$12.1trillionintermsofthenotional,orprincipal,
amountofderivativescontracts.”AlthoughtheGAOrecognizedthatthe$12.1trillionoverstatedthe
actualrisk,italsostatedthat“firmsthatusederivativescansustainsignificantlosses,”implyingthat$12.1
trillionwasalreadyconsideredadangerouslylargenumber.

However,thatnumberpalesincomparisontothelatesttallyofnoti
onalOTCderivativesbytheBankof
InternationalSettlements(BIS).
9
Atmid‐year2008,theBISreported$683.7trillion,or56.5timesthelevel
reportedbytheGAOfor1992.

Worse,amongthesewere$57.3trillionincreditdefaultswaps,orbetsonthefailureofnamed
corporations.Thesecontractsarewidelyrecognizedasthehighestriskcategoryofderivativesandare
directlyresponsibleforth
edemiseofAIG,oneofthelargestthreatstotheglobalfinancialsystemtoday.

7
InSafeMoneyReport,Issue#294,October2,1998,wewrote“EvenastheDowmakesnewhighs,WallStreetandtheworld’s
financialmarketssitatopagiganticmountainofderivatives—high‐riskbetsanddebtsthattotalamind‐boggling$285trillion.”
/>.Similarly,inSafeMoneyReport,Issue#391,November2006,we
wrote“It’saglobalVesuviusthatcoulderuptatalmostanytime,instantlythrowingtheworld’sfinancialmarketsintoturmoil 
bankruptingmajorbanks sinkingbignameinsurancecompanies scramblingtheinvestmentsofhedgefunds overturningthe
portfoliosofm
illionsofaverageinvestors,” />.

8
 />9
 />

14

Atthetimeofthe1994GAOstudy,creditdefaultswapsbarelyexisted;nowtheyarenearlyfivetimes
largerthanthetotaltallyofglobalderivativesinallcategoriesreportedbytheGAOfor1992.

 Inits1994study,theGAOwarnedofextremeconcentrationinthederivativesmarket,withthetopseven
domesticbankderivativesdealersaccountingformorethan90percentofallU.S.bankderivativesactivity
asofDecember1992.

Today,thedatareportedbytheComptrolleroftheCurrency(OCC)demonstratesthatnotonlyhasthere
beenafailuretobetterdiversifyderivativestradingacrossabroaderrangeofplayers,theconcentration
hasactuallyincreased.AsofSeptember30,2008,insteadofsevenmajorplayersamongU.S.commercial
banks,therewereonlyfive.Andinsteadofcontrolling90percent,thesefivebankscontrolled97percent
ofthetotalindustrynotionalamount.
10


Moreover,theOCCalsoreportsthat,ofthe$175.8trillioninnotionalderivativesheldbyU.S.commercial
banksatSeptember30,2008,onesingleplayer,JPMorganChaseBankNA,controls$87.7trillion,or49.9%,
raisingseriousquestionsregardingitsvirtualmonopolyintheU.S.derivativesmarketandthesystemicrisk
impliedbyanyfailure.
11
(Seeaccompanyingtable.)
Rank BankName State
Total
Assets

Total
Derivatives
Total
Futures
(EXCHTR)
Total
Options
(EXCHTR)
Total
Forwards
(OTC)
TotalSwaps
(OTC)
TotalOptions
(OTC)
TotalCredit
Derivatives
(OTC) SpotFX
1 JPMORGANCHASEBANKNA OH
$1,768,65 $87,688,008 $1,442,086 $2,349,629 $8,949,110 $54,385,247 $11,384,205 $9,177,731 $218,733
2 BANKOFAMERICANA NC
1,359,071 38,673,967 1,622,080 643,185 3,651,347 26,796,894 3,479,789 2,480,672 237,758
3 CITIBANKNATLASSN NV
1,207,007 35,645,429 253,586 432,226 5,071,607 20,210,646 6,737,581 2,939,783 536,543
4 WACHOVIABANKNATLASSN NC
664,223 4,221,834 223,423 87,961 211,515 2,913,470 464,389 321,076 15,248
5 HSBCBANKUSANATLASSN DE
181,587 4,133,712 85,293 113,974 565,779 1,938,203 277,515 1,152,948 76,457
6 WELLSFARGOBANKNA SD
514,853 1,429,088 174,358 21,694 468,891 562,659 199,766 1,720 19,149

