Time to worry about the banking system

"Never believe anything until it has been officially denied."
- Otto Von Bismark

Otto may have been one of history's great bastards, but he was also a Machiavellian genius when it came to modern politics.
For instance, on March 10, Bear Stearns denied rumors that they were having a liquidity problem. On March 15, Bear Stearns was effectively bankrupt.
On February 7, 2002, WorldCom denied rumors that it was about to go bankrupt. On July 19, WorldCom went bankrupt.

This pattern gets repeated almost every single year like clockwork. Which is why the news today is more worrying than normal.

The chairperson of the FDIC was all over the news today reassuring us poor, uneducated saps that the banking system was nothing to worry about.

"There will be more bank failures, but nothing compared with previous cycles, such as the savings-and-loans days," Sheila Bair, chairwoman of the Federal Deposit Insurance Corp., said in an interview.

That may be comforting news if the FDIC didn't have such a horrible track record at predicting market trends. For instance, this blog pulled up an old FDIC report from late 2004 in which they basically encouraged borrowers to extract every last cent of their equity from their homes through home equity loans. What makes this particularly notable is that negative equity is the leading cause of foreclosures in America today, and the FDIC recognized this risk in the report and yet still encouraged the practice.

At the very last minute, a taxpayer bailout of HELOCs was added to the housing bailout bill which just got approved by Congress. In other words, a bailout for the banks who lent to people who used their homes like an ATM. More on that below.

But let's not stop there. There are plenty more examples.

1) Paulson appears on Face the Nation and says "Our banking system is a safe and a sound one." If the banking system were sound, everyone would know it (or at least believe it). There'd be no need to say it.

2) Paulson asked for "Congressional authority to buy unlimited stakes in and lend to Fannie Mae (FNM) and Freddie Mac (FRE)" just days after saying "Financial institutions must be allowed to fail."

3) Former Fed Governor William Poole says Fannie Mae and Freddie Mac losses make them insolvent.

4) The Fed has implemented an alphabet soup of pawnshop lending facilities, whereby the Fed accepts garbage as collateral in exchange for Treasury bonds. Those new Fed lending facilities are called the Term Auction Facility (TAF), the Term Security Lending Facility (TSLF), and the Primary Dealer Credit Facility (PDCF).

5) Bank of America agreed to take over Countywide Financial and twice insisted that Countrywide will add profits. Inquiring minds ask: "How the hell can Countrywide add to Bank of America earnings?" Here's how: Bank of America just announced it won't guarantee $38.1 billion in Countrywide debt. Questions over "fraudulent conveyance" are now surfacing.

6) Shares of Ambac (ABK) fell from $90 to $2.50. Shared of MBIA (MBI) fell from $70 to $5. Sadly, the top three rating agencies kept their rating on the pair at AAA nearly all the way down.

7) Of the $6.84 Trillion in bank deposits, the total cash on hand at banks is a mere $273.7 Billion. Where's the rest of the loot? The answer is: In off-balance-sheet SIVs, imploding commercial real estate deals, Alt-A liar loans, Fannie Mae and Freddie Mac bonds, toggle bonds (where, amazingly, debt's paid back with more debt) and in all sorts of other silly (and arguably fraudulent) financial wizardry schemes that have bank and brokerage firms leveraged at 30 to 1 or more. Those loans can't be paid back.

8) Washington Mutual (WM), another troubled bank, refused to honor Indymac cashier's checks.

Washington Mutual is an interesting example. It was only yesterday that Washington Mutual lost $3.3 Billion. It's extremely interesting that WaMu initially refused to honor checks from a bank seized by the FDIC, supposedly with the full backing of the federal government. They later agreed to accept them, but only with an "extended hold period". Wells Fargo has also used a similar policy.
That begs the question: if major banks don't trust the FDIC guarantee, why should you?

But let's take this a step further. Recently WaMu announced "We have no plans to raise capital." On the surface that sounds like a good thing. But when you dig beneath the surface you find something else entirely.

Three months ago, with Washington Mutual's shares at $13.15, a group of investors led by Forth Worth, Texas-based TPG agreed to buy $7 billion of stock at $8.75, a 33 percent discount.

