How a bank has performed in past financial crises indicates how the same bank will perform in future crises. While this is just a theory, it's corroborated by the history of Bank of America (BAC 3.35%). As I discuss below, the 111-year-old bank has come within a hair's breadth of failure in every banking crisis since the Panic of 1907.
Bank of America and the Great Depression
Aside from an agricultural downturn that ravaged banks throughout the 1920s, the next major crisis after the Panic of 1907 was the Great Depression. More than 6,000 banks failed between 1930 and 1933, after which the pace of closures slowed to a nearly imperceptible drizzle. But while Bank of America sidestepped this fate, it only barely survived.
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In the early 1930s, regulators concluded that Bank of America was in "appalling shape." That it was "hopelessly insolvent" and "could not possibly stand up on its own," says Gary Hector in Breaking the Bank: The Decline of BankAmerica. The official book value of its holding company was $49.82 per share in 1930. Yet, the bank's own chairman estimated its value at a mere $14.50 a share.
By 1933, Bank of America was within hours of being declared "unsound" and thus subject to subsequent failure or seizure. The governor of the Federal Reserve Bank of San Francisco believed Bank of America was "on the edge of bankruptcy." Had it not been for a middle-of-the-night appeal directly to the U.S. Treasury Secretary by a well-connected political operative, regulators wouldn't have allowed it to reopen after the week-long bank holiday in March of that year.
The significance of this can't be overstated. As Franklin Delano Roosevelt explained in his first fireside chat, only "sound" banks would be allowed to reopen; the rest would be closed or reorganized (emphasis added):
I do not promise you that every bank will be reopened or that individual losses will not be suffered, but there will be no losses that possibly could be avoided; and there would have been more and greater losses had we continued to drift. I can even promise you salvation for some at least of the sorely pressed banks. We shall be engaged not merely in reopening sound banks but in the creation of more sound banks through reorganization.
Bank of America and the LDC crisis of the 1980s
The U.S. bank industry fell into a 40-year slumber after the Great Depression. While World War II fueled a brisk economic recovery across the United States, memories of the 1930s remained on risk managers' minds. When conflicts arose between revenue growth and risk management, the latter won the day.
This changed in the 1970s. Soaring oil prices from the oil embargos of 1973 and 1979 triggered rapid inflation, caused the Federal Reserve to raise short-term interest rates to nearly 20%, and resulted in the final breakdown of the international monetary system. To top things off, newly enriched oil-producers like Saudi Arabia started depositing billions upon billions of dollars into U.S. banks which then needed to be lent out, lest the banks report lower profitability.
The net result was a series of linked crises in the 1980s that culminated in the less-developed-country crisis. Throughout the period, banks recycled "petrodollars" from oil exporting countries to oil importing countries, principally throughout Central and South America. "Countries don't go broke," was the mantra proselytized by Citigroup's indomitable CEO Walter Wriston.
Despite Wriston's assurances, social agitation coupled with oppressive debt burdens pushed countries like Argentina and Mexico to begin defaulting on their bank loans in the mid-1980s. Virtually every large U.S. lender was hobbled, though few as critically as Bank of America. In 1985, it posted its first quarterly loss since the Great Depression. By the second quarter of 1986, its trailing 12 months' loss exceeded $1 billion. Only one other bank in history, Continental Illinois, had ever lost as much -- and it ended up as a ward of the FDIC.
According to Hector:
Loan write-offs [from 1981-1986] totaled $4.6 billion -- an amount then greater than the average annual income of the population of Sacramento, Louisville, or Tampa. At the end of June [1986], BankAmerica still had more than $5 billion of bad loans on its books, as well as $10 billion of shaky loans to governments and businesses in underdeveloped countries. Even worse, the company was shrinking, which meant that the bad loans were becoming an ever-larger part of the company's total assets.
In short, Bank of America had found itself once again on the precipice of failure. It was so weak and short of capital, says Moira Johnston in Roller Coaster: The Bank of America and the Future of American Banking, there were "rumors in the street that Bank of America was close to bankruptcy, that the Comptroller of the Currency and the Federal Deposit Insurance Corporation were preparing to swoop down and bail out or sell off 'capitalism's greatest prize.'" It did survive, of course, though its CEO was fired and the bank had to shed billions of dollars in assets to raise capital.
