Surprise! Investors have little faith in numbers provided by banks

As bank earning season approaches, the NY Times ran an article documenting that investors have little faith in the numbers provided by banks.

This is a very big problem.

A loss of faith in the numbers provided by the banks is nothing less than a loss of faith in the ability to independently assess the risk of and value the banks.  Investors learned from the subprime mortgage securities that if you cannot independently assess the risk of and value a security not to buy the security.

Investors also learned from the financial crisis that began on August 9, 2007, that bank regulators should not be relied on for an accurate assessment of the risk of the banks (remember the comments about how the subprime problem is contained).

In short, given what investors have learned, the question is how much longer can the market function without faith in the bank balance sheet numbers and when will the global orderly sell-off in bank stocks become a more frantic activity?

There is only one way to solve this problem of a lack of faith in the numbers provided by a bank.  That is disclosure of each bank's current asset and liability-level data.  With this data, market participants can independently assess the risk of and value each bank.

The protesters who have gathered for weeks near Wall Street and the highly paid investors and analysts in the buildings that surround them don’t agree on much. 

But when it comes to the nation’s biggest banks, they have a lot more in common than you would think. Both are deeply frustrated with financial institutions in general and have little faith in the message coming from bank executives. 

... Senator Richard J. Durbin of Illinois, the No. 2 Senate Democrat, took the unusual step of denouncing Bank of America on the Senate floor [over its monthly charge for debit card use], urging customers to “vote with your feet, get the heck out of that bank.” 

Investors certainly have. Bank stocks are at lows not seen since the wake of the financial crisis, and shares of Bank of America, the nation’s biggest bank, are down more than 50 percent since the start of the year, while Citigroup is down more than 40 percent....

And in a kind of unusual convergence, protesters and bank analysts alike have had it with bank management....

“There is a huge skepticism, that goes way beyond normal healthy doubt, about how reliable their numbers and guidance are,” said Chris Kotowski, an analyst with Oppenheimer. “People who were bullish are frustrated and beaten down.” 

Michael Mayo, a longtime financial services analyst, ... argues there is so much pressure on loans, margins and revenue that even at these depressed levels, American bank stocks are too richly priced. And the political and financial uncertainty in Europe makes the sector even more risky. “Underweight bank stocks and put more of your money elsewhere,” he advises. 

Mr. Mayo is not alone...

Analysts expect that auto, credit card and corporate lending will have inched upward in the third quarter, and lower credit losses could mean the release of several billion dollars’ worth of past reserves that will be counted toward current profits. 

But these days, investors are ... increasingly focused on the consequences of prolonged unemployment of around 9 percent and an almost daily drumbeat of other grim economic data. 

What is more, worries are rising that the debt troubles in Europe could infect the balance sheets of American financial institutions. 

Even though the banks insist their exposures are not a cause for alarm, investors have so little faith in the numbers banks have provided that their first reaction is to sell shares first, and ask questions later. 

The credit default swap market provides one clue of how deep those fears run, as the cost of buying insurance against the default of billions of dollars’ worth of bank debt has surged since mid-July. 

Rates on credit default swaps for Morgan Stanley now stand at 420 basis points, while Bank of America’s rate was 379, and Goldman Sachs was at 351. That is equivalent to the cost of insuring junk bonds issued by companies whose credit rating is below investment grade. 

Among the major banks, only JPMorgan Chase and Wells Fargo fare better, with rates at just above 150 basis points.

Did Merkel, Sarkozy pledge to require banks to disclose their asset and liability-level data?

According to a Bloomberg article, Angela Merkel and Nicolas Sarkozy pledged that they will do

'everything necessary' to ensure that banks have enough capital.

By definition, the only way that market participants will know if banks have enough capital is if each bank discloses its asset and liability-level data.  With this data, market participants can do their own analysis and determine if the banks have enough capital.

As a result, the pledge to ensure that banks have enough capital is in fact a pledge to require banks to disclose their asset and liability-level data.

I look forward to working with the European policymakers, financial regulators and the Eurozone banks and turning this disclosure requirement into a data warehouse that is accessible for free by all market participants.