7 BANKOFNEWYORKMELLON NY
218,699 1,193,652 28,549 58,355 383,966 384,724 336,641 1,417 56,668
8 STATESTREETBANK&TRUSTCO MA
276,291 869,294 2,054 713 786,206 17,927 57,249 5,145 54,802
9 SUNTRUSTBANK GA
170,007 276,689 63,232 26,671 14,275 137,461 31,987 3,063 407
10 PNCBANKNATLASSN PA
134,780 198,478 26,441 12,500 6,079 124,859 23,660 4,940 1,580
11 NORTHERNTRUSTCO IL
68,930 175,128 0 0 165,238 9,232 389 269 22,761
12 KEYBANKNATLASSN OH
97,811 136,302 20,652 4,400 15,325 79,430 8,805 7,690 1,277
13 NATIONALCITYBANK OH
141,501 123,530 16,007 350 12,326 49,853 42,700 2,293 123
14 U.S.BANKNATLASSN OH
242,597 97,056 1,640 9,000 23,871 51,272 9,618 1,655 878
15 MERRILLLYNCHBANKUSA UT
61,643 94,255 72,285 246 614 12,086 0 9,025 0
16 REGIONSBANK AL
139,556 80,094 13,964 3,500 1,222 59,482 1,487 439 7
17 BRANCHBANKINGANDTRUSTCO NC
133,166 71,044 3,599 0 8,632 49,228 9,533 52 57
18 RBSCITIZENSNATLASSN RI
132,609 59,474 0 0 4,890 53,129 1,228 228 37
19 FIFTHTHIRDBANK OH
67,318 58,101 94 0 8,999 39,367 9,333 308 863
20 LASALLEBANKNATLASSN IL
63,388 33,701 0 0 0 24,414 7,398 1,890 0
21 UNIONBANKOFCALIFORNIANA CA
62,431 33,557 2,361 0 4,371 18,303 8,522 0 1,059

22 UBSBANKUSA UT
26,176 33,317 0 0 0 33,317 0 0 0
23 DEUTSCHEBANKTRCO NY
43,932 27,004 0 0 391 20,941 601 5,071 0
24 MORGANSTANLEYBANKNA UT
37,638 25,941 0 0 0 2,156 0 23,785 0
25 FIRSTTENNESSEEBANKNA TN
32,587 24,546 287 0 10,870 11,200 2,189 0 2
T
op
2
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
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08
OtherCommercialBanks&TCsWithDerivatives 2,703,969 438,563 6,816 2,869 58,678 290,590 72,421 7,188 1,523
TotalCommercialBanks&TCsWithDerivatives 10,550,43 175,841,765 4,058,807 3,767,273 20,424,203 108,276,088 23,167,006 16,148,388 1,245,931
Source:OCC
 Inits1994study,theGAOalsoreported“asimilarconcentrationofactivityamongU.S.securities
derivativesdealers.Thetopfivebynotional/contractamountsaccountedforabout87percentoftotal
derivativesactivityforallU.S.securitiesfirmsasoftheirfiscalyear‐end1992.”


10
OCC’sQuarterlyReportonBankTradingandDerivativesActivitiesThirdQuarter2008,
/>11
Ibid.,Table1,pdfpage22.


15

Today,mostofthemajorU.S.securitiesderivativesdealershavefailed,beenboughtout,orbailedoutby
thefederalgovernment.

 Inits1994study,theGAOstressedthat“creditriskisakeyconsiderationinmanagingOTCderivatives,”
butpointedoutthat“managingcreditriskcanbedifficultforOTCderivativesbecausecreditexposurecan
changerapidly.”


Today,theOCCdatademonstratethatthecreditriskisbeyondexcessive:FouroutoffiveofthemajorU.S.
commercialbankderivativesplayershavetotalcreditexposurethatexceedstheirrisk‐basedcapital.
(Moreonthissubjectbelow.)

Thus,despit
ethemodestreformsdiscussedintheGAO’s1996follow‐upreport,thedangersassociatedwith
derivatives—theiracceleratedpaceofgrowthandmultiplelevelsofrisk—onlychangedfortheworse.

MeanwhiletheGAO’swarningsaboutthepossibledisastersresultingfromaderivatives‐relatedfailurewere
prescient:

1. AstheGAOclea
rlyimpliedinitsreport,therapidgrowthofunregulatedOTCderivativesnowposesa
seriousthreattotheglobalfinancialsystem.

2. AstheGAOwarned,theconcentrationoftradingamongasmallnumberoflargeplayershaspinnedthe
futureofthefinancialsystemonahandfulofhigh‐rollers.

3. AstheGAOwarned,eachofthefiverisksitcited—creditrisk,marketrisk,legalrisk,operationsriskand
systemrisk—havecometogetherinasingleexplosivemixnowthreateningstability.

4. AstheGAOwarned,thefailureofonelargeOTCderivativesdealerhasposedriskstoothermajorfirms,
includingfederallyinsureddepositoryinstitutionsandthefinancialsystemasawhole.Itsname:Lehman
Brothers.Moreover,asexplainedbelow,thenearfailureofalargerfirm,AmericanInsuranceGroup(AIG),
posesevengreaterthreats.

