Teeter Tot: Third Quarter Stable at the Brink

There's good news of sorts from the third quarter data. The risk distribution of the banking system looks to be in a holding pattern. Life is still full of pain of course. Credit availability remains tight. The prospect for more mortgage losses in 2010 remains looming. Leveraging vehicles for finance are sparse. And the valuation of the real assets underlying capital continues to shrink. But here's the good news. There's a pattern to the pain. The volatility and uncertainty surrounding much of 2009 has morphed to a collection of set piece issues. And that gives me some hope because set piece battles are things we can begin to work on. We Americans tend to be as good at tactical problem solving as we are bad at strategic vision. But this means that overall our problems are moving towards our strenghts rather than our weaknesses.

The risk map at the end of September 2000 was as follows,

IRA Bank Stress Grade Distributions Period A+ A B C D F 200909 3,308 1,481 410 429 77 2,337 200906 3,518 1,449 417 421 72 2,256 200903 3,959 1,431 452 437 88 1,820 200812 3,918 1,448 376 390 98 2,003 200809 4,498 1,293 315 356 63 1,793 200806 4,884 1,323 329 326 66 1,458 200803 5,167 1,271 349 334 68 1,233 200712 5,556 1,196 298 315 70 1,029 200709 5,931 1,083 262 274 37 902 200706 6,056 1,090 236 273 60 824 200703 6,075 1,112 249 284 63 795 200612 6,370 1,087 212 204 39 697

And asset distributions are,

IRA Bank Assets Stress Distributions Period A+ A B C D F 200909 $1,756 $1,938 $4,316 $584 $94 $4,535 200906 $2,005 $2,097 $4,132 $518 $68 $4,458 200903 $3,202 $3,131 $3,587 $729 $86 $2,784 200812 $2,366 $5,398 $403 $694 $46 $4,033 200809 $2,907 $5,504 $525 $704 $144 $3,772 200806 $2,897 $5,256 $400 $695 $51 $3,983 200803 $3,461 $5,119 $384 $630 $36 $3,719 200712 $7,613 $1,719 $1,629 $1,248 $107 $705 200709 $8,384 $3,203 $129 $568 $13 $395 200706 $8,619 $2,804 $98 $497 $56 $170 200703 $8,378 $2,629 $209 $550 $31 $170 200612 $9,004 $2,029 $165 $483 $78 $88 Amounts in $ Billions.

The risk map is roughly identical from 2Q2009 to 3Q2009 give or take a little because of continued but now predictable hemmoraging. So where are America's challenges ahead?

Do we have the political will to do the right thing?

Bringing Wall Street back into the service of Main Street remains elusive. Finance remains a universe separate from the rest of our reality. The excesses of a decade and a half of "financial innovation" have been exposed but the inertia behind the collapse continues to fight on delaying the finance system's reintegration into mainstream society. What else can you say when you witness artifacts such as a stock market that pushes up prices on the arithmetic of expense management paid for by the unemployed and underemployed. Or a derivatives market so steeped in its' habits that it remains hell bent on preventing the kind of transparency that would help ensure the debacle we are living through won't happen again? These are not economic fundamentals, they are social and political risks that this nation cannot afford. The Administration and Congress are by now well aware of these forces and their effects. There is no reason the citizenry should not expect our leaders to do the right thing.

Refocusing industry incentives to make things right.

Just under 2/3rd's of the banking industry's assets lives in the A+/A/B stress range according to our calculations. The remainder have issues clearly requiring some degree of extraordinary administration. But so far, the remediation efforts of the United States remain piecemeal and nearest I can tell, overly focused on a few large entities that fall within the fashionable coverage limit of the major news bureaus. We have so far failed to systemically tap into the single largest source of recovery strength we have, the healthier banks. They are there but they are hamstrung from acting lumped in with the weaker and louder players who's calls for mercy and aid via taxpayer dollars retain our attention. In my job I see and talk to some of these A+/A/B banks and even some really smart C grade banks on the mend that struggle to take advantage of their positional strengths. But what should be a downhill run competitive advantage is an uphill struggle for the best of breed. So here's the challenge to our leadership. Refocus the process from a smattering of narrowly selective aid packages to a tidal of movement to change the nature of the industry so it gets back to an 80 good/ 20 bad ratio. This will involve a much larger shifting of impaired assets to sound foundations. It will undoubtedly manifest as a newsworthty mix of debacles and recombinations. But we need to return to a process of natural selection based on value instead of clout.

Make Main Street the political priority already.

We cannot make lemonade from rotting lemons. You can take comfort deluding yourself looking at day to day economic indicators but the reality is that as of September 2009 the total amount of bank balance sheet real estate loans outstanding by FDIC reporting banks was around $4.5 trillion dollars. That is about the same amount as it was in March 2007. It peaked at a high of $4.8 trillion in March 2008 just as the "crisis" was becoming common knowledge to America.

But here's the thing. In 2007 the annualized default rate on these loans was 11.8 basis points. Today it's 194.3 bp. Main street home ownership is struggling. Let's look at a few more then and now comparisons.

• In March 2007, 30-89 Day overdue loans was $43.7 billion. Today, it's $100.8 billion.
• Over 90 Day overdue loans were $11.2 billion in 2Q2007; today that figute is up to $88 billion.
• Non-Accrual residential real estate loans were $29.2 billion in March 2007; we are at $202 billion now.
• And bank real estate owned was $6.9 billion in March 2007. Today banks own $37 billion worth of real estate.

The challenge is pretty clear. The degraded real estate portfolio of America's banks massive and does not yet shows no signs of abating. Surrounding this challenging financial scenario is a loan modification program that by best estimates will work for no more than 1/3rd of the problem. An infrastructure solution needs to be found for the balance of the U.S. homeownership problem. Banks saddled with such problems cannot lend and therefore cannot help re-stimulate the economy. In economic terms this is a massive downward accelerating force if not dealt with. Numerous proposals surrounding this subject abound as we reach the end of 2009. None yet cohesive enough to represent anything amounting to a solution. We have a collective choice to focus on it or not.