If the European policymakers, financial regulators and Eurozone banks are not enlisting my expertise in creating this data warehouse to support asset and liability-level disclosure, we can be assured they are not serious about recapitalizing the banks.  Most likely, they are relying on the already discredit financial regulators who managed to run a stress test that passed Dexia shortly before it needed to be nationalized.

Opaque structured finance products allow Wall Street to 'swizz' market participants according to George Osborne's private secretary

As defined in the Oxford Dictionary, a swizz is something that represents a mild swindle.

The Telegraph carried a must read article on a structured product being offered by Barclays to its retail clients.

Since before the financial crisis began on August 9, 2007, your humble blogger has been advocating for disclosure.  One area I have focused on is disclosure of all the useful, relevant information in an appropriate, timely manner so that market participants could value structured finance products.

The reason it is important that market participants can value a security is that it is only with the ability to value a security that the market participant knows if the price that Wall Street is offering for the security is too high, what it should be, or a bargain.

Without the ability to value a security, Wall Street is in a position to take advantage of market participants through their marketing (think brokers...).  This situation is what the UK's George Osborne's aide would call a "swizz" and wonders why financial regulators would allow it to occur.

Please note that the same thing occurs with structured finance products sold to sophisticated investors. Examples of this include CDOs, subprime mortgage backed securities and interest rate swaps (think Jefferson County Alabama).

In short, the idea of a swizz applies to every opaque product created by Wall Street.

The only way to end this swizz is for global policymakers and financial regulators to adopt and fully implement the FDR Framework.  Under this framework, no financial product can be sold where all the useful, relevant information is not available in an appropriate, timely manner so that market participants can independently assess the risk of and value the product.

Greg Hands, personal private secretary to George Osborne and a junior member of the Treasury, said he had been offered the structured bond from Barclays as he was a customer of their stockbroking division. He said the complicated nature of the product revealed that banks still had a long way to go to make their offers transparent and suitable for investors. 

High levels of household debt and investments in unsuitable and complicated products was seen as one of the reasons for the financial crisis. 

Mr Hands, who worked in derivatives for eight years before becoming an MP, said the bond was almost impossible to price. "I do sometimes wonder about some of our banks and others with the marketing of their financial products," he said at a fringe meeting at the Conservative Party conference last week. 

No need to wonder Mr. Hands.  Yves Smith would tell you that the reason this product is being marketed is because no one on Wall Street is highly compensated for developing low margin, transparent products.

"I am a client of Barclays stockbrokers and I am amazed at some of the stuff they are putting out to purely retail individual investors, not high net worth clients." 

At the event organised by the Social Market Foundation Mr Hands then referred to the recent offer he had received from Barclays: "This is an exclusive offer until the 28 September," he said the offer document explained, before continuing: "It is a very complicated product that is a bond linked to the level of the FTSE. 

I used to price some of these products and it was not possible to price this product. I'm not saying Barclays is exceptional in this, I believe other banks are likely to be similar. But there are a very complicated set of options embedded in this product which are called in the world of derivatives an American style set of binary options where basically your capital is at risk if at any point during the next five or six years the FTSE falls below a certain level. 

"You could end up losing a considerable part of your capital which I don't think is particularly explicit in this product." 

There is no reason to believe that high net worth or sophisticated investors would be able to do a better job of pricing this product than an individual with experience like Mr. Hands.  The same lack of transparency into the true risk of the product would also be a barrier to their investment advisors in evaluating the product.

Mr Hands said that only at the bottom was there a suggestion that "structured products are not for everyone" or investors should "seek independent advice". He said many retail investors did not have access to suitable advice. "This is basically what you would call on the street a swizz....

Last night, a spokesman for Barclays said: "Barclays Stockbrokers provides a service through which clients can trade a wide range of securities. We make available from time to time structured products which enable sophisticated investors to express a view on the market. The literature complies with FSA guidelines and makes it clear investors' capital is at risk."

The problem currently is and has been since well before the beginning of the financial crisis that disclosure is inadequate.

European Banking Authority turns to disclosure to save latest stress tests: Part II

Regular readers will recall that the European Banking Authority turned to disclosure to try and save the latest stress tests.