5. AstheGAOwarned,thefinanciallinkagesamongfirmshaveheightenedthisrisk.Moreover,asit
explainedwithitsreferencetothe1987stockmarketcrash,theselinkageshavebecomeespeciallycritical
inthewakeofrecentmarketcrashes—inboththeU.S.housingmarketandglobalstockmarkets.


6. AstheGAOwarned,theabruptfailureorwithdrawalfromtradingofoneofthelargedealershas
underminedthestabilityofseveralmarketssimultaneously,leadingtoachainofmarketwithdrawals,firm
failuresandsystemiccrisis:We’veseensimultaneousande
xtremeinstability inthemarketsformortgages,
interbankloans,assetbackedsecurities(ABS),commercialpaper,corporatebondsandevenmoney
marketfunds.

7. Finally,astheGAOalsowarned,theFederalReservehasbeenrequiredtoserveasalenderoflastresort
tomajorU.S.OTCderivativesdealers,whetherregulatedorunregulated:TheFedhasjumpedintoextend
massiveloansnotonlytocommercialbanksunderitsjurisdictionbutalsotobroker‐dealers,insurersand
others.


16

MajorFinancialInstitutionsatRiskofFailure

Duetothecontinuingscarcityofdetaileddataonthemultipleriskfactorsassociatedwithderivatives,itis
difficulttopinpointpreciselywhichlargeinstitutionsareatgreatestrisk.However,theOCChasdevelopeda
measureofthetotalcreditexposureofmajorderivativesplayers,asfollows:

MajorU.S.Ba nksOverexposedtoDefau ltRisk
(CreditExposurewithDerivativesasa%ofRisk‐BasedCapital)
664.2
400.2
259.5
177.6
85.2
0 100 200 300 400 500 600 700

HSBC Bank USA
JPMorgan Chase
Citibank
Bank of America
Wachovia
Data: OCC


Thischartanswersthequestion:Foreachdollarofcapital,howmuchexposuredoeseachbankhavetothe
possibledefaultsofitsderivativestradingpartners?Anditshowsthatamongcommercialbanks,allbutoneof
thefivelargestplayersareexposedtothetuneofover100percentoftheircapital,analarminglevelevenin
theabsenceofafinancialcrisisordepression.

BelowisamoredetailedanalysisofthetwolargestofthefivebankscoveredbytheOCCreport—Citibank
andJPMorganChase—alongwithasummaryreviewoftheremainingthree.

CitibankNA(NV)isthenation’sthirdlargestcommercialbank,with$1.2trillionintotalassets.Despiteits
largesize,how
ever,WeissResearchplacedCitibankonitslistofbanksatriskinAugustof2008.Belowisan
updatedsummaryofouranalysisthatformedthebasisofthisdecision.

1. Citibankhasaveryhighcreditexposurerepresenting259.5percentofitsrisk‐basedcapital,asin
dicatedin
thechartabove.
2. Itholds$2.94trillionincreditderivatives,almostentirelycomposedofcreditdefaultswaps,
12
knowntobe
themostdangerouscategoryofderivatives.



12
TheOCCreportsthat,basedonindustry‐widefigures,99percentofcreditderivativesarecreditdefaultswaps.


17

3. AnditreceivesaborderlineFinancialStrengthRatingofC‐(fair)dueprimarilytonetlossesfromprovisions
forloanlossesandtradinglossesandadeclineinthequalityofitsassets.

Inaddition,Citigroup’sDecember31,200810‐Kreport
13
showsthat

4. Thecompanysufferedanetlossof$27.7billion,or$5.59centspershare,vs.afiscalyear2007profitof
$3.62billion,or$0.72pershare(pdfpage4).
5. Netrevenuesdeclined33%to$52.8billionfrom$78.5billion(page4).
6. Itsprovisionforloanlossesnearlydoubledto$33.6billionfrom$16.8billionintheyear‐earlierquarter
(page54).
7. Itsoverallallowanceforloans,leases,andunfundedlendingcommitmentsclimbedto$30.5billionfrom
$17.4billion(page53).
8. Andtherewasahugeexposuretosinkingconsumerloans,withoverthreefourths(78.2%)ofthe$664.6
billionloanportfoliointh
atsector(page53).

Further,basedonitsQ42008quarterlyfinancialsupplement,
14
wefindthat

9. Thecompany’sglobalcreditcardportfolioishighlyvulnerabletoaneconomicdepression,with175.5
millionaccountsand$191.3billioninaverageloansoutstanding(page9).

