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What’s in the Financial Reform Bill?

The broadest overhaul of U.S. financial rules since the Great Depression won final approval in the Senate on Thursday. Yet over 70 percent of Americans know nothing about the legislation.

By a vote of 60 to 39, the Senate gave final approval to a sweeping measure that tightens regulations across the financial industry.

In comments to CNBC Thursday, Democratic Senator Chris Dodd, a co-sponsor of the bill, noted that the sweeping measures passed by Congress won’t necessarily prevent a future financial crisis, but instead will “minimize the possibility” of another “near-meltdown.”

“The suggestion that any bill can stop future crises is ridiculous,” Dodd said. “The issue is whether we’ve got now the oversight council to keep an eye on what’s occurring.”

Also Thursday, President Barack Obama hailed congressional passage the regulation, saying it will provide greater financial security to Americans and would foster accountability.

“All told, this reform puts in place the strongest consumer financial protections in history and it creates a new consumer watchdog to enforce those protections,” Obama said in a press conference.

“Because of this reform, the American people will never again be asked to foot the bill for Wall Street’s mistakes and there will be no more tax payer funded bailouts,” he continued. “If a large financial institution should ever fail, this reform gives us the ability to wind it down without endangering the broader economy.”

Obama will likely sign the bill into law next week, the White House said.

The legislation, which had been opposed by banks, leaves few corners of the financial industry untouched. It establishes new consumer protections, gives regulators greater power to dismantle troubled firms, and limits a range of risky trading activities by banks in a way that would curb their profits.

The Senate vote caps more than a year of legislative effort after Obama proposed reforms in June 2009. The House of approved it last month.

Despite the landmark overhaul, 38 percent of Americans have never heard of the legislation and 33 percent have heard of it but know almost nothing about it, according to an Ipsos Public Affairs online poll. Another 18 percent said they know “a little bit” about the measure.

The Ipsos poll found 3 percent are very familiar with the legislation, and 8 percent are somewhat familiar.

Now that the bill is set to become law, here’s a rundown of the key elements:

TITLE I. Systemic Risk

A council of regulators chaired by the secretary of the Treasury would be created to monitor big-picture risks in the financial system. The Financial Stability Oversight Council could identify firms that threaten stability and subject them to tighter oversight by the Federal Reserve. The Fed and the council could break up firms that have not responded to earlier measures and pose an urgent threat.

TITLE II. Ending Bailouts

The bill would set up an “orderly liquidation” process that the government could use in emergencies, instead of bankruptcy or bailouts, to dismantle firms on the verge of collapse.

The goal is to end the idea that some firms are “too big to fail” and avoid a repeat of 2008, when the Bush administration bailed out AIG and other firms but not Lehman Brothers. Lehman’s subsequent bankruptcy froze capital markets.

Under the new rule, firms would have to have “funeral plans” that describe how they could be shut down quickly.

The Federal Deposit Insurance costs for running liquidations would be covered in the short term by a Treasury credit line, then recouped by sales of the liquidated firms’ assets. In case of shortfalls, costs could be further covered by claw-backs of any payments to creditors that exceeded liquidation value, and fees charged to other large firms.

The FDIC could guarantee the debts of solvent insured banks to prevent bank runs. But this could only happen if the boards of the FDIC and the Fed decided financial stability was threatened, Treasury approved the terms, and the president activated a rapid process for congressional approval.

TITLE III. Supervising Banks

The U.S. Office of Thrift Supervision, which was widely criticized in the run-up to the 2007-2009 credit crisis, would be closed and most of its duties shifted to the Comptroller of the Currency.

Banks would be barred from converting their charters to escape regulatory enforcement actions.

The FDIC’s deposit insurance coverage would be permanently raised to $250,000 per individual from $100,000.

TITLE IV. Hedge Funds

Private equity and hedge funds with assets of $150 million or more would have to register with the Securities and Exchange Commission, exposing them to more scrutiny. Venture capital funds would be exempted from full registration.