As predicted by this blog under the FDR Framework, the disclosure is useful for market participants.  They are using the disclosure of sovereign exposures to estimate the amount of capital each bank will need under a plan to recapitalize the Eurozone banks.

As for the stress tests themselves.  They have been discredited by the collapse of Dexia, a bank that passed the test.

Europe discussing options for raising bank capital, forget that without disclosure there are no investors

According to a Reuter's article, European policymakers and their banks are talking about the options for raising capital.

The private market cannot be a major source of cash without disclosure of each bank's current asset and liability-level data.  The Irish banks and Spanish cajas showed how hard it is to raise capital from the private markets without this disclosure as potential investors could not assess the solvency of these institutions.

This means that the bulk of capital raised will have to come from governmental sources.

Regardless of where the capital comes from, without disclosure of each bank's current asset and liability-level data the lack of confidence in the banking system and solvency crisis will continue.

European banks may need more than 100 billion euros ($135 billion) to withstand the sovereign debt crisis, Ireland estimated on Saturday ahead of a meeting between German Chancellor Angela Merkel and French President Nicolas Sarkozy to work out how to recapitalize the lenders. 

The falling value of banks' holdings of government debt from Greece and other euro zone periphery states has already provoked the implosion of Belgian lender Dexia, adding urgency to the Merkel-Sarkozy talks. 

"There is a high risk that this crisis further escalates and broadens," German Finance Minister Wolfgang Schaeuble told German paper Frankfurter Allgemeine Sonntagszeitung in an interview released in advance of publication on Sunday. 

Germany and France have so far been split over how to strengthen shaky lenders and fight financial market contagion that may follow a possible Greek default. 

Paris is keen to tap the euro zone's 400 billion rescue fund, the EFSF, to recapitalize its own banks, while Berlin is insisting the fund should be used as a last resort. 

The International Monetary Fund (IMF) has said European banks need 200 billion euros in additional funds. 

Irish Finance Minister Michael Noonan said the capital needed to bolster banks' cushions was likely to come from a variety of sources but the total bill would be large. 

"I think there is general agreement that it will be significantly in excess of 100 billion (euros)," Noonan told reporters on the sidelines of an economic forum in Dublin. 

"I know that some of the big German banks that I was talking to personally intend raising money on the market so it will be private funding. Other banks would like to avail of the EFSF fund. Other banks will rely on their sovereign governments to provide the capital so there is going to be a range of ways of doing it," he said. 

Regulators worry that forcing a raft of major lenders to take state aid would not be the best use of Europe's limited capital resources, while banks fear than singling out only some lenders for extra support could heighten market worries about weaknesses at individual banks. 

German newspaper Frankfurter Allgemeine Zeitung on Saturday cited financial sources as saying France's five-biggest lenders would agree to take 10-15 billion euros in funding from the state but also wanted to see Germany's No. 1 lender Deutsche Bank plump its capital cushion. 

But a senior French banking source shot down the idea that French banks could be pushing for state aid, saying the Frankfurter Allgemeine Zeitung report was baseless. 

"I don't know what game the Germans are playing... This is wishful thinking," the source told Reuters, asking not to be named. 

Deutsche Bank Chief Executive Josef Ackermann is against any role for the state in his own bank's capital position and has ruled out a capital increase....

Banks' need to gird their capital bases is also leading some to merge, such as Spain's No. 5 retail bank Banco Popular, which launched an all-share bid for its smaller rival Banco Pastor on Friday.

Thank you Moody's: With downgrade of UK banks, banks warned not to rely on bailouts

According to a Telegraph article, banks have been warned that they will have to prove that they can pay their way in the future because they cannot count on a bailout.  This warning took the form of a downgrade from Moody's that was partially based on the idea that future bailouts might not be available.

How can banks prove they can pay their own way and not be reliant on future government bailouts?

Regular readers know the answer for banks is by disclosing their current asset and liability-level data.  With this on-going disclosure, market participants can assess the risk of the banks.  With these assessment comes the ability to impose market discipline on those banks with too much risk or that refuse to provide the same level of disclosure (not providing disclosure is equivalent to saying the bank has something to hide).