10. Netcreditlossesinthetotalworldwidecreditcardbusinesssurged49%to$1.67billionfrom$1.12billion
inyear‐earlierperiod(page9).
11. Foretellingoffuturecreditcardlosses,delinquencyrates(90+dayspastdue)jumpedto2.62%ofNorth
Americancreditcardloans,from1.77%ayearearlier(page10).
12. Consumerbankingoperationshadcreditlossesof$3.44billionvs.$1.77billionintheyear‐earlierperiod
(page12).
13. Withtheexceptionofstudentloans,delinquencyrates(90+dayspastdueasapercentofend‐of‐period
loans)inNorthAmericarosesharplyacrosstheboard,asfollows:
 Residentialrealestate—4.73%inQ42008vs.2.22%inQ42007;
 Autoloans—1.85%vs.1.36%;
 Personalloans—3.36%vs.2.57%;
 Commercialloans—0.81%vs.0.37%
 Studentloans—2.75%vs.3.23%(page15)
WeissResearchaction:Giventheabovefactsaswellasthebank’scontinuingneedforemergencycapital
injectionsunderTARP,thebankremainsonWeissResearch’slistofbanksatriskoffailure.
15


13
Citigroup’s10‐Kfiling,availableat />14
Availableat />15
Recentcompanyclaimsaboutpositiveearningsinthefirsttwomonthsof2009donotchangethatoutlook.CEOVikramPandit
saidCitigroupwasprofitableforthefirsttwomonthsof2009,beforetaxes,provisionsforloanlossesandextraordinaryitems.
WhileCitigroupmaywellbecomeprofitablebyreservinglessforloanlos
sesinthecurrentperiodafteraggressivelyreservingin
previousperiods,thecompanymayalsofaceadditionalextraordinarywritedowns.



18


JPMorganChaseBankNA(OH),or“JPM,”isthelargestU.S.commercialbankwith$1.8trillionintotalassets.
 Ithasextremelyel evatedderivatives‐re latedcreditexposure tothetuneof400.2 percentofitsrisk ‐basedcapital.

 Itholdsnearly$9.2trillionincreditderivatives.
16


 IthasapproximatelyhalfofallderivativesheldbyU.S.commercialbanks.Assuch,itwouldbeatground
zeroofanysystemiccrisis.

 Apartfromitsderivativesrisks,itmeritsnomorethana“fair”FinancialStrengthRatingofC+from
TheStreet.com,basedprimarilyonseveralyearsofmediocreearningsperformance,afactorthatcould
threatenitscapital.

Inresponsetoconcernssuchasthese,onFebruary26,2009,JPMprovidedapresentation,entitled
“Derivatives,”inwhichitsoughttoreassureinvestorsregardingthequalityandriskmanagementofits
derivativesportfolio.
17
Inthereport,whileacknowledgingthatitsderivativesareacorecomponentofits
assetsandthattherearemultiplerisksassociatedwithderivatives,itseekstomakethecasethatithas
adequatetoolsformeasuringandmanagingtheassociatedrisk.However,

 JPMdoesnotdemonstratehowitsriskmanagementtoolsareanybetterthanthoseusedbyother
sophisticatedderivativesplayersthatfailed,suchasAIG,BearStearns,LehmanBrothersandMerrillLynch.
Thosetoolsdidnotprovideadequateprotectionagainstunexpected“BlackSwan”events,suchasthe
collapseoftheU.S.mortgagemarketorthefailureoftriple‐AratedcompanieslikeFannieMae,raising
seriousquestionsaboutJPM’sabilitytowithstandshocksofsimilarmagnitudeinthefuture.

 JPMstatesthat,throughtheuseofcollateralandhedges,itreducesitsderivativescounterpartyexposure

almostinhalf.However,with400.2percentcreditexposure,evena50percentreductiondoesnotbring
thebankbackdowntoacceptablerisklevels.

 JPMacknowledgesthatitremainsexposedto“gaprisk”—changesinmarketvaluethataretoosuddento
allowforadditionalcollateralcallsorhedging.Giventhelikelyvolatilityofmarketpricesinacontinuing
financialcrisis,thisrisk,nomatterhowwellmonitored,canbedifficulttocontain.

