It's getting to be a tough season for banks, and not just the ones we normally associate with crummy home loans -- you know, IndyMac Bancorp (NYSE: IMB), Countrywide (NYSE: CFC), or Impac Mortgage Holdings (NYSE: IMH). Today, it's State Street's (NYSE: STT) turn to get beaten by the housing stick.
How, you ask, does an asset manager get pummeled for the sins of the easy-money crowds? Because of all those fancy financial derivatives that Wall Street invented to help peddle mortgages for all these years.
Recent weeks have shown us that hedge funds -- small shops as well as those run by players like Bear Stearns (NYSE: BSC) and Goldman Sachs (NYSE: GS) -- have been pounded by stupid, over-leveraged bets on deteriorating debt securities.
But this week, we're seeing more and more news of banks, especially European ones, getting pinched because their so-called "conduits" are squeezing off. "Conduits" are nothing more than off-balance-sheet entities that issue short-term debt and reinvest it in longer-term securities. Trouble is, many of these banks have been feeding themselves a potentially toxic soup of mortgage-backed securities -- you know, the ones that got AAA ratings because of Wall Street wizardry, rather than actual debt quality. (Here's a prescient Economist article on the subject from a couple of weeks back.)
As home sales have soured, buyers have become scarce, and the securities have become poisonous. According to The Times, State Street has conduit exposure that adds up to 17% of assets, making it the most highly exposed of all its U.S. and European peers. And this is no small problem, especially in Germany. IKB Deutsche Industriebank AG needed a cash infusion to avoid trouble, and state-owned SachsenLB went through a forced sale because of its trouble with mortgage-backed securities in its conduits. (The Wall Street Journal describes it all here.)
This, of course, is what happens when you play "hide the risk" for so many years. As long as housing went up, there were no major problems, and people assumed that the risk really didn't exist. But now that non-performing loans and foreclosures are killing scads of mortgage-backed derivatives, risk is popping up all over, and in some cases, governments (and therefore taxpayers) are going to foot the bill.
How much toxic waste is in your bank's conduits? I'd love to be able to say that only a diligent read of the filings will let you know for sure. But even that might not do it. This stuff wasn't shoved off the balance sheet to make it visible to punk investors like us.
Be careful out there.
At the time of publication, Seth Jayson, a top-10 CAPS player, had no positions in any company mentioned here. See his latest CAPS blog commentary here. View his stock holdings and Fool profile here. Fool rules are here.
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