"I've been bullish in the past and I've been bearish too, and today I'm more bearish than ever," Oppenheimer & Co. analyst Meredith Whitney said at the opening of her presentation at the Oppenheimer Israel 9th Annual Investor Conference in Tel Aviv yesterday. Talking to journalists earlier, Whitney justified her reputation as Wall Street's new prophet of doom.
"The banks will be under pressure for the rest of the year, and will have to raise capital to survive," she said. "It may sound crazy, but we're not even halfway through the crisis."
Whitney covers banks and financial institutions at Oppenheimer, one of Wall Street's smaller investment banks. She won glory last November when she downgraded Citigroup, after reaching the conclusion that the bank would be forced to cut its dividend, or raise capital, or both. "At the time, we wrote that Citigroup was short of capital to the tune of $30 billion, and people were astonished. Since then, they've raised $40 billion, and also cut the dividend," she says.
The downgrade led to a sharp fall in Citigroup's stock price, which dragged the rest of Wall Street down with it. "I knew my recommendation would affect Citi," Whitney recalls, "but I didn't imagine that it would have such an impact on the entire market."
Can you understand why other analysts didn't see what you saw?
Whitney: "There were other analysts with sell recommendations, but none of them focused on Citigroup's shareholders' equity or cast doubt on the dividend. That was a sacred cow. But math is math it was clear to me that they were short of capital and couldn't distribute a dividend like that.
"But there's no doubt that there's more pressure on analysts in the research departments of large firms. Other firms are more involved in banking and are scared of arousing controversy."
And what about the role of the rating agencies?
"The rating agencies still haven't downgraded some of the financial institutions. The agencies are paid by the institutions they rate, and that can clearly be a problem. They lost a lot of credibility after the Enron affair, and lost so much more in the current crisis, to the point that the bond market no longer takes any notice of them. On the other hand, the market needs some kind of institution like the rating agencies to maintain such a high volume of trading."
And what about rating of the financial products themselves?
"Here there's another problem. I called it "the ring of fire." Under regulatory rules, the banks are obliged to maintain a certain amount of shareholders' equity for all debt they hold. As soon as a debt instrument that a bank holds is downgraded, the bank needs more equity. And then, either the bank raises capital externally, or it cuts its dividend, or it has to sell the problem assets, and as soon as it sells them, asset prices fall further, and the cycle repeats itself.
"No-one knows how much capital the banks will have to write off and raise from other sources, and so I say, even if it sounds crazy we really aren't even midway through the crisis. At the moment, the banks are raising capital just to fill holes, and I estimate that it will take the financial institutions between nine and eighteen months to deal with the crisis."
On the other hand, in the past month or two, stocks have started rising again.
"That can't go on, certainly not in financial stocks. The banks' profit estimates continue to fall, actual profits continue to fall, and if stock prices don't fall accordingly that means that multiples are rising. When risk rises, multiples are supposed to fall, not rise. I predict that, in the near future, financial stocks will only become cheaper."
The regulators overreact
What's your opinion of the way Bernanke handled the crisis?
"Bernanke inherited a bad situation. The information at his disposal is also problematic a lot of the data decision makers use are simply not up to date. As far as interest rate cuts are concerned, it's pretty clear that there's no more room for rates to fall.
"Another point about Bernanke rescuing Bear Stearns wasn't the best idea. In a capitalist environment, it's OK for institutions to fail, and the US government doesn't have the money to save all the financial institutions on Wall Street."
There are those who blame the crisis on the regulators.
The regulators certainly stood aside and watched it all happen. It's pretty amazing that even when US interest rates started rising again, variable rate loans continued to grow. That's surely absurd; no customer who understands what he's signing would want that. That should have set red lights flashing about the way the banks grant loans. On the other hand, now the regulators have gone overboard in their response, in that they want to require more shareholders' equity from the banks for every loan. That may be good in the long term, but it's problematic at the height of a liquidity crisis."
Where do you see the next bubble?
I'll give you an unorthodox answer: the next bubble is a regulation bubble. This isn't a bubble in the accepted sense, as in technology or commodity stocks, but it's a bubble in terms of a mistaken concept. The regulators will now overreact to everything they missed for five years."
The investments by sovereign funds, from Gulf and Asian countries, have recently caused a storm of debate in the US.
"You have to remember that all the capital investments by sovereign funds in the banks were made without voting rights. In principle, I think that if the US is allowed to invest all over the world, then it should be permissible for all of the world to invest in the US. Politically it’s interesting when, on one hand, it's something vital for resolving the crisis in the US, and on the other hand it's happening at a time when the US is becoming more and more protectionist."
If the US really does slide into recession, will that necessarily drag down the rest of the world?
"In some ways you see economies that are growing independently, regardless of the US. But the US consumer is still the most important consumer in the global economy. Britain is certainly connected to the US, and so is the rest of Europe. Surprisingly, Latin America seems less affected at the moment Mexico, for example, is holding up nicely but that can't continue very much longer."
What do you think about the dollar-euro exchange rate?
"In the long term, everything is connected to growth possibilities. If we can grow faster and if we accumulate less debt the dollar will rise again. As a tourist I certainly think the euro is too expensive (laughs)."
In the past few months, you've been in the headlines a lot. Do you manage to enjoy that?
"The truth is that it's the coolest thing in the world. So many smart people that I held in high esteem suddenly discovered me. There are people that I looked up to for years, and there I am, invited to the same panels and discussions and dinner parties. There's nothing cooler than that. On the other hand, you have to be wary of the press. I wouldn't want to be remembered for one downgrade; I want to be remembered for quality research over time."
Published by Globes [online], Israel business news - www.globes.co.il - on May 19, 2008
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