Investment advisers would have to manage assets of $100 million or more to be federally regulated, an increase from the present $30 million level. The change would shift some of the oversight for small firms from the SEC to the states.

TITLE V. Insurance

A new federal office would be created to monitor, but not regulate, the insurance industry, which is now policed only at the state level. The move would appease opponents of centralized regulation by keeping real power out of Washington’s hands, while giving big insurers that want a single regulator a foothold they might be able to expand from in the future.

TITLE VI. Volcker Rule And Bank Standards

Under a rule proposed by White House economic adviser Paul Volcker, the bill would bar proprietary trading unrelated to customers’ needs at banks that enjoy government backing, with some of the details of implementation left up to regulators.

Banks could continue to invest up to 3 percent of their Tier 1 capital in private equity and hedge funds, not to exceed 3 percent of any single fund’s total ownership interest.

Private equity and hedge fund interests above the new caps would have to be divested over time, under the Volcker rule.

In addition, the largest banks’ ability to expand would be limited by a new cap on share of industry-wide liabilities.

Non-bank financial firms supervised by the Fed would face limits on proprietary trading and fund investing as well.

Bank holding companies within five years would have to stop counting trust-preferred securities and other hybrids as Tier 1 capital, a key measure of a bank’s balance sheet strength.

Firms with assets under $15 billion could count current holdings of hybrids as Tier 1 capital, but not any new ones.

The bill would also require credit exposure from derivative transactions to be added to banks’ lending limits.

In addition, bank capital standards could not sink below those already on the books, and a 15-to-1 leverage standard could be imposed on firms that threaten financial stability.

The bill would also make bank holding companies follow higher capital standards observed by bank subsidiaries.

Analysts expect the Volcker rule and related changes to cut profit at firms such as Bank of America, Goldman Sachs, Morgan Stanley and JPMorgan Chase.

TITLE VII. Over-The-Counter Derivatives

The bill would impose regulation for the first time on the $615 trillion over-the-counter derivatives market, including credit default swaps like those that dragged down AIG.

Much OTC derivatives traffic would be rerouted through more accountable and transparent channels such as exchanges, electronic trading platforms and central clearinghouses.

Banks would also have to spin off the riskiest of their swap-clearing desk operations, but could keep many swaps in-house, including derivatives to hedge their own risks.

Some end-users of OTC derivatives would be exempted from central clearing requirements. Swap-dealers’ ownership interests in clearinghouses would be limited.

JPMorgan, Bank of America and other commercial banks could face structural changes from the bill, while it could boost business for clearing and trading venues such as CME and Intercontinental Exchange, analysts said.

TITLE VIII. Payment, Clearing And Settlement

Supervision of firms that settle payments among financial institutions would be broadened.

TITLE IX. Protecting Investors

On brokers and how they interact with investors, the SEC, after a study, could order brokers who give investing advice to follow a higher standard of client care.

On credit rating agencies, a new SEC office to regulate the agencies would be created. The SEC would have two years to study the widely criticized industry. Afterward, unless it comes up with a better idea, the agency would have to implement a plan to form a government panel to assign agencies to debt issuers for initial ratings of new structured securities.

Rating agencies would also be exposed to more legal risk.

On debt securitization, lenders that make loans and then sell them off as securities would have to retain at least 5 percent of the loans’ risk on their books, unless the loans meet certain standards for reducing risk.

The SEC’s enforcement powers would be beefed up and its funding levels raised.

On executive pay, shareholders periodically could cast non-binding votes on top managers’ compensation packages, while their role in electing directors would also be enhanced.

Corporations would have to allow claw-backs of executive pay if it was based on inaccurate financial information.

TITLE X. Protecting Consumers

A new government watchdog would be established to regulate mortgages, credit cards and other consumer financial products.

The Consumer Financial Protection Bureau would be a separate unit within the Fed and funded by the central bank. It would consolidate consumer programs now dispersed across several agencies. Its director would be nominated by the president and confirmed by the Senate.

