The Wachovia situation is a good example to illustrate the point I have been making insufficient capital at Banks, and their extended leverage.

Citigroup Inc. to Acquire Banking Operations of Wachovia

Under the agreement, Citigroup Inc. will absorb up to $42 billion of losses on a $312 billion pool of loans. The FDIC will absorb losses beyond that. Citigroup has granted the FDIC $12 billion in preferred stock and warrants to compensate the FDIC for bearing this risk.

They are saying in effect that the $312 bn loan portfolio has significant bad debts and that Citi will absorb up to $42 Bn.  If we look at the last balance sheet here, Wachovia’s capital base was $74 Bn at the last quarter.  If the $42 Bn is correct, then Wachovia’s capital would be more than cut in half.  If the losses are greater, then the entire capital base could be erased.

Managing leverage and sound lending practices are essential for Banks, and Wachovia is a good example of how bad lending practices combined with high leverage is a disastrous combination.