The Trickle-Up Theory

Throughout the summer, the bad news in the mortgage industry generally centered around the collapse of independent subprime lenders or the shutdown of units of larger companies. (A conspicuous exception was Bear Stearns, which saw two of its hedge funds go belly up due to extensive investments in securities backed by subprime mortgages, and is a now rumored takeover target for everyone from the Chinese government to Warren Buffett.) But now, as third-quarter earnings roll in and banks stand naked before Wall Street and reveal their finances, the impact of the mortgage crisis on the top tier of banks is becoming clearer, with losses not only impacting their lending departments but also investment banking operations involved in underwriting and trading mortgage-backed securities.

The numbers are staggering. To start the week, the biggest bank in the country gave the Street a case of the Mondays. In addition to a 57% drop in earnings, Citigroup announced that it is writing down $1.35 billion worth of loans related to the once-booming, now-stagnant private equity market; assuming more than $1.5 billion of losses from loans that the company had expected to sell to investors; and taking a whopping $2.98 billion charge for consumer credit costs, including provisions for future losses. Number two Bank of America increased its provisions to cover consumer and small business credit costs by nearly $1 billion.  Wachovia recorded $1.3 billion of loan losses and writedowns for the quarter and quadrupled its provisions for expected future losses. Despite an uptick in earnings, JPMorgan Chase also reported $1.3 billion in writedowns and loan-loss provisions. Wells Fargo set aside nearly $1 billion, mainly to cover losses in home equity and car loans.

With the rough going expected to continue, some are looking to the government to lend a hand, either by bailing out failing bank-sponsored structured investment vehicles with exposure to troubled loans or by cutting interest rates again. The Department of the Treasury is taking a more hands-on approach: US Treasurer Anna Escobedo Cabral is traveling to one of the cities hit hardest by the meltdown, Cleveland, to offer mortgage advice to homeowners. She may want to add trips to some bank board rooms to her itinerary.