 JPM’sreportseemstominimizethethreatofits“Level3”assets—assetstypicallyvaluedusinguncertain
financialmodelsratherthanactualmarketprices.AlthoughJPMstatesthattheserepresentonly6.4
percentofJPM’sassets,afigurethatmayappearsmall,JPMfailstoexplicitlypointoutthattheyrepres
ent
averyhigh91.2percentofrisk‐basedcapital.
18
Bycomparison,priortotheirdemise,BearStearnshad
Level3assetsrepresenting155percentofcapitalandLehmanBrothershadLevel3assetsof160percent
ofcapital.AlthoughtheseLevel3/capitalratiosmaynotbedirectlycomparableduetoinherent
differencesinthebusinessmodelsofsecuritiesfirmsandcommercialbanks,theydoindicatethatJPM’s


16
Seenote11above.
17
JPMorganChase&Co.,“Derivatives,”February26,2009,
/>BillWinters.pdf
18
Ibid.,page12.JPMstateslevel3assetswere$145billionasofSeptember30,2008,or6.44percentoftotalassets,whichwere
$2.251trillion.SinceJPM’stotalrisk‐basedcapitalwas$159billion,theratioofLevel3assetstorisk‐basedcapitalwas91.2percent.


19


exposuretotheseassetsmaybedifferentindegree—butnotsignificantlydifferentinkind—fromthose
ofotherlargederivativesplayersthathavefailed.

 Mostimportant,althoughJPMhighlightsitsmonitoringofrisk,itdoesnotdisclosedetailregardingits
assumptionsorscenariosusedinstresstesting,asignificantomissiongiventheextremenatureofrecent
derivativescollapsesandeconomicdislocations.

WeissResearchaction:Inlightofmountingdangersinthefinancialmarketsandtheeconomy,aswellasthe
additionaldatarevealedbythecompanyinitsreportonderivativesofFebruary26,WeissResearchhasadded
JPMtoitslistofU.S.banksatriskoffailure.

HSBCBankUSANA(DE)istheU.S.‐basedoperationofthisglobalbankandwasincludedonWeissResearch’s
listofbanksatriskinAugust2008.Itcurrentlyhasanextremelyhighcreditexposureof664.2percentofits
risk‐basedcapital.Inaddition,separatefromitsderivativesrisk,thisbankmeritsaborderlineFinancial
StrengthRatingofC‐(fair)becauseofcontinuingdeclinesinthequalityofitsassetsandweakearnings.

WeissResearchaction:ItremainsontheWeissResearchlistofbanksatriskoffailure.

BankofAmerica,NA(NC)hasahighcreditexposureof177.6percent.However,unliketheothermajor
derivativesplayers,itsFinancialStrengthRatingofB‐(“good”)isapositive,reflectingseveralyearsofstrong
assetqualityandpositiveearningsthroughthefirstthreequartersof2008.

WeissResearchaction:ThankstoitspositiveFinancialStrengthRating,BankofAmericaisnotcurrentlyon
WeissResearch’slistofbanksatriskoffailure.

WachoviaBankNA(NC)hasalreadysufferedadefactofailureandwaspurchasedbyWellsFargoinanall‐
stocktransactionannouncedonOctober3,2008.

WeissResearchaction:Basedonitsbroaddefinitionoffailurecitedattheoutset,WeissconsidersWachoviaa

failedinstitutionandthereforedoesnotincludeitonitslistofbanksatriskoffuturefailure.

Inaddition,inAugustof2008,duetoelevatedexposuretorealestatelending,WeissaddedSunTrustBankto
itslistaswell.

Insum,inadditiontothelistofinstitutionswithTheStreet.comFinancialStrengthRatingsofD+ orlower,
WeissResearchhasaddedfourbankstoitslistofinstitutionsatriskoffailure,asfollows:

BanksAddedbyWeissRese
archto
ListofBanksatRiskofFailure
Bankname Totalassets($billions)
Citibank1,207.0
HSBCBankUSA   181.6
JPMorganChase  1,768.7
SunTrustBank   174.7
Total3,157.3


20

Inconclusion,beyondthe$2.32trillioninassetsofbanksatriskbasedontheirFinancialStrengthRatingscited
inPartI,WeissResearchestimatesthereareadditionalassetsof$3.16trillioninlargeinstitutionsatrisk,fora
totalof$5.48trillioninat‐riskinstitutions.

21


PartIII
SilencingthePotentialTriggersof

GlobalCollapseDoesNotAddressItsCauses

AnyonestillskepticalofthenatureandmagnitudeofthesystemicdangersneedonlyreviewtheFebruary26,
2009draftmemorandumissuedbyAIG,titled“AIG:IstheRiskSystemic?”Althoughmarked“strictly
confidential,”itfounditswayintothepublicdomaininearlyMarch.
19
Init,AIGstates:

 “Systemicriskistheriskimposedbyinter‐linkagesandinterdependenciesinasystemormarket,which
couldpotentiallybankruptorbringdowntheentiresystemormarketifoneplayeriseliminated,ora
clusteroffailuresoccurs.

 “Systemicfinancialrisksoccurwhencontingencyplansthataredevelopedindividuallytoaddressselected
risksarecollectivelyincompatible.Itisthequintessential‘kneeboneisconnectedtothethighbone ’
whereeveryelementthatonceappearedindependentisconnectedtoeveryotherelement.