The CFPB would answer, in some instances, to the Financial Stability Oversight Council. Car dealers, who fought for and won an exemption, would be beyond the watchdog’s reach. Fees charged on debit-card transactions would be limited.

TITLE XI. Federal Reserve

The Fed’s emergency lending would be exposed to congressional scrutiny, but not its decisions on interest rates. New limits would be placed on the Fed’s so-called 13(3) emergency lending authority

TITLE XII. Financial Access

Programs would be supported to help people without bank accounts to open them and to improve access to small loans and enhance financial literacy.

TITLE XIII. Funding

The costs of the reform bill would be met by funds raised from shutting down the $700 billion Troubled Asset Relief Program, and increasing the amounts of money that banks must pay to insure their deposits.

An earlier funding plan that targeted a new tax at large Wall Street banks and financial firms was dropped after some Senate Republicans complained about it.

TITLE XIV. Mortgage Reform

Mortgage lenders would have to assess borrowers’ ability to repay before making a loan. Pre-payment penalties against borrowers and bonuses to lenders known as “yield spread premiums” would be barred, with violators facing penalties.

Other new protections would be set up for borrowers aimed at ending predatory and abusive mortgage lending practices.

Source: Reuters via CNBC

 

 

Posted by: Shmuel Shayowitz, Approved Funding

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Biggest Defaulters on Mortgages Are Now the Very Rich

LOS ALTOS, Calif.—No need for tears, but the well-off are losing their master suites and saying goodbye to their wine cellars.

The housing bust that began among the working class in remote subdivisions and quickly progressed to the suburban middle class is striking the upper class in privileged enclaves like this one in Silicon Valley.

Whether it is their residence, a second home or a house bought as an investment, the rich have stopped paying the mortgage at a rate that greatly exceeds the rest of the population.

More than one in seven homeowners with loans in excess of a million dollars are seriously delinquent, according to data compiled for The New York Times by the real estate analytics firm CoreLogic.

By contrast, homeowners with less lavish housing are much more likely to keep writing checks to their lender. About one in 12 mortgages below the million-dollar mark is delinquent.

Though it is hard to prove, the CoreLogic data suggest that many of the well-to-do are purposely dumping their financially draining properties, just as they would any sour investment.

“The rich are different: they are more ruthless,” said Sam Khater, CoreLogic’s senior economist.

Five properties here in Los Altos were scheduled for foreclosure auctions in a recent issue of The Los Altos Town Crier, the weekly newspaper where local legal notices are posted. Four have unpaid mortgage debt of more than $1 million, with the highest amount $2.8 million.

Not so long ago, said Chris Redden, the paper’s advertising services director, “it was a surprise if we had one foreclosure a month.”

The sheriff in Cook County, Ill., is increasingly in demand to evict foreclosed owners in the upscale suburbs to the north and west of Chicago—like Wilmette, La Grange and Glencoe. The occupants are always gone by the time a deputy gets there, a spokesman said, but just barely.

In Las Vegas, Ken Lowman, a longtime agent for luxury properties, said four of the 11 sales he brokered in June were distressed properties.

“I’ve never seen the wealthy hit like this before,” Mr. Lowman said. “They made their plans based on the best of all possible scenarios—that their incomes would continue to grow, that real estate would never drop. Not many had a plan B.”

The defaulting owners, he said, often remain as long as they can. “They’re in denial,” he said.

Here in Los Altos, where the median home price of $1.5 million makes it one of the most exclusive towns in the country, several houses scheduled for auction were still occupied this week. The people who answered the door were reluctant to explain their circumstances in any detail.

At one house, where the lender was owed $1.3 million, there was a couch out front wrapped in plastic. A woman said she and her husband had lost their jobs and were moving in with relatives. At another house, the family said they were renters. A third family, whose mortgage is $1.6 million, said they would be moving this weekend.

