If 'Too Big to Fail' Banks Fail, We'd Be Greece (Correct)

(Corrects article originally published earlier Wednesday to change $900 billion to $900 million and $675 billion to $675 million.)

NEW YORK ( TheStreet) -- The financial health of the four "too big to fail" banks are the key to the U.S. economy as our nation faces the continued debate on the debt ceiling and the failed monetary policy that will soon be led by the presumed next Federal Reserve chairman, Janet Yellen.

Last Friday both JPMorgan Chase ( JPM) and Wells Fargo ( WFC) reported their third-quarter earnings.

JPMorgan, which closed Tuesday at $52.31, actually lost 17 cents a share, but after adjusting for $7.2 billion in legal fees it beat EPS estimates by 14 cents earning $1.42 per share on revenue of $23.9 billion. With such a huge balance sheet a "too big to fail" bank can just about report earnings at will given its great team of accountants. JPMorgan also disclosed it set aside $23 billion for expected future fines and settlement legal fees. JPMorgan expects to lose money on its mortgage operations in the second half of 2013.

Wells Fargo, which closed Tuesday at $41.54, beat EPS estimates by 2 cents earning 99 cents a share. Their earnings were boosted by a $900 million reduction in reserves for losses, but the bank reported that revenues from their mortgage origination business fell by 35% year over year in the third quarter.

Citigroup ( C) reported its quarterly results in the premarket on Tuesday. Citi missed EPS estimates by 4 cents earning an adjusted $1.02 per share. Revenue at $17.9 billion was shy of expectations. The bank reduced loan loss provisions by $675 million.

Bank of America ( BAC) reports its quarterly results premarket this morning. Bank of America is expected to report that it earned 18 cents a share. This stock was downgraded to hold from buy Tuesday morning, according to ValuEngine.

The "too big to fail" banks began their growth spurts after the Glass-Steagall Act, also known as the U.S. Banking Act of 1933, was declared no longer appropriate by President Clinton in 1998 after the Federal Reserve approved Citibank's affiliation with investment banking firm Salomon Smith Barney.

Beginning in the year 2000, the four 'too big to fail' banks began their dramatic growth through acquisitions.

In 2000, Chase Manhattan Corp. bought JPMorgan, creating JPMorgan Chase. In 2004, Bank of America bought FleetBoston Financial. In 2004, JPMorgan Chase bought Bank One. In 2005 Bank of America bought MBNA.

Then the forced purchases began. In 2006 Wachovia bought Golden West Financial in a $25 billion deal adding many bad mortgage loans to its balance sheet.

In 2007 Bank of America bought LaSalle Bank in a $21 billion deal and Wachovia bought World Savings Bank in a $25 billion deal. These purchases involved portfolios of toxic mortgage loans.

In January 2008, before the banking regulators acknowledged the Great Credit Crunch, Bank of America bought Countrywide in a $4 billion deal.

In March 2008, JPMorgan Chase bought Bear Stearns for $10 a share, or just $1.2 billion, with the Federal Reserve taking on a portfolio of about $30 billion in toxic assets.

In the second half of 2008, the soon-to-be-known as "too big to fail" banks were arm-twisted into additional bailout mergers.

Bank of America purchased Merrill Lynch in a $50 billion deal announced on Sept. 15, 2008.

JPMorgan Chase bought the deposits and branches of Washington Mutual for $1.9 billion, a deal announced on Sept. 25, 2008.

Wells Fargo bought Wachovia in a $15.1 billion deal announced on Oct. 3, 2008.

This table shows the assets among the four "too big to fail" banks at the end of the second quarter of 2008 compared with the end of the same period this year.

At the end of the 2008 second quarter, Bank of America was the biggest bank with $1.787 trillion in assets, which is 13.43% of the $13.3 trillion of all assets in the banking system. At this time Wachovia was the fourth-largest bank, with $781.88 billion in assets, and Washington Mutual was in sixth place with $353.07 billion in assets.

Let's look at the four "too big to fail" banks at the end of the second quarter of 2008 compared with the end of second-quarter 2013 with the Washington Mutual assets added to JPMorgan assets and with the Wachovia assets added to Wells Fargo assets.

