Bank of America — still struggling to iron out the portfolio of bad loans it acquired by buying the giant mortgage lender Countrywide Financial in 2008 — is an extreme case, but it is not alone. Just three years after the financial crisis drove some of the biggest names in finance to the brink of collapse, the combination of European disarray, the downgrading of U.S. debt and a stagnating global economy have rekindled fears about the banking sector’s stability.
Thursday, those fears gripped investors again, driving U.S. stock markets down as much as 5 percent and pummeling banking shares even worse. Shares of British-based Barclays closed down more than 11 percent; Credit Suisse dropped 9 percent; UBS fell more than 8 percent; and Citigroup and HSBC were down more than 6 percent.
One factor: word that the Federal Reserve Bank of New York has stepped up its scrutiny of European banks, seeking information about their ability to fund themselves. Banking sources said French giant Societe Generale, one of the biggest lenders to Greece, has been unable to obtain overnight funding from private firms and has been relying on the European Central Bank for support.
This time, however, battered bank shares are not a sign that bailouts from U.S. taxpayers are on the horizon.
By almost any measure, banks are on far better financial footing than they were in the bailout days of 2008. They have fewer bad investments on their books. They have more cash on hand to deal with troubles, seen and unforeseen. They are receiving essentially free loans from the Federal Reserve — because of the near-zero interest rates set by Fed policymakers — and are turning profits in some business areas.
“We all took our leverage down” since 2008, said a senior New York banker dealing with commercial real estate who did not have the bank’s authorization to speak publicly. “It’s different now.”
But that is cold comfort to shareholders, banking experts say. Wall Street banks still have plenty of problems that continue to weigh down their bottom lines, some of their own making and some — such as the banking crisis in Europe and the growing hesitancy among U.S. borrowers — that remain largely out of their control.
Shareholders, rather than taxpayers, are likely to shoulder whatever burden arises as banks atone for the bad decisions they made before the crisis and struggle with the sluggish economy.
“Their shareholders need to be concerned because they will need to bear these losses, but there is no solvency crisis,” said Darrell Duffie, a professor of finance at Stanford University’s business school. “I don’t think there would be any need for emergency bailouts.”
Much of the improvement in bank balance sheets is thanks to the Fed. By keeping interest rates at zero percent, the Fed has enabled banks to borrow cheaply and lend at higher rates.
“That has made it easier for banks to get back on their feet,” said Duffie, adding that banks should “have a hard time losing money on any prudent loans right now.” Now that the Fed has promised to keep rates at or near zero until 2013, Duffie said, banks “will be able to continue coasting for a couple of years.”
Of course, Fed officials do not want banks to coast; they want them to push money into the economy and stimulate growth. But no matter how low interest rates are, consumers might be too worried to borrow and spend.
“Investors and consumers have just been through a terrible financial crisis,” Duffie said. “They read about debt crises here and in Europe and say, ‘I think I’ll just sit on my money.’ ”
The New York banker who deals with commercial real estate said, “Every guy in the process of doing a transaction, unless the money was hard, is rethinking.”
That’s made it harder for banks to build sound new business while they struggle to resolve the problems plaguing their earlier business.
For starters, the ongoing housing crisis has continued to be a drag on many banks’ balance sheets. Facing underperforming loans, investigations into foreclosure practices and multibillion-dollar lawsuits over mortgage-backed securities, big banks continue to set aside billions to cover possible losses.
Some U.S. banks have also been stung by their exposure to the debt troubles brewing in Europe.
At the same time, new regulations arising from the Dodd-Frank law overhauling financial oversight are beginning to crimp some sources of bank profits. For instance, new rules limiting the fees that banks can charge merchants for purchases made with debit cards are set to take effect this fall, and many other rules have yet to be written.
Regulators have pressed banks to keep plenty of cash on hand and steer clear of the risky loans that contributed to the crisis, even as policymakers have continued urging banks to lend more to spur economic growth.
No bank illustrates the recent volatility and uncertainty about future earnings more than Bank of America, the largest bank in the country by assets.
Last month, the bank reported a quarterly loss of $8.8 billion, and the firm has faced persistent questions about its ability to manage its hefty portfolio of bad loans, particularly those attached to its purchase of Countrywide.
“There aren’t many days that I get up and think positively about the Countrywide transaction,” Moynihan said in a recent conference call.
In addition, Bank of America has been bombarded by lawsuits from investors who poured money into mortgage-backed securities that turned out to be worthless. Last week, insurance giant American International Group filed a $10 billion lawsuit over such losses. In June, Bank of America agreed to pay $8.5 billion to investors on similar claims, and even that settlement has been challenged as insufficient.
A case in New York State Supreme Court could add another $9 billion to the bank’s running tab if the judge sides with insurer MBIA, which is demanding that Bank of America buy back bad loans even if the bank’s underwriting errors were not the cause of defaults.
More mortgage losses and litigation seem certain. The bank is trying to negotiate a settlement with state and federal officials over shoddy foreclosure practices and is facing an investigation by the New York attorney general into the process it used to convert loans into financial securities.
For all the firm’s problems, Nancy Bush, an analyst with NAB Research in New Jersey, and other observers agree that Bank of America will weather its mortgage problems. Moynihan said it has built reserves for mortgage issues “from a negligible amount . . . to over $18 billion,” not counting litigation reserves.
Rochdale Securities analyst Richard Bove said, “The bank’s balance sheet is just incredibly strong relative to any period in its history that I’m aware of,” noting that the bank had $139.8 billion in cash on hand at the end of June. He said that means that if every holder of short-term debt “came knocking on the door and wanted it back tomorrow, they could get it.”
In addition, the bank has made 29 divestitures since 2009, including mortgage and credit card portfolios and a life insurance subsidiary, which has helped shrink its balance sheet and put it on firmer footing.
Meanwhile, it’s not just the banking giants that are struggling to return to normality.
Camden Fine, president of the Independent Community Bankers of America, called the Fed’s move to keep rates low through 2013 a “backdoor bailout” to Wall Street at the expense of the thousands of small banks.
“Wall Street is getting free money,” he said, noting big banks’ ability to put those funds to use in ways not available to community banks. “You’d have to be an idiot not to make money.”
For small banks that rely on customer deposits and on the spreads they make from loans, Fine said, it makes it nearly impossible for them to get a decent return on investments.
“It’s basically counterproductive to any kind of economic recovery on Main Street,” he said.
This year, the Federal Deposit Insurance Corp. has overseen 64 bank failures, down from last year’s record rate but still far above average. As of March 31, the agency had 888 banks on its problem bank list, the highest figure in nearly 20 years.
Bush, of NAB, said the situation isn’t helpful to anyone. The Fed policy “smacks of desperation.” Shareholders are facing lackluster returns. Customers are receiving little interest on savings. Banks of all sizes are paralyzed by uncertainty, reluctant to lend and facing layoffs as they scale back operations.
Until that changes and confidence courses through the banking system again, she said, any meaningful recovery remains unlikely.
“Our economy will not be healthy until the banks are healthy,” Bush said. “Banks take us into recession, and they take us out.”