At a vacant house with a pool, where the lender was seeking $1.27 million, a raft and a water gun lay abandoned on the entryway floor.

Lenders are fearful that many of the 11 million or so homeowners who owe more than their house is worth will walk away from them, especially if the real estate market begins to weaken again. The so-called strategic defaults have become a matter of intense debate in recent months.

Fannie Mae and Freddie Mac , the two quasi-governmental mortgage finance companies that own most of the mortgages in America with a value of less than $500,000, are alternately pleading with distressed homeowners not to be bad citizens and brandishing a stick at them.

In a recent column on Freddie Mac’s Web site, the company’s executive vice president, Don Bisenius, acknowledged that walking away “might well be a good decision for certain borrowers” but argues that those who do it are trashing their communities.

The CoreLogic data suggest that the rich do not seem to have concerns about the civic good uppermost in their mind, especially when it comes to investment and second homes. Nor do they appear to be particularly worried about being sued by their lender or frozen out of future loans by Fannie Mae, possible consequences of default.

The delinquency rate on investment homes where the original mortgage was more than $1 million is now 23 percent. For cheaper investment homes, it is about 10 percent.

With second homes, the delinquency rate for both types of owners was rising in concert until the stock market crashed in September 2008. That sent the percentage of troubled million-dollar loans spiraling up much faster than the smaller loans.

“Those with high net worth have other resources to lean on if they get in trouble,” said Mr. Khater, the analyst. “If they’re going delinquent faster than anyone else, that tells me they are doing so willingly.”

Willingly, but not necessarily publicly. The rapper Chamillionaire is a plain-talking exception. He recently walked away from a $2 million house he bought in Houston in 2006.

“I just decided to let it go, give it back to the bank,” he told the celebrity gossip TV show “TMZ.” “I just didn’t feel like it was a good investment.”

The rich and successful often come naturally to this sort of attitude, said Brent T. White, a law professor at the University of Arizona who has studied strategic defaults.

“They may be less susceptible to the shame and fear-mongering used by the government and the mortgage banking industry to keep underwater homeowners from acting in their financial best interest,” Mr. White said.

The CoreLogic data measures serious delinquencies, which means the borrower has missed at least three payments in a row. At that point, lenders traditionally file a notice of default and the house enters the official foreclosure process.

In the current environment, however, notices of default are down for all types of loans as lenders work with owners in various modification programs. Even so, owners in some of the more expensive neighborhoods in and around San Francisco are beginning to head for the exit, according to data compiled by MDA DataQuick.

In Los Altos, Los Altos Hills and the most expensive neighborhood in adjoining Mountain View, defaults in the first five months of this year edged up to 16, from 15 in the same period in 2009 and four in 2008.

The East Bay suburb of Orinda had eight notices of default for million-dollar properties, up from five in the same period last year. On Nob Hill in San Francisco, there were four, up from one. The Marina neighborhood had four, up from two.

The vast majority of owners in these upscale communities are still paying the mortgage, of course. But they appear to be cutting back in other ways. The once-thriving Los Altos downtown is pocked with more than a dozen empty storefronts in a six-block stretch.

But this is still Silicon Valley, where failure can always be considered a prelude to success.

In the middle of a workday, one troubled homeowner here leaned over his laptop at the kitchen table, trying to maneuver his way out from under his debt and figure out the next big thing.

His five-bedroom house, drained of hundreds of thousands of dollars of equity over the last 13 years, is scheduled for auction July 20. Nine months ago, after his latest business (he has had several) failed in what he called “the global meltdown,” the man, a technology entrepreneur, said he quit making his $9,000 monthly payments.

“I’m going to be downsizing,” he said.

The man spoke on the condition of anonymity because, he said, he did not want his current problems to interfere with his coming reinvention. “I’m a businessman,” he explained. “I have to be upbeat.”

