The news hit Friday that the Federal Reserve is allowing big banks to pay sharply higher dividends. I don't understand how the Fed justified that decision. And not just because the results of the so-called "stress tests" are secret.
At least our four biggest banks are insolvent, Adam Levitin explains at the blog Credit Slips. The banks' balance sheets only come out in positive territory if home equity loans made during the bubble years are valued at much closer to their face value than good accounting or even common sense would dictate. First mortgages are apparently similarly overvalued. This isn't some fantasy of Levitin's, by the way: Paul Krugman and many other experts have described our banks -- big and small -- as "zombies" with fictional balance sheets.
And it's not as if those balance sheets are free from other stresses. One big near-term danger is banks' potential liability for the mortgage and foreclosure mess. Settling that tab with regulators and law enforcement agencies supposedly will cost the financial industry $20 billion to $30 billion -- though who knows if there will be a settlement at all. Those numbers are big enough that Republican lawmakers worry that a settlement would render big banks insolvent. (As if they weren't already.)
In the medium term, banks also face a serious risk from the growing mass of lawsuits over mortgage-backed securities: There are several scenarios under which those suits and the buybacks the banks may be forced into could threaten their balance sheets.
So why are the banks being allowed to give away cash to their shareholders that would be better applied to shoring up those shaky, fictional balance sheets? Yes, bigger dividends means the big executives, who are also big shareholders, get to pay themselves even more "compensation," but I'm not cynical enough to imagine that's what motivated the Fed to give the OK. So what gives?
It's one thing to lack the political will to "nationalize" the banks temporarily, wiping out shareholders, but cleaning up the banks' balance sheets for real. It's another thing entirely to let zombie banks pay big dividends. Regardless of what it would have the rest of us believe, surely the Fed knows better than to think these financial emperors are wearing clothes.
Introduction to Value Investing
Are you the next Warren Buffett?View Course »