After 12 British banks had their credit ratings cut by Moodys, the Chancellor said yesterday: "As I understand it, one of the reasons they are doing this is because they think the British government is actually moving in the direction of trying to get away from guaranteeing all the largest banks in Britain. 

"In other words, how we are going to avoid Britain and the British taxpayer bailing out banks in the future, this Government is taking steps to do that and therefore credit rating agencies and others will say actually these banks have got to show that they can pay their way in the world." 

Treasury officials stressed that banks were currently well-resourced and the future plans would not put savers' money in jeopardy. The Chancellor pledged to use "all the tools available" to tackle the current economic crisis.

Mr Osborne said that Britain had been at the "epicentre" of the initial banking crisis in 2008 but insisted that action taken by the Coalition "has moved Britain out of the eye of the storm".

Happy 3rd Anniversary Bank Bailouts

According to a Guardian article, it was three years ago this week that the UK engaged in the first bank bailout.  Shortly thereafter the US and Eurozone also bailed out their banks.

With these actions, a terrible precedent was set.  This precedent was even worse than the precedent set by crediting regulatory capital to insolvent US savings and loans in the 1980s.  The clear lesson from crediting regulatory capital was that it resulted in increasing the cost to taxpayers of unwinding the insolvent savings and loans.

What made the actual cash bailouts worse is that now, not only did it increase the cost to taxpayers, but global financial regulators and policymakers felt compelled to lie about the solvency of the banks.

For all its faults, the Office of Thrift Supervision never claimed the savings and loans that received regulatory capital were actually solvent, but rather with the addition of regulatory capital they did not have to be closed.

With the actual cash bailouts, global financial regulators and policymakers undertook a very public campaign to say that the banks were solvent.  Global financial regulators and policymakers have repeatedly made this claim and taken actions as if it were true.

However, given the available evidence, this claim was never believable in the first place nor required (as the savings and loans have shown, insolvent financial institutions can remain open for business for years until they are closed by the financial regulators).

• In the US, analysts are debating whether Bank of America needs to raise upwards of $200 billion in equity - well over $100 billion more than US financial regulators have ever said was necessary if BofA was to remain solvent;  

• In Europe, after each year's stress tests, within weeks banks that easily passed the test had to be nationalized - think Irish banks and Dexia.

By itself, this evidence suggests the claim of solvency is highly suspect.

Unfortunately, there is much more evidence.

• The Eurozone policymakers are meeting to discuss how much more capital to inject into the Eurozone banks - if the banks are solvent, then why do they need capital?

• Market participants are throwing out suggested capital shortfalls - Christine Lagarde and the IMF are suggesting 200 to 300 billion euros; BlackRock's Larry Fink is suggesting 2 trillion euros - if he is right then the interconnectedness of the global financial system is going to require that US and UK banks are bailed out too if Europe does not go for the full 2 trillion.

Why don't financial regulators and policymakers acknowledge that the banks are insolvent?  Without requiring banks to disclose their current asset and liability-level data, market participants already assume that there is something to hide.

More importantly, market participants know that what is hiding on the bank balance sheets or in the structured finance market will eventually emerge.  First, it was the sub-prime debt (which is still there and marked to make believe).  Now it is the sovereign debt.

Does anyone wonder why confidence is ebbing and market participants are aggressively reducing their risk?  They know that there is too much debt and that borrowers do not have the resources to repay it.  As a result, it is highly likely another problem area will emerge.

They are justifiably worried about the ongoing cycle of debt problems emerging that financial regulators and policymakers apparently did not see coming and the need for on-going bailouts.  Bailouts that the countries putting up the cash cannot afford and that are undermining their social fabric.

Since before the credit crisis began, your humble blogger has been suggesting an alternative policy for global financial regulators and policymakers that would have ended this cycle before it began and moderated the damage from the credit bubble.  This policy is based on bringing disclosure to all the opaque areas of the financial marketplace including structured finance securities and bank balance sheets.

Not just disclosure, but disclosure of all the useful, relevant information in an appropriate, timely manner so that market participants can use this information to assess the risk of and value a security or bank.