 “AIG’sbusinessmodel—asprawlof$1trillionofinsuranceandfinancialservicesbusinesses,whoseAAA
creditwasusedtobackstopa$2trilliondollarfinancialproductstradingbusiness—hasmanyinherent
risksthatarecorrelatedwithoneanother.Astheglobaleconomyhasexperiencedmulti‐sectorfailures,
AIG’svastbusinesshasbeenweakenedbythesemulti‐sectorfailures. 

 “IfAIGweretofailnotwithstandingtheprevioussubstantialgovernmentsupport,itislikelytohavea
cascadingimpactonanumberofU.S.lifeinsurersalreadyweakenedbycreditlosses.Stateinsurance
guaranteefundswouldbequicklydissipated,leadingtoevengreaterrunsontheinsuranceindustry. 

 “Inaddition,thegovernment’sunwillingnesstosupportAIGcouldleadtoacrisisofconfidencehereand
abroadoverotherlargefinancialinstitutions,particularlythosethathavethusfarremainedviablebecause
ofgovernmentsupportprograms.

 “Thelossofconfidenceislikelytobeparticularlyacuteincountriesthathavelargeinv

estmentsinU.S.
companiesandsecuritiesandwhosecitizensmaysuffersignificantlossesasaresultofthefailureofAIG’s
foreigninsurancesubsidiaries.

 “ThiscouldleaddirectlytoadecreaseintheattractivenessofU.S.governmentsecuritiesanda
consequentincreaseinborrowingcostsfortheU.S.governmentandrelatedissuingentities 

 “TheextentandinterconnectednessofAIG’sbusinessisfar‐reachingandencompassescustomersacross
thegloberangingfromgovernmentalagencies,corporationsandconsumerstocounterparties.Afailureof
AIGcouldcreateachainreactionofenormousproportion 


19
AIG,StrictlyConfidential.“AIG:IstheRiskSystemic.”Draft‐February26,2009. />Systemic‐090309


22

 “JustasthegovernmentwasunabletopredictthatthefailureofLehmanwouldleadtothecollapseofthe
ReserveFund,followedbymuchofthemoneymarketindustry,thegovernmentwouldbeevenless
capableofpredictingthefalloutfromthecollapseofamuchlarger,moreglobalandmoreconsumer‐
orientedinstitutionsuchasAIG.”

TheagendabehindAIG’sconfidentialmemorandumispreciselytheoppositeofacompany’stypicalagendain
publiccommunications:Ratherthansugar‐coatthefacts,theysoughttomakethegloomiestpossible
argumenttopersuaderegulatorstoprovidemorebailoutfunds.

AIG’sthesis:Thecompanyissolargeandhaslinkagestosomanyothermajorplayersinthederivatives
market,itsdemisewouldcauseachainreactionoffinancialcollapses.


ItistruethatAIGisverylarge.Andbasedonitsrecentdisclosures,it’salsotruethatitislinkedtomajor
derivativesplayersaroundtheglobe.Asdepictedintheaccompanyingchart,

 AIGdoesbusinesswithatleast30financialinstitutions,primarilyintheU.S.andWesternEurope.

 Someofthosecompanieshavesignificantfinancialweaknessesoftheirown,asindicatedbythe
borderlineratingsissuedbyTheStreet.comandless‐than‐stellarratingsbyMoody’s.

 Thosecompanieshavetotalassetsofatleast$36trillion,farmorethanthetotalcommittedbytheU.S.
andEuropeangovernmentsforcorporatebailouts.

AIGCounterparties Ticker
TheStreet.com
Ratin
g
Moody's
Issuer
TotalAssets

($
Mil.
)

AIGInternationalInc AIGUS A3 860
,
418
BancoSantander SANSM Aa1 1
,
464
,

499
BankofAmerica BACUS B‐ A1*‐ 1
,
817
,
943
BankofMontreal BMOCN N
/
A 358
,
947
Barcla
y
s BARCLN A1 2
,
992
,
218
BNPParibas BNPFP Aa1 2
,
859
,
535
Cal
y
on N
/
A N
/
A 902

,
427
Citadel N
/
A N
/
A N
/
A
Citi
g
rou
p
 CUS C‐ N
/
A 1
,
938
,
470
CreditSuisse CSGNVX N
/
A 1
,
095
,
013
Danske DANSKEDC Aa3 664
,
294

DeutscheBank DBKGR Aa1 2
,
898
,
465
DeutscheZentral‐Genossenschaftsbank DZBKGR N
/
A 676
,
436
DresdnerBankAG DRBGR Aa3 753
,
139
DresdnerKleinwort N
/
A N
/
A 729
,
830
GoldmanSachs GSUS A1 884
,
547
HSBCBankUSA 521903ZUS C‐ Aa3 186
,
583
ING INGANA N
/
A  1
,

