More Off-Balance Sheet Troubles

The size of the "Shadow Banking" system must be huge. More off-balance sheet problems for financial conglomerates.

In an unusual move, banks such as Citigroup, JPMorgan Chase and Bank of America have come to the rescue of the off-balance-sheet vehicles that help them to fund credit card loans.

Issuers typically sell their credit card loans to trusts which in turn sell bonds to investors. The banks retain a small interest and manage the trust.

There limits to the amount of liquidity and leverage an economy can absorb but "Too Big" conglomerates don't care because the need the fees and returns to survive. I digress.

The problem for the financial conglomerates is that these off-balance sheet trusts are starting to lose money fast. Any cushion or reserves are being eaten up by mounting credit card defaults.

For example, BofA, Citi and American Express have issued, and bought, new bonds that would absorb the first wave of losses in the trusts, in an effort to provide existing bondholders with an additional layer of protection.

Got that - more leverage in an overly leveraged system. But hey, "Stress Tests" said the financial conglomerates were OK. Who are we to question their "zombie" status? After all the financial conglomerates are using innovated means to combat this problem such as the use of "discount option".

This allows issuers to divert some of cardholders' incoming principal payments into the fund that pays out bondholders and covers losses.

This temporarily eats into lending capacity but creates the appearance of higher yields for the trust and helps it avoid hitting triggers that would force it to repay bondholders early.

While most credit card securitisations are still well above such triggers, banks have a strong incentive to provide support before accelerating credit card losses put the trusts in the danger zone.

The financial conglomerates are using this ploy to cover-up how bad the situation truly is. But the financial conglomerates have a bigger problem in the form of an accounting rule change. Financial Accounting Standard will in January require banks to move off-balance sheet vehicles such as these credit card trusts and move them on to their balance sheets. This will force them to increase their capital reserves.

It is a shame we have to wait until January 2010 to shed light on this "Shadow Banking" system and just think it is not the Obama Administration or the Fed that (actually they hate the idea) is improving financial reporting transparency - it is accountants.

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Can you dig out the details

of the specifics? This one needs a slide presentation, graphs on how it operates. How confusing! But "hiding the scam" is always confusing.

This is the first I've read about this too, so exposing more of the details would be dynamite!

What light?

Sorry, but do you really think that the zombie banks will be forced to reveal the depths of their off-balance sheet problems? Remember mark-to-market accounting rules? Gone. We now have mark-to-fantasy. Wall Street banks have already started their efforts to shut down the rule requiring them to bring SIVs and the like onto their balance sheets. Their target is the same FASB that knuckled under on the M2M rules. Since it's a biological impossibility in the human species (and probably all vertebrates) to regenerate an entire new spine once it's been removed, I expect a similar outcome. Off-balance sheet vehicles will stay off the balance sheets until the weight of all that garbage forces an Enron-like collapse.

The Financial Dark Ages

I had an image where we had a genocide, a witch hunt, the Spanish inquisition, regarding any accuracy on the true state of these conglomerates financial health.

Good question through, with trillions in financial commitments, taxpayer funds, is it still possible that the Zombies will not have their fill and actually we will have a later Enron implosion anyway?

Off balance-sheet liabilities

I had a dream last night that these packaged "assets" were just another large -- huge, that is -- bubble. Too big to imagine, let alone fail. They grew and grew, but were mostly invisible to regulators and politicians. Then some people with pitchforks came along. They threw their credit cards into a huge bonfire and added their credit card bills to the enormous blaze. They had decided to stop living on credit and go to cash. If it cost too much, they wouldn't buy it. If a bill collector called, they changed their phone numbers or used caller ID and answering machines to duck them. Then the pitchforks began to pierce the bubble. The result was that the off-balance-sheet liabilities were no longer invisible -- the banks began asking for more money from TARP, son of TARP, and the Fed. They said they could bring down the financial system. Then they themselves began to notice the pitchforks. But what the hell -- it was just a dream.