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One Year Later: The Big Risk We're Still Facing

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September 2008 was an extraordinary month, even by the standards of an extraordinary crisis. We witnessed the failure of Lehman Brothers, the rescues of AIG (NYSE: AIG  ) , Fannie Mae (NYSE: FNM  ) , and Freddie Mac, and the conversion of the remaining bulge bracket investment banks into bank holding companies. As we mark the one-year anniversary of one of the most tumultuous months in the history of modern finance, it's worth pausing to ask: One year on, what has changed, and what hasn't?

Banks are better capitalized
As the following table shows, the largest banks have significantly improved their capital ratios (or reduced their leverage, if you prefer). Those firms that were thought to be at greatest risk, including Citigroup (NYSE: C  ) and Bank of America (NYSE: BAC  ) , have appropriately made the greatest strides:


Tier 1 Capital Ratio (End of Q2 2009)

Tier 1 Capital Ratio (End of Q2 2008)

Goldman Sachs (NYSE: GS  )






Bank of America



Wells Fargo (NYSE: WFC  )



JPMorgan Chase (NYSE: JPM  )



Source: Capital IQ, a division of Standard & Poor's.

... But they remain "too big to fail"
Witnessing the financial and economic repercussions of the failure of Lehman Brothers last September has only reinforced the notion that the largest, most interconnected institutions are "too big to fail" -- it's unlikely the government would allow the system to endure that sort of stress again.

Furthermore, with the disappearance of Lehman, Bear Stearns, Washington Mutual, and Wachovia, the banking and securities industries have become more concentrated at the top than they were prior to the crisis. In that respect, the risks associated with a major bank failure have actually increased.

Banks that are "too big to fail" benefit from an implicit taxpayer subsidy since their funding costs do not adequately reflect the risk of failure. That subsidy, in turn, creates an economic incentive for banks to grow large enough to achieve "too big to fail" status. We urgently need to abrogate that subsidy and put an end to that vicious cycle.

Preparing for death
As such, the creation of so-called "living wills" for these organizations is one of the most pressing items of reform for the financial sector. A living will would spell out a systematic regime under which a failing institution could be wound down; the existence and application of such contingency procedures would avoid creating a shockwave that would reverberate throughout the rest of the financial system.

Shareholders can also play a positive role: It wouldn't be absurd for the owners of some of these banks to ask management whether these institutions have simply become too big to manage on a day-to-day basis, let alone too big to fail. In some cases, a breakup or, at the very least, a tight rationalization of activities may be just what the activist investor ordered.

Fannie Mae, Freddie Mac stabilized ... for now
Speaking of "too-big-to-fail," the real poster children for that problem are mortgage giants Fannie Mae (NYSE: FNM  ) and Freddie Mac. Formally known as "government-sponsored entities" (GSEs), these miscreants proved that sponsorship doesn't come cheap in a crisis -- to the tune of up to $400 billion in direct aid pledged by the government (without even mentioning the $5.2 trillion in mortgage securities the two GSEs own or guarantee).

Fannie and Freddie were and continue to be two hybrid monstrosities with private shareholders and a political mandate ("Increase home ownership whatever the cost, and keep the political contributions coming!"). At least now, the companies openly state that they are not being run with the goal of maximizing shareholder returns.

Despite the government's intervention, Fannie and Freddie's ultimate fates remain unknown. While the Obama administration has mentioned several different options, it doesn't expect to disclose its plans until the beginning of next year. I fear the worst: Given the special interests involved and the complexity of the project, a "muddle through after fixing it with Scotch tape and rubber bands" solution looks a lot more likely than the bold solution that is required.

Firefighting vs. fire prevention
The government took some necessary steps to stabilize the financial system last September. However, that was firefighting, not fire prevention. Much remains to be done if we are to reduce the risk and severity of future crises (I'm not naive enough to believe that we can actually prevent crises altogether, since they are consonant with human nature). Ensuring that no institution is too big to fail should be one of our first priorities.

Wells Fargo, JPMorgan Chase, and Goldman Sachs are high quality companies. Morgan Housel has identified three other high-quality companies that are still cheap.

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Alex Dumortier, CFA, has a beneficial interest in Wells Fargo, but not in any of the other companies mentioned in this article. Try any of our Foolish newsletters today, free for 30 days. Motley Fool has a disclosure policy.