935
,
151
JPMor
g
an JPMUS C+ Aa3 2
,
175
,
052
KFW N
/
A N
/
A 517
,
279
LandesbankBaden‐Wuerttember
g
 2525ZGR N
/
A 787
,
371
MerrillL
y
nch MERUS A1*‐ 667
,
543
Mor

g
anStanle
y
 MSUS A2 658
,
812
PalomaSecurities 1788305ZLN N
/
A 221
Rabobank RABONA Aaa 854
,
061
ReconstructionFinanceCor
p
 N
/
A N
/
A N
/
A
Ro
y
alBanko
f
Scotland RBSLN N
/
A 3
,
500

,
408
SocieteGenerale GLEFP N
/
A 1
,
576
,
637
UBS UBSNVX Aa2 1
,
885
,
384
Wachovia WBUS N
/
A 764
,
378

Data:Bloomberg,TheStreet.com,Moody's
TOTALASSETS: $36,405,060

23

However,ifthisglobalstructureisshaky,neitherafuturefailureofAIGnorthe2008bankruptcyofLehman
Brotherscanbeproperlyconstruedastheunderlyingcause.Rather,theyaremerelypotentialtriggersofa
globalcollapse.

Theunderlyingcausesofglobalinstabilityaremanyyearsofoverborrowingandundersaving,plusthe

cumulativeweightoftheU.S.housingbust,mortgagemeltdown,widespreaddeleveraginginthefinancial
system,andthedeepesteconomicdownturnsincetheGreatDepression.

Meanwhile,thepotentialtriggersofaglobalcollapseareubiquitous—notlimitedtojustoneortwofirms
suchasAIGorLehmanBrothers.Aswedemonstrateinthispaper,inthebankingindustryalone,thereareat
leastfourmegabanksandthousandsofsmallerinstitutionsatrisk.Thus,althoughabundanttaxpayerfunds
maylockdownsomeofthepotentialtriggerssomeofthetime,itisunreasonabletoexpectthegovernment
tosilenceallthegunsallthetime.



24

PartIV
U.S.CommercialBanksAreVulnerableto
ContagionDespiteExpandedDepositInsurance

Onejustificationoftencitedprivately—andsometimespublicly—forgovernmentactionstoavertlargebank
failuresistheconcernthat

 thefailuresmightleadtohastywithdrawalsbydepositors,
 thepaniccouldspreadtootherinstitutions,and
 inaworst‐casescenario,thecontagioncouldshutdowntheentirebankingsystem.

Thisfearisnottotallyunjustified.Bankingandrelatedpanicshaveoccurredbefore—notonlyinprioreras
butalsoinmorerecenttimes.

InJanuary1991,forexample,duetoafloodofwithdrawalsbypanickeddepositors,RhodeIslandGovernor
BruceSundlundeclaredabankingemergencyandshutdownall45state‐charteredsavingsbanksandcredit
unionsinhisstate.Shortlythereafter,wewitnessedasimilarsituationinMaryland.Thelessonwasthatpanic

andcontagionwasnotstrictlyaphenomenonthatendedinthe1930s.

AnInstructiveCaseStudy:
TheRoleofRegulatorsinaMajor
DisintermediationCrisisAmongLifeInsurers
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EvenmorepertinentlessonscanbelearnedfromthedisintermediationthatstruckseverallargeU.S.lifeand
healthinsurersintheearly1990s.

Theirproblemscanbetracedtotheearly1980swhenmanyinsurershadguaranteedtopayhigh,fixedyields
toinvestors,butfoundthemselvesunabletomeetthosepromisesasinterestratesdeclined.Tobridgethe
gap,severalreachedouttolowerrated,higher‐yieldingsecurities,includingjunkbondsandunratedbonds.
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Untilthisjuncture,higherriskbondportfoliosintheindustrycouldbeexplainedasastopgapsolutio
nto
fallinginterestrates.Butafewinsurers—especiallyExecutiveLifeofCalifornia,FidelityBankersLife,andFirst
CapitalLife—sawthepotentialofhigh‐riskbondportfoliosasamajorbusinessopportunity.
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Thesecompaniesweren’tsimplyreluctantbuyersofjunkandunratedbondstofulfillpriorcommitments.
Theirentirebusinessplanwaslargelypredicatedontheconceptofjunkbondsfromtheoutset.Thekeywas
tokeepthejunkbondaspectlargelyhiddenfrompublicview,whileexploitingthefaiththepublicstillhadin
theinherentsafetyofinsurance.Tomakethemodelasuccess,however,theyneededtwoadditional
elements:thecooperationoftheWallStreetratingsagenciesandtheblessingofthestateinsurance
commissioners.
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Thecooperationoftheratingagencieswasrelativelyeasy.Formanyyears,thestandardoperatingprocedure
oftheleadinginsurancecompanyratingagency,A.M.Best&Co.,wastoworkcloselywiththeinsurers:Ifthe
companydidnotliketheratingandrequesteditnotbepublished,Bestcomplied.Ifthecompanywassatisfied
withtherating,Bestwouldchargethecompanytoprintitsra
tingreports,whichcouldbeusedbythe