After adding the assets of Wachovia to Wells Fargo and the assets of Washington Mutual to JPMorgan, JPMorgan moves into first place with $1.806 trillion, controlling 13.58% of all assets basis in the second quarter of 2008. Wells Fargo moves ahead of Citigroup into third place with $1.340 trillion controlling 10.08% of all assets basis 2Q 2008. Overall the four "too big to fail" jumped from controlling 38.52% of all assets to controlling 47.05%.

Five years later, JPMorgan is even bigger, with $2.027 trillion in assets controlling 14.07% of the $14.41 trillion of total assets in the banking system. Bank of America reduced assets by 7.20% over the last five years to $1.658 trillion in assets controlling 11.51% of all assets in the banking system. Overall, the four "too big to fail" banks control 43.95% of all assets in the banking system at mid-year 2013.

Here is a list of some of the issues these banks face:

The primary drivers of improved profitability in recent quarters had been noninterest income and reduced loan loss provisions, not increased lending.

All four banks have cut back on their mortgage origination businesses including layoffs, after the quick rise in mortgage rates that began in early May. In my opinion, banks continue to be reluctant to lend and they do not want to hold mortgages on the books with rates as low as they are.

The federal funds rate has been at 0.0% to 0.25% since Dec. 16, 2008, which has shut out savers on Main Street. Savers do not invest in the stock market and depend upon interest on bank CDs for living expenses. The big banks have not raised rates on CDs following recent higher yields on U.S. Treasuries. With the five-Year U.S. Treasury yield at 1.45% the median five-year CD rate among the "too big to fail" banks is a paltry 0.5%.

Before Wells Fargo took over Wachovia, Wachovia had a small business line of credit program priced at 200 basis points above the 3.25% prime rate, setting this rate at 5.25%. After the Wells Fargo name was changed on the bank buildings it raised the rate to 500 above the prime rate at 8.25%. Two months ago it raised the spread to 600 to a rate of 9.25%. I guess the big banks do not want to help small businesses.

The FDIC Quarterly Banking Profile for 2Q 2013 showed a mark-to-market loss of $51.1 billion in fixed-income securities in the "available-for-sale" category. This mark-to-market loss is likely growing.

Other Real Estate Owned in the banking system totals $32.6 billion. The "too big to fail" banks were the major mortgage lenders so they likely have the lion's share of this exposure.

The deposit insurance fund (DIF) totaled $37.9 billion at the end of the 2013 second quarter. Even if insured deposits do not grow and remains around $6 trillion in September 2020, the DIF would need to be funded at about $81 billion. The "too big to fail" banks will have the largest increases in DIF assessments.

Noncurrent loans still total $239.3 billion. My bet is that the 'too big to fail" banks account for 40% to 50% of this amount.

Since the end of 2007 notional amount of derivatives in the banking system are up 42.4% to $236.5 trillion and most of this exposure is controlled by the four "too big to fail" banks. There are likely more time bombs ticking in this category.

I am not an expert on FASB accounting rules, but I understand that new rules will require the bigger banks to increase capital.

Two senators are trying to work together to bring us a "21st Century Glass-Steagall Act." They are Elizabeth Warren, D-Mass., and John McCain, R-Ariz. They agree that traditional banking such as mortgage lending and checking accounts be separated from the speculative activities in investment banking and derivatives trading. I agree with this initiative.

Meanwhile, Main Street USA is beginning to have similar issues as Main Street, Greece: lower family incomes, more part-time jobs, tight lending standards and increasing costs for insurance of all types, homeowners, life, flood and health care.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

Richard Suttmeier is the chief market strategist at AlphaPlus Analytics in addition to ValuEngine.com. He has been a professional in the U.S. Capital Markets since 1972, transferring his engineering skills to the trading and investment world.

Suttmeier has an engineering degree from Georgia Tech and a Master of Science degree from Brooklyn Poly. He began his career in the financial services industry in 1972 trading U.S. Treasury securities in the primary dealer community. He became the first long bond trader for Bache in 1978, and formed the Government Bond Department at LF Rothschild in 1981, helping establish that firm as a primary dealer in 1986. This experience gives him the insights to be an expert on monetary policy, which he features in his newsletters, and market commentary.

Suttmeier's industry licenses include, Series 7 and Registered Principal (Series 24). He has been the Chief Market Strategist for ValuEngine.com since 2008 and often appears on financial TV.

Click here for details on Suttmeier's "Buy and Trade" investment strategy.

Richard Suttmeier can be reached at RSuttmeier@Gmail.com

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