Read/Post Comments (19) | Recommend This Article (21)

Comments from our Foolish Readers

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  • Report this Comment On September 09, 2009, at 4:07 PM, plange01 wrote:

    risks ? the US is 9 months into a depression with 20% of the workforce already unemployed.the real risk is the country moving toward a major collapse not a few banks closing.the US is in far worse shape now than this time last cant go by the idiot stock market wall street is as clueless as obama!

  • Report this Comment On September 09, 2009, at 5:54 PM, brow0905 wrote:

    Plange01 - wow you're clearly the brightest bulb on the tree. The stock market is the leading indicator of the state of the economy. It leads the charge out of a recession or depression every time.

    Why? Well incase you didn't attend college or an Econ 101 class as equity's grow and companies prosper so do their shareholders. Since most everyone has a 401k now a days or if not at least an IRA or an Ameritrade Account that means that we the people begin to see our "net worth" return. As we see that consumer confidence grows. As that grows the profits of the companies listed on the "idiot stock market" will also grow. It is the confluence of all of these things over a period of months or years that has lead all capatilist societies out of the recessions they were in.

    The unemployment rate in this country is far lower than 20%. Those that are unemployed and no longer employable will learn new skills and trades and find other work. Or they will move from manufacturing towns like Detroit to hotter tech thriving cities like Dallas.

    Must I go on...

    People like you can blame Obama for all your problems and the "idiot stock market." The reality is we're heading towards prosperity again and it's because of a guy like Barrack and his economic team that we're getting out of this mess.

    But I'm sure since you didn't use any facts in your post none of the truths or facts I used to tear apart your argument will hold any water hmmm?

  • Report this Comment On September 09, 2009, at 6:09 PM, jason2713 wrote:

    @brow0905 -

    You've got to be kidding me.

    "The stock market is the leading indicator of the state of the economy"????

    We will have to agree to disagree, but when our gov't tries to stop "corrections" by creating bubble, after bubble, after bubble...the stock market is not a leading indicator. Maybe in the true sense, you're correct, but there are several variables that I think your missing, and the largest one is in Washington D.C.

    Obama has forged us down a path we can no longer turn back from. Once you charge your credit card as a gov't, and spend it in your country, there's no buyers going back. China and other countries will want their interest payments and they will want them now. Did you miss this piece of the puzzle also? Or is it one of those, "We'll cross that bridge when we get there" kind of things? This is the exact mentality that got us in this mess in the first place.

    "Those that are unemployed and no longer employable will learn new skills and trades and find other work. Or they will move from manufacturing towns like Detroit to hotter tech thriving cities like Dallas." Can you please show me where jobs are growing and I may agree with you? So far we are still CONTRACTING as a nation, don't buy into all the political cheerleaders.

  • Report this Comment On September 09, 2009, at 6:12 PM, TMFAleph1 wrote:


    Unfortunately, the stock market's current valuation does not accurately reflect present economic prospects. Frothy equity prices suggest that a robust, sustained recovery is imminent -- a scenario that is pretty unlikely.

    Alex Dumortier

  • Report this Comment On September 09, 2009, at 6:32 PM, brow0905 wrote:

    @ jason2713

    I will agree to disagree on several of your points. In the interest of defending myself let me guide you through my logic:

    - First you were correct when you stated Washington D.C. as a variable. Let us agree that gov't spending has been out of control for some time. But the second you state "Obama has forged us down a path..." you discount all the ridiculous sums of money the previous administration spent. Like Barrack flew into Washington and magically created a giant defecit.

    - Second the reason I give him credit for helping dig us out is beside the market being up, mortgage applications are up, housing has bottomed in several markets and unmeployment has seemed to bottom as well. Obama has spent money, some say irresponsibly. But look at the FHA and it's regulations. Look at the cash for clunkers program. The tax payer money that was given for new cars purchased help STIMULATE the economy. Over 750,000 cars were sold through that program which helped shareholders of auto companies, manufacturers, owners of junk yards, etc. That's money well spent in my book. You can disagree, that's your right.

    - Finally you stated "China will want it's interest payments now." Any facts or data to back up that statement? Please point them my way. The reality is China is an export based economy. They are a power house and they scare the hell out of me too, don't get me wrong, they hold way too much of our debt. That said while they're heading in the right direction they still rely far too heavily on keeping their labor low and their costs low because a giant segment of their economy is fueled by exporting manufactured goods and services to the US and other counties. Until that changes they aren't calling in their debt. When it happens it will be painful, I completely agree and by no way am I trying to minimize that. But it's not like Obama created that problem. Trust me when I say this, China held a ton of our debt before January of 2009 my friend...