This story originally appeared in the The New York Times

URL: http://www.cnbc.com/id/38163917/

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 Mortgage Turmoil Video

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http://money.cnn.com/news/storysupplement/economy/bank_failures/index.htm

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This great article from the Wall Street Journal further supports my theory of collusion in the US Government between the US/Regulators and their beloved Goldman Sachs. Remember, a lot of former Goldman “boys” have played a monumental role in some of the Federal programs, bailout, and administration…

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A Tale of Two Bailouts: Goldman’s profits, CIT’s trouble, and ‘too big to fail.’

Yesterday saw one TARP recipient, Goldman Sachs, report $3.44 billion in profits even as another, CIT, teeters on the edge of either bankruptcy or another taxpayer bailout. Which way CIT will tip remained unclear as we went to press, but its very plight shows how the government’s approach to systemic risk has created groups of financial “haves” and “have nots.”

What the Goldmans of the world have in addition to profits is the widespread belief that they are too big to fail. Both Goldman and CIT converted into bank holding companies at the height of the financial panic last fall, which made them eligible for TARP injections. Goldman also benefited at a crucial moment from the Federal Reserve takeover of AIG, and it received the additional filip of FDIC-guaranteed debt issuance through the Temporary Liquidity Guarantee Program. CIT was excluded from the latter program on grounds that it didn’t pose a systemic risk, even as larger competitors like General Electric were allowed in.

CIT’s asset quality has since fallen further, and it now faces $2.7 billion in maturing debt this year that investors fear it will not be able to roll over. So it is seeking another taxpayer rescue, and officials at Treasury and Fed are sympathetic.

But if CIT — a company one-tenth the size of Lehman Brothers — can be bailed out long after the panic has passed, the word “systemic” has lost all meaning. CIT has long been a lender to subprime corporate borrowers, and this decade it took on even greater risks at precisely the wrong time. It has lost money for eight straight quarters. Its lending supports less than 1% of the total U.S. retail and manufacturing, and plenty of competitors could pick up its market share.

There’s also a question of why the FDIC — which is supposed to protect bank depositors — should be the rescue agent. CIT’s bank is only a small part of the company and is so far walled off from trouble. CIT executives want permission to stuff some of the company’s assets into the bank so they can finance them with brokered deposits. But that would put the FDIC’s deposit fund at greater risk just when it is stretched from other bank failures. The FDIC should also be winding down its debt guarantee program, not extending it to new and riskier companies. Taxpayers shouldn’t be put at risk for further losses via the FDIC merely because Treasury and the Fed don’t want to admit losses on their TARP investment.

Of course, if the feds do let CIT fail, this will only confirm that the only certain survivors in the current market are banks big enough that the government figures it must bail them out. Just ask the many small banks that have been rolled up by the FDIC at a rate of two a week since the beginning of the year, with eight so far in July alone. That can only strengthen the likes of Goldman, which apparently needs no help printing money anyway.

Goldman’s traders profited in the second quarter from taking advantage of spreads left wide by the disappearance of some competitors (Lehman, Bear Stearns) and the risk aversion of others (Morgan Stanley). Meantime, Goldman’s own credit spreads over Treasurys have narrowed as the market has priced in the likelihood that the government stands behind the risks it is taking in its proprietary trading books.

Goldman will surely deny that its risk-taking is subsidized by the taxpayer — but then so did Fannie Mae and Freddie Mac, right up to the bitter end. An implicit government guarantee is only free until it’s not, and when the bill comes due it tends to be huge. So for the moment, Goldman Sachs — or should we say Goldie Mac? — enjoys the best of both worlds: outsize profits for its traders and shareholders and a taxpayer backstop should anything go wrong.

We like profits as much as the next capitalist. But when those profits are supported by government guarantees or insured deposits, taxpayers have a special interest in how the companies conduct their business. Ideally we would shed those implicit guarantees altogether, along with the very notion of too big to fail. But that is all but impossible now and for the foreseeable future. Even if the Obama Administration and Fed were to declare with one voice that banks such as Goldman were on their own, no one would believe it.

