Chris Whalen On The Upcoming "Worst Economic Contraction Since WWI (Forget WWII)"

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From Chris Whalen at Institutional Risk Analytics

Exposure at Default: Does Bank American Have Any Alternatives for Countrywide?


The erosion of the profitability of
the U.S. banking industry over the past two years under the glorious
Summers-Geithner-Bernanke rescue scheme is the proverbial fly in the
ointment for both major political parties. Democrats and republicans
alike are going to be fed into the meat grinder over the next several
years as the banking sector deals with literally hundreds of billions of
dollars in direct and indirect expenses from the deflation of the
mortgage bubble. For the economy, this slow process of muddle along
championed by Summers and Geithner will ensure that Barack Obama becomes
the Herbert Hoover of the Democratic Party.

The economic carnage that will causes these losses, as we described in a recent post in Reuters,
"Double Dip or Global Deflation?,"
is
going to represent the worst economic contraction since WWI. Forget
WWII. Think "shrinkage" to use the Gilded Age description for economic
deflation. And frankly nothing that either the Fed or Treasury does in
the near-term can change this basic economic fact of restructuring.
Banks such as Ally, which is the owner of the ResCap legacy portfolio as
we all know, can impose moratoriums and issue press releases, but the
losses remain. It is only a question of when they are recognized.

Thus we turn the pages back to August of 2008, when we were just returning from our annual Maine fishing trip with David Kotok of Cumberland Advisors. In our comment
“Is Countrywide Financial Headed for Bankruptcy?,”
we described the lawsuit by Bank of New York Mellon (Q2 2010 BSI Rating: "A+") to force Bank of America (JPM/Q2 2010 BSI Rating: “C”) to
formally take responsibility for the debt of Countrywide Financial. BAC
management had made statements to investors during conference calls
that Countrywide was being kept “bankruptcy remote” from the BAC parent.

Since then, most talk of a bankruptcy by
Countrywide has been squelched because of the legal and practical
obstacles involved. We’ll be going into these issues in detail for
subscribers to the IRA Advisory Service later this week. Suffice to say
that while the legal situation may seem clear and mitigate against a
bankruptcy filing by Countrywide to limit legacy claims, both liquidated
and unliquidated, the economic situation at BAC and among all of the
legacy zombie banks continues to worsen. No amount of bullshit from
Washington changes the fundamental economic situation inside the largest
U.S. lenders.

In earlier comments,
'An Involuntary Transaction: Why BAC + CFC May Never Close', May 6, 2008
and
'Update: Are Countrywide Financial Bond Holders Bankruptcy Remote?', May 1, 2008,
we
had further described the shenanigans by BAC management with respect to
the Countrywide acquisition in that year. And as we wrote then and we
remind one and all now, the decision by former Treasury Secretary Hank
Paulson, Fed Chairman Ben Bernanke and OCC Head John Dugan to slam
Countrywide and Merrill Lynch into BAC, Wachovia Bank into Wells Fargo & Co (WFC/Q2 2010 BSI Rating: “B") and Bear Stearns into JPMorgan (JPM/Q2 2010 BSI Rating: “C”) was a fundamental error -- and one that is only creating the precursors for the next systemic crisis.

The difference between the Lehman Brothers
bankruptcy and the JPM acquisition of Bear Stearns is that the
unliquidated claims against the former firm for securitization and other
exposures are all being managed by the U.S. Bankruptcy Court for the Southern District of New York.
Jamie Dimon and his shareholders are on the hook for all of the claims
against the legacy Bear Stearns securitization business, but Dimon is
fortunate compared to his counterparts at WFC and BAC. The claims
against Washington Mutual, for example, are sitting in the U.S. Bankruptcy Court in Wilmington -- except, of course, for the covered bonds issued by WaMu and conveyed to JPM via the FDIC receivership. Wonder if our friend Meredith Whitney has noticed this issue yet...


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