As losses mount, a clause in the TPG agreement makes it more costly for WaMu to raise capital or be acquired. If WaMu is sold for less than $8.75 a share or is forced to raise more than $500 million in equity, it must compensate TPG for the difference, according to filings with the U.S. Securities and Exchange Commission.

"We don't know how their investment plays out, but we also don't know how this affects WaMu to the extent they need to raise more capital," said Steven Davidoff, law professor at Wayne State University Law School in Detroit. "They really can't raise equity."

Consider a major bank that is losing billions of dollar and can't raise equity? The terms "rock" and "hard place" come to mind.

WaMu isn't alone in this regard. Merrill Lynch also agreed to the same limitation on equity issues when they accepted capital from Temasek (the Singapore sovereign wealth fund) earlier this year. Speaking of Merrill Lynch, they lost nearly $4.7 Billion this past quarter and nearly $19 Billion over the past year.
Citigroup is in a similar situation with penalties for issuing new equities, but also suffering massive losses.
Of course the big loser of the week is Wachovia, which lost nearly $9 Billion this past quarter.

Remember when losing a few million dollars got people excited? Now people get excited when a company doesn't lose as many billions as expected. Someone is in denial, and that someone is on Wall Street.

Why are these banks losing money hand over fist? The housing bust, of course. The problem is that the housing bust is far from over.

Foreclosures may be "nearing a plateau," he said, but it could also mean that lenders are "swamped and can't handle processing any paperwork."

Sean O'Toole, founder of the data tracking firm ForeclosureRadar, thinks the leveling off may mean that defaults on subprime mortgages -- loans made to poorly qualified buyers -- are nearing a peak.

But the housing market still could face a new wave of defaults from other loans that will adjust to higher rates, including pay-option adjustable-rate mortgages and so-called Alt-A loans, which are a step between subprime and high-quality prime loans.

"Most resets on those products are still in front of us," O'Toole said.

UCLA economist Edward Leamer agreed that the default rate on Alt-A loans, a specialty of failed Pasadena lender IndyMac Bank, could be pivotal.

O'Toole said that even if foreclosures do level off, it probably will take years for the market to absorb all the homes that are being resold by lenders at steep discounts.

Credit quality is deteriorating everywhere according the latest Moody's report. Which brings us to the topic de jour - the taxpayer bailout of Fannie Mae and Freddie Mac.

``It sounds like the GSEs got what they wanted again,'' said Paul Miller, an analyst with Friedman Billings Ramsey & Co. in Arlington, Virginia. ``They got a big backstop and they got language that the Treasury doesn't necessarily have to stop them from paying dividends or cap compensation."

Yep, the taxpayer is going to pick up the bill without any real reforms of these institutions at all. The Democratic Congress has stabbed us all in the back.
How much will this bailout cost us? No one knows! This is a blank check because the numbers have been pulled out of thin air.

The budget office, while acknowledging that the $25 billion was, at best, a rough estimate, did not explain fully how it came up with the figure. The office said it analyzed the companies’ financial statements and consulted with regulators, analysts, market participants and the companies themselves to estimate possible future losses and the amount of any cash injection that might be needed from the Treasury.

Senator Jim DeMint, Republican of South Carolina, said lawmakers were generally supportive of the overall rescue plan, but he added that he had doubts about the $25 billion estimate. “Everyone knows it’s just a wild guess,” Mr. DeMint said. “We are either going to spend zero or we’re going to spend a whole lot more than they are talking about.”

You better believe that the number isn't "zero", and the $25 Billion number only covers to the end of 2009.
The fact that they raised the national debt limit by $800 Billion as a mandatory part in this same exact bill should give you a hint.

The funniest part of this bailout bill is the fact that the FHA is supposed to take part. But the FHA is already losing billions of dollars from their previous bailout efforts.

“Let me repeat: F.H.A. is solvent,” Mr. Montgomery said on Monday in a speech at the National Press Club. “However, no insurance company can sustain that amount of additional costs year after year and still survive. Unless we take action to mitigate these losses, F.H.A. will soon either have to shut down or rely on appropriations to operate.

We are looking at a bailout that has the potential of rivaling the costs of the Iraq War, but no one here seems to care. You should be outraged now because you will be outraged eventually, but then it will be too late.

[Update: Three more articles from today expand on this thread.]

