Can the banking industry rise like a phoenix from the bonfire of its vanities?

Mixed metaphors aside, the future of banking may arise by changing fundamentally how its problems are addressed. Indeed, I am beginning to think that a changed approach may force itself into the open if the ballooning-debt plans become more obviously non-viable. As I've been examining the possibility that the banking index ($BKX) might have seen its lows in the charts, I've also been pondering how that could happen from a fundamental perspective. The only explanation I could come up with in a post on that topic about 10 days ago here, was to posit that some banks may just have to fall by the wayside and the remaining ones can grow stronger as they carry on business. It was actually just before I heard about the "good banks/bad banks" idea, but I'm not convinced that the actual mechanics of that proposal would really get the job done. I liked Niall Ferguson's remarks in an interview last week with Alexis Glick of Fox Business News, including his point that we "already have a bad bank - it's called the Federal Reserve"!

Now Niall Ferguson has written more in his column at Financial Times, in Beyond the age of leverage: new banks must arise. (Thanks to the talented Yves Smith of naked capitalism for featuring this.) Niall's article states, in pertinent part:

Call it the Great Repression. The reality being repressed is that the western world is suffering a crisis of excessive indebtedness. ... Worst of all are the banks. The best evidence that we are in denial about this is the widespread belief that the crisis can be overcome by creating yet more debt.
...
There is a better way to go but it is in the opposite direction. The aim must be not to increase debt but to reduce it. Two things must happen. First, banks that are de facto insolvent need to be restructured – a word that is preferable to the old-fashioned “nationalisation”. Existing shareholders will have to face that they have lost their money. Too bad; they should have kept a more vigilant eye on the people running their banks. Government will take control in return for a substantial recapitalisation after losses have meaningfully been written down. Bond­holders may have to accept either a debt-for-equity swap or a 20 per cent “haircut” (a reduction in the value of their bonds) – a disappointment, no doubt, but nothing compared with the losses when Lehman went under.
...
The second step we need to take is a generalised conversion of American mortgages to lower interest rates and longer maturities. ... Repeatedly during the course of the 19th century governments changed the terms of bonds that they issued through a process known as “conversion”. A bond with a 5 per cent coupon would simply be exchanged for one with a 3 per cent coupon, to take account of falling market rates and prices. Such procedures were seldom stigmatised as default. Today, in the same way, we need an orderly conversion of adjustable rate mortgages to take account of the fundamentally altered financial environment.

... One solution would be for the government-controlled mortgage lenders and guarantors, Fannie Mae and Freddie Mac, to offer all borrowers – including those on fixed rates – the same deal. Permanently lower monthly payments for a majority of US households would almost certainly do more to stimulate consumer confidence than all the provisions of the stimulus package, including the tax cuts.

No doubt those who lose by such measures will not suffer in silence. But the benefits of macroeconomic stabilisation will surely outweigh the costs to bank shareholders, bank bondholders and the owners of mortgage-backed securities. Only a Great Restructuring can end the Great Repression. It needs to happen soon.

A longer version of this article is available at https://www.glgpartners.com/pdf/Beyond_The_Age_Of_Leverage_Niall_Ferguson.pdf.

Yves Smith comments in agreement to the first half of Niall's suggestion, but would prefer a more surgical approach for remedying the mortgage problem.

For myself, I understand Yves' concern and can agree that a more surgical approach might be better out of fairness and also to minimize any "free rides" by mortgage-holders who would not need government-mandated assistance to pay their mortgages. Weighing against that, though, is the public perception that some action must be taken promptly; and the real estate quagmire is affecting everyone. There's an old saying that "perfection is the enemy of the good." That idea doesn't justify unfair or unnecessary programs, of course; but there are times when it's more important to start making progress in the generally right direction, rather than spend too much time fine-tuning all details.

Who knows - it may be possible that a plan like that might actually be approved by bank shareholders if it gains acceptance and provides certainty as a way to get through the problems. There are times when an announcement such as cutting dividends to put a company on more solid footing provides the catalyst for a stock to complete a bottom and rally. Might that happen with the banks? Frankly - it is too early to say, from a chart perspective. One doesn't have to be a pencil-pushing analyst or a chart technician to see that the banking index doesn't have much air space left at the bottom of this chart:

Here's one more thing that caused me to feel pessimistic again about this sector - the ETF that tracks the financials (XLF, which is therefore a little different from KBE which tracks the banking sector as such), now appears on today's list of "Top Bullish" at the ISE! Of course, this is just one data point, and doesn't look at whether there are similarly over-heated positions on the banking sector and most stocks in the financial and banking sectors. But it does raise a cautionary sign.

And we mustn't forget, as John Plender also reminds us at Financial Times today, that "It may sound indelicate, but many banks are bust" (he asserts that more public ownership is both inevitable and potentially helpful). Bad fundamentals can make problematic charts, and I wouldn't want any readers' portfolios also to go bust following the banks down. That's why we must look for confirmation and use stop loss protection as always.

So, the Fibonacci and Elliott Wave analysis told me the banking sector might have put in an important low, but chart action since then does not give confirmation yet (such as an Elliott Wave impulse up or at least a convincing trap door reversal pattern). It can still happen ... it could even happen after another new low, if the Elliott Wave pattern needs to do that to finish the wave structure. As an unbiased trader, all I can do is point out that the opportunity still remains, but the clouds over this sector haven't parted yet.

What about the Federal Reserve's place in all this? Certainly they are trying ... in another action described earlier today by Mark Felsenthal writing at Reuters, the Fed extend[ed] liquidity facilities, forex swaps by 6 months, through October 30. These are "swap lines" that provide U.S. dollars to 13 central banks. (It said the Bank of Japan would consider a similar extension at its next policy meeting.) The Fed also extended through October 30 other programs "providing liquidity to the U.S. commercial paper and money markets, and to large Wall Street firms".

There are provocative charts circulated on financial websites showing the Fed's massive balance sheet increases (I posted one that Kosta had on his blogspot, at my UBTNB3 site). One has to wonder whether it will be able to escape the banking problems and the solutions unscathed. The Fed has plenty of motive to avoid being the "bad bank." But the Fed will have to be very agile to be a part of any "phoenix" to rise from the ashes when all the bad paper goes up in smoke.