Banks' Worst Fear for 2012

NEW YORK (TheStreet) -There are so many threats to the largest U.S. banks it can be dizzying trying to keep up with it all.

Analysts have been saying for months that bank stocks are at historic low valuations, and yet lower still they go. Before the 2008 crisis, trading below book value was considered to be absurdly cheap, but now we have even industry leaders like JPMorgan Chase (JPM) and Goldman Sachs (GS) trading well below book, and industry laggard Bank of America (BAC) trading at a quarter of book value.

New York Attorney General Eric Schneiderman

The issue for Bank of America is its massive exposure to troubled mortgages, but following a detailed analysis of those risks that added up to more than 50 pages, Citigroup analyst Keith Horowitz concluded that even if the bank is under-reserved by $32 billion--a worst case in his view-- "when you factor in the earnings power and the time it will take to resolve these issues it appears to be manageable."

But there is a far, far worse case than that, according to Paul Miller, analyst at FBR Capital Markets.

"The real problem is up in New York, what Schneiderman's doing," says Miller, referring to New York Attorney General Eric Schneiderman. "He is saying that the securitization process itself is corrupt and the securities were not legal entities. So then you wake up one day and I'm a bank--let's just use Bank of America, for example--that issued $1 trillion over its life of non-agency securities, and they're all done wrong."

Schneiderman, along with Attorneys General from Delaware and Massachussetts, has refused to go along with their counterparts in other states in agreeing to an estimated $20-25 billion settlement with banks including Bank of America, JPMorgan Chase, Citigroup, and Wells Fargo over mortgage servicing issues.

They refused, according to an essay published in Politico by Schneiderman and Delaware Attorney General Beau Biden in November, because, as part of the proposed settlement "the financial institutions on the other side of the negotiating table have predictably sought releases that are as broad as possible from future liabilities."

Biden and Schneiderman resist such a deal because they have other mortgage-related investigations pending, including the one into the mortgage securitization process itself.

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