With this disclosure, market participants and regulators would already know which banks are solvent and which are insolvent and how the insolvent banks are going to be returned to solvency or closed, debt would have been written down to levels that are affordable to the borrowers and the focus would be on the next great investment.

Its a solvency crisis, not a liquidity crisis

By treating a solvency crisis as a liquidity crisis, have global financial policymakers set the global economy up for what the Bank of England's Mervyn King fears is "the most serious financial crisis at least since the 1930s if not ever?"

Yes.

This is the unmistakable conclusion when you realize that four years after the solvency crisis began, global market participants still do not know which banks are solvent and which banks are insolvent.

In Europe this month, the questions are:

• will it take 200 billion or 2 trillion euros to fill the hole in the bank balance sheets; and 

• will market participants believe that the solvency issue is ended regardless of which number European policymakers choose.

It is the second question that is the more difficult because if market participants do not believe the solvency issue is ended, like the original bank bailouts, all these new bank bailouts will do is buy some time.

Fortunately, there is a way to get market participants to believe in the adequacy of the number.

Regular readers know that

• requiring banks to disclose their current asset and liability-level data would allow market participants to determine which banks are solvent and which banks are insolvent.  

• More importantly, it would also allow market participants to determine how much capital is needed by each bank and in total to end the solvency crisis and believe that this amount of capital is sufficient.  

• Even more importantly, it would restore market participants' confidence so that they could voluntarily be the source of capital rather than government balance sheets.

• Perhaps most importantly, it would also result in debt being written down to a level where the borrower could service the debt (this occurs as part of the process of assessing a bank's solvency as solvency is defined as the market value of the bank's assets minus the book value of its liabilities).

Yet, here we are four years into the solvency crisis and banks are still not required to disclose this data and work has not begun on a data warehouse so that all market participants can access this information.

Now, we have European policymakers having to make a choice.  Do they require banks to disclose their current assets and liability-level data and involve market participants in ending the solvency crisis or Do they listen to Wall Street and use the taxpayers' money to bailout the banks.

Given the lack of progress on disclosure, the odds heavily favor bailing out the banks and a continuation of the most serious financial crisis since the 1930s if not ever.

Update


Quote from Mervyn King

The situation in 2008/9 around the world was so much easier than it is today. Those measures taken then did not solve the underlying problems.This is undoubtedly the biggest financial crisis the world has ever faced.

This is exactly the point I have been making since the beginning of the financial crisis.

Germany's Merkel backs plans to recapitalize banks, but how much capital do they need? (updated)

A Telegraph article reports that Germany's Chancellor Angela Merkel backs plans to recapitalize the Eurozone banks.

The key questions are:  how much capital do the banks need and will there be disclosure of each bank's current asset and liability-level data so that market participants can confirm the adequacy of this additional capital injection?

Confirmation of the adequacy of the capital injection is critically important to restore market confidence because the mere discussion of another round of capital injections in the Eurozone banks clearly shows that the first round of capital injections was inadequate.

As previously discussed on this blog, potential recapitalization amounts range from the single digit billion euros (based on the EU financial regulators stress tests) to 200 - 300 million euros (based on the IMF's analysis) to maybe as much as 2 trillion euros (based on BlackRock Larry Fink's comment).

Regardless of what number is selected for recapitalizing the banks, market participants and Germany's Merkel are going to want to be able to verify that this recapitalization is sufficient to restore and maintain bank solvency.  The only way to do this is if each bank discloses its current asset and liability-level data.

If regulators do not require banks to make this disclosure, market participants and Germany's Merkel could easily conclude that the regulators are hiding something and that the banks are in fact not adequately capitalized.  After all, there is no reason not to disclose this data unless the banks are hiding something.

The German Chancellor's intervention on Wednesday rallied European markets after fears that EU's determination to prop up banks was wavering after a meeting of finance ministers on Monday failed to take a decision. 

"I think it is important, if there is a general view that the banks are not sufficiently capitalised for the current market situation, that one does it," she said following talks in Brussels.  Chancellor Merkel said that she was ready to support and to decide on a eurozone bank capitalisation plan as early as October 17, at an EU summit. 