Bank borrowing from Fed biggest ever

NEW YORK (Reuters) - U.S. banks' direct primary credit borrowing from the Federal Reserve rose to the highest level ever in the latest week, reflecting the growing need of the banking sector to rely on the central bank for cheap funding, analysts said.

Biggest demand ever at Fed's TSLF auction

"This data suggests a greater dependence on the Fed," said Ward McCarthy, managing director with Stone & McCarthy Research Associates, in Princeton, New Jersey.

And lastly, WaMu creditors pulling funds

July 24 (Bloomberg) -- Washington Mutual Inc. tumbled for a second day in New York trading after Gimme Credit LLC said unsecured creditors were ``pulling funds'' from the biggest U.S. savings and loan. Washington Mutual disputed the report.
...
``We won't use the phrase `run on the bank,' but we would be remiss if we did not observe that many creditors have quietly been pulling funds,'' wrote Shanley, based in Chicago. Their actions are ``presenting an increasing funding challenge,'' she wrote. Gimme Credit is an independent research firm serving corporate bond investors.

Comments

contrary view

What I see happening is the housing bill is passed and Freddie/Fannie are bailed out, which will affect US deficit, economy, but later, and banks are just setting up to gobble up all of the failed banks in some major acquisition pig fest similar to private equity firms. I just don't see this being economic Armageddon, more of another financials stock drop but in a rigged game.

They also might be pumping up the stock price, due to those equity deals.

But, I think foreign sovereign wealth funds, someone will come down and swoop this up in some insider trade to keep the ponzi scheme going.

Hey, you can say the Democratic party stabbed us in the back on EP, ain't it nice to call 'em when you see 'em?

You must have Javascript enabled to use this form.

It's all the fault of bloggers

This is classic stuff

The federal agency insuring bank deposits learned that it can't afford to ignore the blogs following its seizure this month of IndyMac Bank, the largest bank failure since the 1980s.

"The blogs were a bit out of control," Sheila Bair, chairman of the Federal Deposit Insurance Corp., told the San Francisco Business Times after a speech in San Francisco this week.

That's putting it mildly. Following the FDIC's takeover of IndyMac on July 11, widely followed blogs were speculating on bank runs on some of California's largest banks based on nothing more than people waiting for their branch to open or large deposits moving between financial institutions.

The FDIC plans to pay closer attention to the blogosphere in the future.

"We're very mindful of the media coverage and blogs in controlling misinformation. All I can say is were going to continue to stay on top of it," Bair said. "The misinformation that came out over the weekend fed a lot of depositors' fears."

IndyMac couldn't have possibly failed because of incompetence. It had to have been those darn bloggers like you, Robert! Shame on you! ;-)

You must have Javascript enabled to use this form.

oh those damn bloggers!

That is incredibly amusing. That said, to be honest, I will leave them nameless but I have seen posts on certain major blogs where they are generating panic. I mean come on, there is no way people are not going to be able to get their deposits under 100k. I think NDD would back me up on this one, you too. Even in the Great Depression most banks were solvent. What I find even more incredible that anyone would take financial advice from a blog post to the point of making a run on their bank. But, then, I always underestimate the stupidity of mass psychology (the crowd).

Perhaps we need a "hey, what do to with your money if you're worried about a bank failure besides stuff it under your mattress or buy up all of the gold at the Pawn shop and that's not shove it down your pants or pad your bra!" blog post.

But to try to blame the bloggers on IndyMac, ha, ha, ha....it's the bloggers who have been on the case on this implosion for months and months, before Congress I think held one hearing.

You must have Javascript enabled to use this form.

Reneging on FDIC insurance

is one of the few things that could actually cause Americans to take to the streets en masse and endanger the lives of Senators and Members of Congress. They will print the $$$ or slash military spending to the bone before they renege.

It wouldn't surprise me at all if a significant number of banks fail in the next couple of years, including one or more very large ones. FDIC has already indicating they are making an additional levy on member banks to shore up their funding. But the system as a whole going down? If that happens, hiding the currency in your mattress won't matter.

You must have Javascript enabled to use this form.

I can't confirm

this, but I've heard that the FDIC has up to 99 years to get you back your money.

Obviously, the time frame at which your money is returned to you matters a great deal.

You must have Javascript enabled to use this form.