insurer’ssalesforcetomarketitsproducts.
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25
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Threenewerentrantstothebusinessofratinginsurancecompanies—Moody’s,S&P,andDuff&Phelps(now
Fitch)—offeredessentiallythesameservice.Butinsteadofearningtheirmoneyfromreprintsofratings
reports,theychargedtheinsurancecompaniesaflatfeeforeachrating,rangingfrom$10,000to$50,000per
insurancecompanysubsidiary,peryear.Later,A.M.Bestdecidedtochangeitspricestructuretomatchthe
otherthree,chargingtheratedcompaniessimilarup‐frontfees.
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Asawhole,theratingsprocesswasstackedinfavorofthecompaniesfromstarttofinish.Thecompanies
wereempoweredtodecideifandwhenandbywhomtheyweretoberated.Theyweregivenapreviewof
theirratingbeforeitwasrevealedtothepublic.Theyhadtherighttoappealanadverseratinganddelayits
publication.And,asmentionedabove,iftheywerestillunhappywiththerating,mostoftheratingagencies
allowedthemtosuppressitspublication.
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Notsurprisingly,theratingagenciesgaveoutgoodgradeslikecandy.AtA.M.Best,thegradeinflationwasso
severethatindustryinsiderswidelyrecognizedthata“good”Bestratingwasactuallybad.Ithadtobe
“excellent”toreallybegood.
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Thus,inthisfriendlyratingsenvironment,itwasnotdifficultfortheinsurerswithlargejunkbondportfoliosto
getexcellentgradesfrommostoftheratingagencies.
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Gettingsimilarcooperationfromtheinsuranceregulatorswasnotquiteaseasy.Infact,stateinsurance
commissionersweregettingsoconcernedabouttheindustry’sbulginginvestmentsinjunkandunratedbonds,
theydecidedtosetupaspecialofficeinNewYork—theSecuritiesValuationOffice—tomonitorthe
situation.
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Akeyquestionhotlydebatedbetweentheindustryandregulatorswas:What’sajunkbond?Thestandard
WallStreetanswerwasundisputed:anybondwitharatingfromS&PorMoody’sofdouble‐Borlower.

However,insurerswithsubstantialholdingsofjunkbondswerenotsatisfiedwiththatdefinition.Theyknewit
wouldexposethetruesizeoftheirjunkbondholdingstothepublic.Sotheylobbiedtheinsurance
commissionerstoredefinethedefinitionofajunkbond.Thecommissionersinitiallystruggledwiththis
request,buttheyultimatelyobliged.
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InsteadofthestandardWallStreetdefinitionofjunk,theSecuritiesValuationOfficeestablishedthefollowing
fourbondclasses“yes,”“no*,”“no**,”and“no.”Thefirstcategorywasconsideredinvestmentgrade,while
thethree“no”categorieswereconsideredjunkbonds.However,the“yes
”categoryactuallyincludedbillions
ofdollarsofbondsratedBBorlower(thestandarddefinitionofjunk)bytheleadingratingagencies.

Thiscontinuedforseveralyears.Finally,however,afterprotestsfromindustrywatchdogs,theinsurance
commissionersrealizedthisamountedtoajunkbondcover‐upandmadethedecisiontoendthecharade,
adoptingthestandarddouble‐Bdefinition,andreclassifyingover$30billionin“secure”bondsasjunkbonds.

Basedonthefaultydefinitionofjunkbondsuseduntil1989,theinsurancecommissionershadreportedthat
FirstCapitalLifehad$842million,or20.2percentofitsinvestedassetsinjunkbondsatyear‐end1989.
However,basedonthecorrect,standarddefinitionofjunkbonds,whichthecommissionersfinallybegan
usingin1990,itturnedoutthatFirstCapitalactuallyhad$1.6billioninjunkbonds,or40.7percentofits
investedassets.FidelityBankersLife’sjunkbondholdings,previouslyreportedat$639million,or18.3percent
ofinvestedassets,jumpedto$1.5billion,or37.6percentofinvestedassets.Alltold,theindustry’sjunkbond