If there is a lesson in this week’s tale of two banks, it’s that it won’t be enough to give the Federal Reserve a mandate to “monitor” systemic risk. Last fall’s bailouts are reverberating through the financial system in a way that is already distorting the competition for capital and financial market share. Banks that want to be successful will also want to be more like Goldman Sachs, creating an incentive for both larger size and more risk-taking on the taxpayer’s dime.

One policy response to the incentives created by last fall’s bailout is simply to restrict the proprietary trading done by the subsidiaries of bank holding companies that enjoy both FDIC deposit insurance and an implicit government subsidy on their cost of capital. This is what Paul Volcker proposed, only to be overruled by Tim Geithner and Larry Summers. Another answer would be an FDIC-style bailout tax, perhaps tied to leverage ratios, for those in the too-big-to-fail camp. Developing a template to facilitate the seizure and orderly winding down of failing financial giants is also an essential element of whatever reform Congress cooks up.

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(Reuters) – The U.S. credit-card industry may pull back well over $2 trillion of lines over the next 18 months due to risk aversion and regulatory changes, leading to sharp declines in consumer spending, prominent banking analyst Meredith Whitney said.

The credit card is the second key source of consumer liquidity, the first being jobs, the Oppenheimer & Co analyst noted.

“In other words, we expect available consumer liquidity in the form of credit-card lines to decline by 45 percent.”

Bank of America Corp, Citigroup Inc, and JPMorgan Chase & Co represent over half of the estimated U.S. card outstandings as of September 30, and each company has discussed reducing card exposure or slowing growth, Whitney said.

Closing millions of accounts, cutting credit lines and raising interest rates are just some of the moves credit card issuers are using to try to inoculate themselves from a tsunami of expected consumer defaults.

A consolidated U.S. lending market that is pulling back on credit is also posing a risk to the overall consumer liquidity, Whitney said.

Mortgages and credit cards are now dominated by five players who are all pulling back liquidity, making reductions in consumer liquidity seem unavoidable, she said.

“We are now beginning to see evidence of broad-based declines in overall consumer liquidity.”

“Already, we have witnessed the entire mortgage market hit a wall, and we believe it will, for the first time ever, show actual shrinkage over the next few months,” she wrote.

The credit card market will be 18 months behind the mortgage market and will begin to shrink by mid-2010, Whitney said.

Whitney also expects home prices to continue falling another 20 percent hurt by lower liquidity. They are down 23 percent from their peak, she said.

“In a country that offers hundreds of cereal and soda pop choices, the banking industry has become one that offers very few choices,” Whitney wrote in a note dated November 30.

She also said credit lines to consumers through home equity and credit cards had been cut back from the second-quarter levels.

“Pulling credit when job losses are increasing by over 50 percent year-over-year in most key states is a dangerous and unprecedented combination, in our view,” the analyst said.

Most of the solutions to the situation involve government intervention, and all of them require more dilutive capital to existing lenders, she said.

“Accordingly, we continue to be cautious on our outlook on US banks.”

SUGGESTIONS

In a column in the Financial Times, Whitney suggested four adoptable changes to make a difference.

The first would be to re-regionalize lending, which has gone from “knowing your customer” or local lending, to relying on what have proven to be unreliable FICO credit scores and centralized underwriting, due to the nationwide consolidation since the early 1990s, she wrote in the column.

Expanding the Federal Deposit Insurance Corp’s guarantee for bank debt will also help as the banks need to know they can access reasonably priced credit for an extended period to continue to extend new credit lines, she wrote in the column.

Whitney also advised delaying the introduction of new accounting rules, which would bring off-balance-sheet assets back on balance sheet, until 2011 or 2012, as the primary assets that will come back are credit card loans.

Whitney suggested amending the proposal on Unfair and Deceptive Lending Practices that is set to be adopted in 2010, saying restricting lenders’ ability to reprice an unsecured loan will cause them to stop lending or to lend less.