"Germany is prepared to move to recapitalise. We need criteria. We are under pressure of time and we need to take a decision quickly," she said. 

Actually, as your humble blogger has repeatedly pointed out, Eurozone policymakers are not under time pressure to inject capital into the Eurozone banks.

Eurozone policymakers are under time pressure to put in place a mechanism for determining how much capital each bank needs.

Only after the size of the capital shortfall has been determined is it appropriate to talk about how and if each bank will be recapitalize - which banks will recapitalize themselves through retained earnings, which banks will be recapitalized by raising equity from the capital markets, which banks will be recapitalized by their host governments, and which banks are so far underwater that they will be closed.

The "how to" roadmap for doing this involves the following steps:

1. Each bank discloses its current asset and liability-level data to all market participants;
2. Market participants analyze this data and determine how much capital each bank needs;
3. Working with market participants, the regulators determine appropriate strategy for recapitalizing each bank; and 
4. Banks recapitalized.

Please note, these steps will not be completed in 5 weeks.  However, that is not what is needed to restore confidence in the market.

What is needed is that the market sees the Eurozone governments committed to a path that will address and end the solvency crisis.

... Germany is said to support a move by the European Banking Authority to raise minimum capitalisation levels, a change that would lead to a need for financial support for banks with exposure to Greek or other sovereign debt risk.... 

Germany's intervention soothed markets but will intensify pressure on France. 

France, with banks that are among the most exposed, including its stake in Dexia, is opposed to recapitalisation. Nicolas Sarkozy, the French president, is concerned that the huge sums he might have to pay out could threaten the French AAA sovereign debt rating ahead of elections next year.

Using my approach, it is not clear that governments will have to inject huge sums of money in their banking systems.  Private investors are likely to put up the money when they can assess the risk of each bank.

"I think it will be a very important signal to the international financial markets," she said.

The key is to send the right message.  My modest proposal is the message that needs to be sent.

"There's just news of discussions about a possible bank recapitalisations, there's no details yet," said Kasper Kirkegaard, currency strategist at Danske in Copenhagen. "There's a high risk of a further sell-off if we don't get details on this soon."

The details that need to be laid out is a credible plan for addressing the need to recapitalize the banks.

Update


A Wall Street Journal article discusses a 'plan' to restore investor confidence in Eurozone banks.  Under the plan, each EU nation and its financial regulators are now suppose to tell how much capital each bank actually needs.

Currently, the plan lacks verifiability by market participants.  Instead, market participants are suppose to simply believe these numbers.

This plan is highly unlikely to restore confidence.  At a minimum, it excludes two key ingredients to restoring confidence.  These ingredients are current asset and liability-level disclosure and investor participation in the determination of how much capital each bank needs.

Germany is putting pressure on other euro-zone governments to declare how they would recapitalize their banks if the need arose, as part of a concerted effort to repair investors' battered confidence in European banks....

German officials hope that a coordinated demonstration by euro-zone governments that they have contingency plans for their banks in place would calm financial-market fears of a banking crisis in the region....

As well as alleviating such funding strains, German officials hope that a system of backstops for banks would give the euro zone more freedom to deal with Greece's teetering debts—including the option of restructuring Greek bonds. 

Investors fear that some European banks would struggle to digest the losses that would follow from a major Greek debt restructuring, unless the banks receive capital injections from national or European authorities....

Banks should seek to raise capital first from private investors, and from national authorities if they can't tap the market, she said. If national authorities don't have the necessary resources, banks should turn to currency bloc's main bailout fund, the European Financial Stability Facility, she said....

Germany has said in recent days that it stands ready, if necessary, to reactivate its national banking bailout fund, which was set up in 2008 but is now closed to new aid requests from banks. Reopening the fund would require approval from Germany's parliament, but Berlin officials believe they could get that authorization quickly.

Germany professes confidence that its own banks, which have so far avoided the worst of the recent funding strains, don't need more capital. But Europe's biggest economy wants the single-currency bloc to send a united, reassuring signal to financial markets about its banks.

