What Whitney didn't fully appreciate back in 2005 was how the proliferation of interest-only, negative-amortization, and other exotic mortgages would transform many prime borrowers into subprime credit risks. As she wrote last December, the crucial mistake many lenders made was relying on FICO credit scores to gauge default risk, regardless of the size of the down payment or the type of loan. Many prime customers who took on mortgages with 90% or 100% loan-to-home-value ratios (LTVs) are now "performing closer to subprime loans," she wrote. The reason: Any borrower who's upside down in his mortgage - i.e., the size of his mortgage is bigger than the value of his home - is likely to make car and credit card payments before paying his home loan. "The hierarchy of payments has totally shifted," Whitney now says.

One of Citigroup's problems was that of all the banks, it had the greatest exposure in dollar terms to high-LTV mortgages. When housing prices turned south, the delinquency rate on Citi's home loans soared - rising 53% during the third quarter of 2007 (over the third quarter of 2006). Whitney says it was obvious that Citi would have to shore up its balance sheet. The bank's $10.8 billion in annual dividend payments was a clear source of potential savings. Less than three months after Whitney put out her report, Citi announced a 41% dividend cut designed to save the company $4.4 billion a year.

Whitney's current concern is that banks aren't slashing costs and cutting losses in their loan portfolios fast enough. On the cost side, she says, banks have yet to come to terms with the disappearance of the securitization market, which she believes will stay in hibernation for the next three years.

Why does this matter? From 2001 through 2005, for every dollar of bank capital used to make mortgage loans, ten were supplied via investors in mortgage securities. All that secondary-market capital is now sidelined, but the staffing levels of bank lending departments don't yet reflect it. By Whitney's reckoning, banks have laid off about 7% of their employees; she thinks the cuts need to reach 25%. "These companies have got to resize their businesses," she says. "Right now their expenses do not match their revenues."

She also argues that banks need to "get real" about how they're valuing their problem mortgage-related debt, much as Merrill Lynch has now done. And her idea of "real" is pretty drastic. Whereas most banks are estimating 20% to 25% peak-to-trough declines in housing prices, the Case-Shiller housing futures traded on the Chicago Mercantile Exchange portend a much steeper 33% decline, she points out. In fact, Whitney thinks the actual declines will be worse - closer to 40% - because of the loss of the securitization market and the paucity of mortgage credit available. And that means more defaults: "The consumer's ability to refinance his way out of trouble has diminished greatly."

This is where Whitney's critics start licking their chops. Thomas Brown, a veteran bank analyst and co-founder of bankstocks.com (with Hill, coincidentally), disagrees sharply with Whitney's contentions that banks need to rid themselves of problem loans and that their stocks won't rebound until the write-downs abate.

Brown counters that the numbers Whitney keeps trotting out are actually lagging indicators. "During the last credit crisis the stocks hit bottom in November 1990, and the losses and nonperforming assets didn't peak until well into 1991," he says. "Every cycle there's one analyst who races to be the most bearish, and this time it's her. Honestly, I think we'll look back and see that Meredith Whitney's credibility peaked on July 15" - the day many bank stocks hit their low point for the year (so far at least).

Brown goes a step further, alleging that it's "incredibly arrogant" of Whitney to tell banks and investment banks either to unload their problem loans and mortgage securities or to "get real" about how they're valued. He says there's plenty of history to indicate that holding tight may be the wisest course of action. "In the last cycle," Brown says, "Morgan Stanley made a fortune buying written-down commercial real estate assets from banks at 40 cents on the dollar." What peeves Brown most about Whitney is her unwillingness to assign a fair market valuation for the stocks she's trashing: "The only explanation I can see is, she has no idea how to evaluate the possible downside risks."

To be fair, Whitney has never said bank stocks are worthless. She would buy Wachovia at $5, for instance. (It's now $16.) But with his salvo Brown has actually restated, albeit pejoratively, a core part of Whitney's thesis. If she has no idea how to properly value bank stocks right now, it's because the metrics don't work. Price-to-earnings ratios are useless when earnings are nonexistent. And valuing banks on price-to-book ratios is just as futile. Those book values - which reflect underlying assets and liabilities - are moving targets. "Citibank has lost 50% of its book value since last year," Whitney says. "The point is, I do not think we are near the end of write-downs, so I continue to see capital levels going lower, capital raises diluting existing shares further, and stocks going lower."

Another negative: two little-talked-about regulatory changes Whitney says will stymie banks' recoveries. One is a new accounting rule known as FAS 141R. Given the depth of the crisis, Whitney expects to see bank regulators arranging shotgun marriages between well-capitalized institutions and foundering ones. Problem is, any such deals would have to happen before FAS 141R takes effect in December. The new rule, she says, "will make it almost impossible to do bank mergers." The rule demands that an acquirer not only immediately mark to market the portfolio of the company being bought - and remember, bids for mortgage assets are now few and far between - but also mark to market its own portfolio as well. "Nobody's going to want to do that," Whitney says.

Another regulatory change that may wreak havoc: Starting next year, the Office of Thrift Supervision will bar credit card issuers from using outside credit information to reset interest rates. For instance, Wells Fargo couldn't increase the rate on your Visa just because you were late on an electric bill. While Whitney thinks the OTS proposal is well intentioned, she's convinced that it will force banks to reduce the amount of credit they extend to consumers, dimming a business that has been a rare bright spot. With their credit lines trimmed, consumers will cut back even more on spending, deepening the recession. "When this takes effect," she says, "it's basically going to amount to a pay cut for the average American consumer."

Whitney's ability to find consumer peril in a proposal ostensibly so consumer-friendly speaks volumes about the darkness of her view. Indeed, she's so far out on a limb and so unequivocal in her bearishness, it's hard to envision how she could reverse course without losing credibility. It's a predicament similar to the one Abby Joseph Cohen faced in 2000 and 2001 - one that left her with egg on her face when the stock market faltered.

Fitzgibbon says she recently asked Whitney how it would all end, and Whitney's answer was fatalistic: "I'll make a bad call, and that'll be it." When I ask Whitney what's next for her, career-wise, she isn't sure. Getting into management holds some interest. Joining a hedge fund - a common next step for star analysts - does not. "All I know is, I want to do something big. I want to earn the right to be at the table with the smartest people."

Whatever her future holds, Whitney says she doesn't spend time fretting about whether her epic call on banks might be wrong. "Look, I always worry about what I might have missed, which is why I work so many hours and get so little sleep," she says. "But the numbers speak for themselves. And what they're all saying is, this is far, far from over."

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