It seems almost quaint by comparison, how last October UBS took a $3.7 billion write-down on the value of its mortgage-related securities — an admittance that its assets were worth far less than it had thought. By December the Swiss bank was writing off another $10 billion and selling a 10% stake of itself to investors in Singapore and the Middle East in order to raise much-needed capital. Then on Tuesday, UBS outdid itself once again, taking a $19 billion hit to its balance sheet, and showing chairman Marcel Ospel the door.
UBS, of course, is hardly alone. It may be the current banking leader of the write-down scorecard, but the implosion of the U.S. subprime mortgage market and general deflating of home prices has hit Wall Street all around. Merrill Lynch, which ousted CEO Stan O'Neal in October, has written down some $25 billion worth of assets. Citigroup, which booted CEO Chuck Prince in November, is approaching $24 billion. On April 1, the same day as UBS, Deutsche Bank declared another $4 billion write-down. Across the board, banks are out some $200 billion since the beginning of 2007.
And despite the stock market's most fervent hopes, there are few signs that the write-downs are anywhere near finished. In a March 25 research note, Oppenheimer analyst Meredith Whitney predicted an additional $13 billion for Citigroup in the first quarter, $4 billion for Bank of America, nearly $3 billion for JP Morgan, and $1.5 billion for Wachovia. An April 1 report from Morgan Stanley and the consultancy Oliver Wyman estimated that investment banks alone have $60 to $100 billion more to go in 2008.
All of which raises the question: why is this taking so long and when will it stop?
At the heart of the issue is the unendingly discussed fact that house prices continue to fall after their long and unsustainable run-up. In January, home prices in 20 U.S. metropolitan markets fell for the 13th consecutive month, according to the S&P/Case-Shiller home-price index. And as much as the federal government may try to help pressure or legislate mortgage lenders into rewriting the terms of home loans that have gone bad, that sort of action will likely help individual homeowners exponentially more than the financial system as a whole.
Part of that is because the value of mortgage-backed assets has largely decoupled from the value of mortgages themselves. As credit markets around the world have seized up — in all sorts of lending, not just home loans — investor perceptions have taken an outsized role in valuing these sorts of securities. "It's less important if people are paying their mortgages back, and more important if the market thinks they'll pay them back in the future," says Nick Studer, who runs the corporate and institutional banking practice at Oliver Wyman and co-authored the study with Huw van Steenis of Morgan Stanley. The more people worry, the less they're willing to pay for assets, and the less they're worth in the market — which is what counts in accounting. Eventually, Studer says, we'll start seeing write-ups, as securities valuations more realistically align with their underlying worth.
But don't hold your breath. Charles Morris, a lawyer, former banker, and author of the impeccably-timed The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash, says even once banks work through revaluing their subprime loan assets, there will be plenty of other mark-downs to be had. Financial outfits have moved on to marking down securities backed by slightly-better-than-subprime Alt-A and jumbo home loans, but beyond that are still securities tied to commercial mortgages, take-over debt, credit cards and auto loans. Deflating home prices don't come into play there, but the general paralysis of credit markets worldwide, not to mention the specter of recession, does. "It's like Chinese water torture," says Morris. "Drip, drip, drip."
Why not just get it over and done with all at once? If banks tried to do that they would, as Morris says, "not have any equity capital left." And so we are left with what we have seen since October: a wave of write-downs, encouraging the notion that the worst may be behind us, and then another wave. Beyond the balance sheet, that means months, and even years, of profits that banks booked are being erased.
In between bouts of write-downs, banks do what they can to shore up their funding, like procuring cash infusions from sovereign wealth funds abroad and other investors. On March 31, Lehman Brothers raised $4 billion by selling new convertible preferred shares of stock; UBS made a similar move to the tune of $15 billion. Then there is the Federal Reserve, which has started lending directly to investment banks (which have very happily borrowed) in order to instill confidence in the system. And if the federal government will take mortgage-backed paper as collateral, how bad could it be, really?
The answer, it seems, is worse.