  • Report this Comment On September 09, 2009, at 9:19 PM, xetn wrote:


    So you think that "Cash for Clunkers" was a roaring success? Just how will a temporary incentive correct the jobs market? As for you econ 101 class, I think you slept through it.

    Consumption does not an economy make. Try consuming something before it is produced. Can't do it.

    Production is what drives an economy; production is what "creates" jobs and what drives production? Savings and investment! Where are they? If you think that maybe the FED creating money out of thin air is equivalent to saving and investment, think again. Just look at the dot. com and housing bubble. All of that unsustainable FED stimulus led to massive losses.

    How do you suppose that unemployment has bottomed? The fact that it is less than projected? No, unemployment is getting worse. And it is over 20% if you go back to the basic method of calculating it; before previous administrations decided to eliminate those that have run out of benefits or have given up looking. Just check out these charts and try to see a glimmer of a recovery:

    Then ask yourself what is going to happen when the dollar finally crashes and we have price inflation like Zimbabwe.

    As for China, they are already moving out of the dollar and buying Yen and Euro based instruments and gold. And the reason is they fear the loss of purchasing power of the over-inflated dollar.

  • Report this Comment On September 09, 2009, at 9:47 PM, jason2713 wrote:


    -Obama has taken us down this path. No other president in history has put us so far in debt so quickly. Not Washington through Bush **COMBINED** But I'm sure you've heard that stat before (at least I hope), but if not, its true. We are locked in to the policies he has put in place, and I don't think anything has gotten any better. Eventually the stimulus will run out, the gov't won't be able to hold their hand out to China for more. So then what?

    - Cash for clunkers was like a 6 pack of redbull given to the economy. Once it's all gone, and you're basically on speed, the crash after that will be worse. All the demand that was eventually going to come any ways is gone, and I believe time will tell that the tax payers are on the hook for 3 billion dollars given out to people who now have larger car payments that they probably wont be able to sustain once their jobs are cut. I've read many have "buyers remorse" since now they are in larger amounts debt (wow, what got us in this mess in the first place). Not only that, but the sales of automobiles will plummet this month compared to last. Does that sound like economic stimulus?

    - Unemployment is not bottoming. If you're thinking July's numbers looked great, and unemployment actually lowered to 9.4%....SIKE! The gov't came out with their "revised" numbers which actually INCREASED the unemployment numbers for those months. Housing has not hit a bottom. 2011 we will see almost 50% of homes underwater according to a few analyst. Lets say that number is half at 25%, that's still bad. Furthermore, the treasury said today that there are MILLIONS of foreclosures coming. Why? Unemployment is hitting the pockets of those who actually have GOOD credit, and they can no longer afford their homes. That's a real problem.

    - China is not the power house they make themselves out to be. Please read my blog, their 8% growth they boast is fraud. They are hurting just like the rest of us, but they aren't in this MOUNTAIN of debt like we are, so they are much better off.

    My blog:

    China is already nervous about the dollar and will refuse to buy any more debt.

  • Report this Comment On September 10, 2009, at 1:52 AM, Ibeatmykids wrote:

    Obamas plan is to print as much money as it takes to pay off China. He will soon print a a few trillion dollar bills and this mess will be over. Sure these dollars won't be worth anything but we will be debt free.

    This is the only way I can make sense of this mess.

  • Report this Comment On September 10, 2009, at 2:01 AM, justputt2 wrote:


    You are a hired Democrat Troll.

    Go somewhere else.

  • Report this Comment On September 10, 2009, at 4:18 AM, tarig wrote:

    Bernanke was (and is) determined not to make the same mistakes that were made during the 1929-1933 he's going to make new ones.

    The US averted a complete financial collapse 12 months ago, and the action to save the major banking institutions was bold and necessary.

    Many of the programs put in place by the Obama administration were worthy in their own right, although they have two flaws (a) they were not, by and large, designed to maximize the stimulus effect, but rather were democrat's pet projects that might have had some stimulative effect but not all that much "bang for the buck" and (b) more seriously, taken together, the $9 trillion - and growing - deficit will have a long-term detrimental effect on the value of the US dollar.

