Loan Loss Reserves at U.S. Mega Banks Are Far from Safe Levels

Loan Loss Reserve to Total Loans for All U.S. Commercial Banks

“There is zero chance that the megabanks in the U.S. are properly reserved for what comes next.”

By Pam Martins and Russ Martins of Wall Street on Parade.

It’s time to revisit that scene from the movie, The Big Short, where Steve Carell, playing Mark Baum, is sitting in the audience at the American Securitization Forum and interrupts the speaker on stage who has just stated that he expects subprime losses “will be contained at 5 percent.” Baum loudly asks: “Would you say that it is a possibility or a probability that subprime losses stop at 5 percent?” The speaker says: “I would say that it is a very strong probability, indeed.” Baum sits down but then begins to waive his arm in the air, forming a zero with his fingers. Baum then shouts out: “Zero! Zero! There is a zero percent chance that your subprime losses will stop at 5 percent.”

You can view the scene from the movie below.

That scene came to mind when we graphed the loan loss reserves at U.S. banks through the second quarter of this year, using data from the St. Louis Fed. (See above chart.)

Consider us on record as waving our arm in the air and shouting that there is zero, ZERO! chance that the megabanks in the U.S. are properly reserved for what comes next.

The reason that these publicly-traded mega banks, with CEOs making in the range of $25 million to $30 million a year, don’t want to properly reserve for potential losses is that it crimps quarterly earnings, which might crimp their stock awards, which might crimp their pursuit of becoming a billionaire like Sandy Weill did at Citigroup – not long before the bank began secretly receiving the largest bailout in history from the Federal Reserve Bank of New York, topping out at more than $2.5 trillion in cumulative loans according to a government audit released in 2011. Good quarterly earnings also provide a prop under the share price so that the guys in the corner offices can cash out their stock option grants at a fat profit.

These same mega banks are also the most politically-connected. Quietly, they managed to get relief from reserving for losses on financial instruments stuffed into the CARES Act stimulus bill passed by Congress in the spring. The language in the bill relieves the banks from a new accounting measure that would have forced these banks to begin anticipating losses and reserving for them. The measure is called Current Expected Credit Losses or CECL (pronounced Cecil). We had watched numerous Senate hearings prior to the passage of the CARES Act where Republicans argued for relief for the banks from Cecil. They cleverly managed to get it stuffed into the desperately needed CARES Act…

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