German officials have complained that some other governments haven't put in place national contingency plans to support their banks. German Finance Minister Wolfgang Schäuble was frustrated at the lack of progress in some countries when European finance ministers discussed the issue in Luxembourg early this week, according to people familiar with the matter....

France's government, however, is reluctant to reactivate its banking bailout measures dating from 2008, according to people familiar with the matter. Paris is deeply worried about losing its triple-A credit rating if the rating agencies decide the country can't afford any costly new bank-support measures, these people say....

French banks are also against announcing a new national banking backstop, for fear that it could spook financial markets already worried about French lenders' exposure to indebted Southern European countries.

Dexia, Ireland and the Good Bank/Bad Bank fallacy

According to a Bloomberg article, Dexia will be split up into a Good bank and a Bad bank.

Readers may remember that Ireland tried to do the same thing with its banks.  In fact, Ireland tried without success on multiple occasions to remove all of the bad assets from its banks.

The fallacy of the Good bank/Bad bank concept is it requires market participants to "believe" that all the losses were put in the bad bank.  Without disclosure of the good bank's current asset and liability-level data, how are market participants suppose to verify how the bad assets were actually split up?

Without this verification, why should investors trust that the Good bank was cleaned-up and they should invest?

Dexia SA (DEXB), Belgium’s biggest bank, plans to pool its troubled assets into a “bad bank” with Belgian and French government guarantees to protect depositors and its municipal-lending business. 

The Belgian-French lender bailed out by the two governments in 2008 will put its “legacy” division, which held 113 billion euros ($150 billion) of assets at the end of June, into the bad bank, Belgian Prime Minister Yves Leterme told reporters in Brussels yesterday. Finance Minister Didier Reynders said...“What we’re looking for is not to spend taxpayers’ money on a dossier such as this one,” Reynders said. “Our wish is to consolidate, reinforce and safeguard the banking activity in Belgium, as our colleagues will do in France.” 

The creation of a separate entity with government guarantees may help shield Dexia’s banking units and avoid a repeat of the 2008 taxpayer-funded capital infusion. Belgium and France said yesterday they will take “all necessary measures” to protect clients and will guarantee Dexia’s loans. Both governments have stakes in the bank following its 2008 bailout...

For Dexia, “the fact that two countries are involved, both under pressure from rating agencies, makes it even more difficult,” said Benoit Petrarque, an Amsterdam-based analyst at Kepler Capital Markets with a “hold” rating on the shares. “We are not in 2008 anymore, when you could just inject multibillions of cash.” 

Prime Minister Leterme said yesterday that there’s “no reason justifying” Dexia Bank Belgium’s clients pulling deposits from the bank. Belgium guarantees that no client “will lose a single eurocent,” he said....

Dexia posted a 4 billion-euro loss for the second quarter, the biggest in its history, after writing down the value of its Greek debt. Once the world’s biggest lender to municipalities, it received a 6 billion-euro bailout from Belgium, France and its largest shareholders in September 2008 following the collapse of Lehman Brothers Holdings Inc.... 

Reynders said yesterday the guarantees that will be provided now will be “inferior” to the ones granted in 2008, when Belgium’s share exceeded 90 billion euros. 

He also said that Belgium has “no intention” of chalking up losses, adding that it will collect a fee in return for the guarantees. Dexia paid 489 million euros last year for use of guarantees, according to company filings. 

Dexia’s legacy division, which will be folded into the bad bank, has a pool of long-term assets that were put together so they could be financed with earlier debt guarantees. The division was created to meet European Union demands that earlier debt guarantees not be used to finance its commercial businesses and give investors greater clarity about its capacity to generate profits. 

At the end of June, the division included 95 billion euros of bonds with an average maturity of almost 13 years and $9.5 billion of mostly U.S. residential-mortgage backed securities, the majority of which were sold in July. 

It also had 11 billion euros of municipal loans in countries where Dexia has halted operations. 

Dexia may also transfer an additional 50 billion euros of assets from its municipal-lending units in Italy and Spain into the bad bank. Dexia agreed to dispose of its controlling stakes in Rome-based Dexia Crediop SpA and its joint venture with Barcelona-based Banco de Sabadell SA to win European Commission approval for its 2008 bailout.