Bank of America and the financial crisis of 2008-09
Thirty years later, Bank of America confronted the prospect of failure yet again; this time during the financial crisis of 2008-09. A new generation of leaders was at the helm. And, as new leaders are apt to do, they threw caution to the wind. They embarked on a series of massive acquisitions, two in particular, that would eventually leave the bank at the mercy of the federal government for the third time in a century.
In 2005, Bank of America bought credit card giant MBNA. It did so to create, as then-CEO Ken Lewis said, "the country's top retailer of financial services with the size and scale to drive distribution and marketing efficiencies." However, as The Wall Street Journal explained, an ulterior motivation stemmed from its long-running competition with Wachovia:
[Lewis] learned that Wachovia was having serious discussions with [Bruce] Hammonds, MBNA's chief executive. Although MBNA had long been one of the most profitable card-issuers, the Wilmington, Del., company jolted investors this spring by reporting a 94% drop in first-quarter net income.
Lewis moved quickly and agreed to a higher premium than that under consideration by Wachovia, say people familiar with the situation. Lewis said yesterday that he had to quickly overcome worries about MBNA's relationships with banks that compete with Bank of America. "We liked it more and more and more as we got into the details," he said.
But Bank of America's affinity for MBNA soon waned as losses from the combined company' credit card division mounted. It wrote off $20 billion in bad credit card loans in 2008, $29.6 billion in 2009, and $23.1 billion in 2010, split between provisions for loan losses and a goodwill impairment charge to the book value of the credit card franchises. In these three years alone, Bank of America charged off $60 billion more than its normal $4-billion-a-year run-rate for bad credit card loans.
"In the boom we pushed cards through the branches and in mass mailings," CEO Brian Moynihan later said to Fortune's Shawn Tully. "To drive growth we gave cards to people who couldn't afford them."
In 2008, Bank of America compounded its problems by acquiring Countrywide Financial, the largest mortgage originator in America at the time. It was a blunder of unprecedented proportions. Countrywide had long-since abandoned any semblance of prudence and integrity when it came to underwriting and selling mortgages. Its property appraisers inflated home values. Its loan officers helped applicants fudge their income and assets. And its capital markets team misrepresented the quality of the resulting mortgages to institutional investors like Fannie Mae and Freddie Mac.
The net result for Bank of America has been years of costly litigation, substantial loan losses, and a bloated expense base. By my estimate, it has incurred $91.2 billion worth of legal fines and settlements since the beginning of 2008, most of which relate to mortgages. For example, in 2011, Bank of America paid $8.5 billion to compensate private investors for losses on Countrywide-issued mortgage-backed securities. In 2012, it paid $11.82 billion, split between monetary and nonmonetary relief, to settle allegations of abusive foreclosure practices. And over the last few years, it has settled claims by Fannie Mae and Freddie Mac for a combined $20 billion in relief.
To complicate things even further, from 2003 to 2007, Bank of America depleted its capital cushion by buying back $40 billion worth of common stock. It's average purchase price was $52 per share. Eighteen months later, the Federal Reserve ordered it to raise $33.9 billion in new capital to absorb losses and build capital. It did so by issuing 3.5 billion new shares at an average price of $13.47 per share. The grand total came out to $47.5 billion. Suffice it to say, the resulting dilution devastated shareholder value, which, to the present day, is off by 70% from its pre-crisis high.
Bank of America and the future
There's no point to arguing that Bank of America's checkered past necessarily means that its future will chart a similar course. Maybe this time the nation's second largest bank has finally learned its lesson. Maybe this time it genuinely grasps the importance of a consistently conservative credit culture. And as a result, maybe next time the economy goes to hell in a handbasket, things really will be different for Bank of America. I, for one, wouldn't bet on it. To co-opt one of our generation's most notable phrases: "Fool me once, shame on you. Fool me four times, shame on me."