    The other major negative consequence is that we, as a nation, will be paying for the bailouts in higher taxes for decades to come, no matter who is in charge. The policy decision was made not to take our medicine now, but to spread the pain over the longest possible time period (preferably to future generations).

  • Report this Comment On September 10, 2009, at 10:29 AM, plange01 wrote:

    with the busy summer travel season for what it was now over airline and car rental stocks look to be some of the best shorts around....

  • Report this Comment On September 10, 2009, at 10:45 AM, sglubis2 wrote:

    I'm not sure how anybody could classify "cash for clunkers" as a success. Let me analyze the results of that Obama debacle:

    1) Most of the cars purchased under this program were foreign-made. Maybe some of them were assembled in America but the head office with all of its engineering, marketing, testing, finance,and all the other infrastructure is offshore. I'm sure they're grateful for the Obama dollars in Korea.

    2) The turned-in vehicles were scrapped despite many of them being perfectly driveable.

    3) The American public absorbed even more consumer debt in a time of economic turmoil.

    4) Nobody has calculated the true environmental cost of destroying perfectly driveable cars to save gas. The premature destruction of a product carries an environmental pricetag. The CARS program is really no different than destroying your house because a new, better one is available. The old vehicles cannot even be used for parts.

    5) The whole program was paid for with money borrowed from China that will be paid back by future generations (I hope).

    6) It delays the necessary "creative destruction" that is the lifeblood of a capitalistic society.

    The American people are being led by fools that were voted in by fools. The best that we can hope for is financial stasis that curtails the socialist plans of this benevolent dictator.

  • Report this Comment On September 11, 2009, at 5:10 PM, JoeBtsflk wrote:

    Some comments have discussed the unemployment rate as if it would predict the future course of the recession. Unemployment is painful and emotional. It is a dramatic yardstick for the impact of a recession. However, it is not a leading indicator, it is a trailing indicator. Never base an economic prediction on a trailing indicator.

  • Report this Comment On September 11, 2009, at 6:00 PM, JoeBtsflk wrote:

    Obama has already put us more in debt than all other presidents combined?? FY2009 will probably stand forever as the biggest deficit in history. FY2009 was the final Bush budget, starting in October 2009. Bush approved the budget, then added the $700 billion emergency spending, while the Fed announced another $800 billion to ease lending, all before Obama took office. Bush has put us more in debt than all other presidents combined.

  • Report this Comment On September 11, 2009, at 6:01 PM, JoeBtsflk wrote:

    (I meant FY 2009 started in October 2008.)

  • Report this Comment On September 11, 2009, at 11:25 PM, Djohans wrote:

    Just want to make a little comment on "Cash for Clunkers" program.

    From outside point of view, it is a good idea to get the country economy going. However, the US government is not helping own country brands. Instead, this program benefits foreign brands, such as Honda, Toyota & Hyundai, which is really a shame since the money is flowing out of the country at the end of the day.

  • Report this Comment On September 13, 2009, at 2:08 AM, wrkdiver wrote:

    "Cash for Clunkers" a SUCCESS? What about all the doors, seats, hoods, windshields from those vehicles which could have been reused? Exactly WHICH of those parts added to the poor fuel mileage? They could have been resold at a profit for the wrecking yards and helped folks like me who decide not to take on a new load of debt, but keep using my old one a while longer.

    Hey JoeBtsflk! Read your own numbers!

    "Bush... added $700 Billion...Fed announced another $800 Billion... Didn't you notice? Obamaramalama is dealing in TRILLIONS!! Those, I hear, are a Thousand Billion EACH!!

    And they already announced that we Social Security recipients won't be receiving a cost of living increase next year! I guess when Obamacare gets paid for out of savings on Medicare, we'll get so depressed by THOSE cuts we'll be happy ro have the interview with the nice Doctor who'll offer us lots of nice painkillers instead of a pacemaker or hip replacement!

  • Report this Comment On September 13, 2009, at 11:45 PM, Econo1 wrote:

    Bush's deficits added a net $5 trillion to the national debt. Check the U.S. Commerce Dept. Web site to confirm. Judge Obama after 4 or 8 years.

  • Report this Comment On September 14, 2009, at 11:01 AM, stonebusted wrote:

    We are in a situation where the rich and the elite run our country and econamy. They have to get the regulars pacified to avoid revolution which might not be the worst thing.

    Realisticly all the average guy can do is try to guess where the crooks are going and bet accordingly.

    May God bless us.

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