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The worst is yet to come. ‘No market for old men,’ TCW investment strategist warns in gloomy forecast

SAN FRANCISCO (MarketWatch) — An influential investment strategist has a dire forecast for U.S. stocks, credit markets and the continued independence of some of the nation’s top financial institutions. Jeffrey Gundlach, chief investment officer at Los Angeles-based mutual-fund company TCW Group Inc., told clients on a conference call late Wednesday that the crisis in credit and housing may not abate for several years and is actually getting worse.

In the deteriorating climate he sees unfolding, Gundlach said, the Standard & Poor’s 500 Index could fall another 30%, giant Citigroup could become an “AIG-sized debacle,” Morgan Stanley would merge with a banking company, Wachovia won’t be able to stand alone, default rates on even prime mortgages could soar, and European banks’ woes are just beginning. “This is no market for old men,” said Gundlach, who also manages TCW’s flagship Total Return Bond Fund. “This is no market for old-school thinking.”

Gundlach based his assessment on a belief that housing prices still face several more years of decline, a protracted slump, he said, not seen since the Great Depression. Moreover, Gundlach said it’s possible that home prices could be sluggish until 2022. “If it’s like the Depression experience — and it sure is shaping up that way — it could take several years. Maybe we won’t see a bottom in home prices until 2014,” he said.

Write-offs could top $1 trillion

As a forecaster, Gundlach didn’t just climb aboard the gloom-and-doom wagon. He was early to spot the cracks that subprime loans were making in the financial system, and among the first to warn that an era of easy money would come to a bad end. “The subprime market is a total unmitigated disaster and it’s going to get worse,” Gundlach told money managers and financial advisers at an investment conference in June 2007. See full story.

And Gundlach has put his shareholders’ money where his mouth is, shunning derivatives and counterparty risk in his bond fund portfolio. That defensive posture should offer protection in the continuing credit storm that Gundlach foresees. In this bleak scenario, an unprecedented — and growing — number of home foreclosures, along with mortgage loans that are under water as soon as they’re originated and a glaring lack of buyers for even modestly risky assets keeps the financial system under enormous stress.

Expect loan default rates to rise, Gundlach said, not just in the subprime market, but among the top-drawer prime borrowers as well. The prime default rate could approach 10% from a current 2% before the carnage is over, he said. “The current environment is maybe a little worse that what was experienced in the Depression in terms of the housing market,” Gundlach said.

More troubles ahead

Accordingly, financial institutions may suffer write-offs that could surpass $1 trillion before conditions improve, he said. As of late August, credit losses and writedowns at the world’s 100-largest banks and brokerages topped $506 billion, he noted. Among the casualties, Gundlach said, is Citigroup. The company’s balance sheet problems could be on a scale similar to that of insurer American International Group, which the U.S. bailed out this week. “I would give a very meaningful probability to the biggest, next AIG-size debacle being Citigroup,” the strategist said. “I would definitely not be a buyer of Citigroup stock,” Gundlach said. “If I were going to buy financial market stocks,” he added, “I would be a buyer of Wells Fargo, JPM and BAC. Other financial giants also won’t escape the crisis unscathed, Gundlach said. “I don’t see how Wachovia can make it as a standalone,” he said. He expressed the same sentiment about Morgan Stanley.

Indeed, late Wednesday the New York Times reported that Morgan Stanley was exploring a merger with Wachovia or another bank. Europe’s financial giants are in similar or even worse shape than their U.S. counterparts, Gundlach said, with “substantial exposures to assets which U.S. banks are now getting taken to the woodshed over. I would rate all European banks as not a buy.” The breakdown will take a further toll on U.S. stocks, Gundlach added. The S&P 500 will tumble below 800, he said, about 35% below its 1156 close on Wednesday.

Said Gundlach: “None of us have ever seen this, and it’s no market for old men, but risk aversion is the order of the day.”

Jonathan Burton is an assistant personal finance editor for MarketWatch, based in San Francisco.

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