Blank Banks Blink

On March 1^st, FDIC head, Sheila Blair, wrote a letter to the senior managers of the 8,305 insured banks and savings & loans, telling them that there would be an increase in FDIC assessments to prevent the Federal Deposit Insurance Corporation (the government corporation that protects depositors from bank failures up to $250,000) from becoming insolvent. In her words: "Without substantial amounts of additional assessment revenue in the near future, current projections indicate that the fund balance will approach zero or even become negative."

This additional assessment ($27 billion this year alone) will reduce an already strained credit market by literally reducing the amount of money that banks are legally permitted to lend – as if they were actually really lending. But with the FDIC projecting $65 billion in insured losses from expected bank failures by 2013, the remaining $18.9 billion (as of the end of 2008, down from $52.4 billion at the end of 2007) is clearly inadequate. From January of 2008 to present, we’ve seen 41 banks fail… and this is only the beginning. Bank examiners applying the legendary “stress test” are very likely to accelerate the failure rate as they uncover hidden “surprises.”

In fact, “surprises” are proving quite a challenge to the new administration, in power less than two months and discovering that their projection of fourth quarter GDP contraction - 3.8% - was really nearly double that at a nasty 6.2% (the highest since the end of the Great Depression)… and we don’t even have the new unemployment and contraction numbers for the first quarter of 2009.

As the government issues new treasury bonds to pay for the rising deficit, as international buyers are willing to purchase fewer and fewer of our bonds (they have their own problems and cash shortfalls), we are watching the Federal Reserve increasing their purchase of these governmental debt instruments. Ask yourself where the Fed gets the money to make these “market-sustaining” bond purchases? They just buy them… increasing “the M1 – money supply” … in laymen’s terms, they “print” (in a virtual way) money. If the rest of the world weren’t so horribly positioned, particularly Europe, we’d already be seeing the beginnings of an inflationary spiral.

Some people call what has occurred a reset, in which assets are dropping from over-inflated values driven by easy credit to their real values (a permanent adjustment, a new bottom that will be the total basis for future growth), and this government interference is merely an unsustainable attempt to hold those inflated values to the previously unacceptable levels through all of this market support. Here’s how it looks in the banking sector: Bank of America stock is hovering a near-insolvency levels at a couple of dollars a share – even Citigroup slipped under a buck (it once traded at $55/share), and if the NYSE hadn’t recently changed its rules, would have already been de-listed from the exchange. Lots of other big banks are not too far behind.

So many financial institutions are still carrying assets like subprime derivatives on their books at values that are unsustainable in light of the facts. Like this one from J.W. Elphinstone at the Associated Press on March 5^th: “A stunning 48 percent of the nation's homeowners who have a subprime, adjustable-rate mortgage are behind on their payments or in foreclosure, and the rate for homeowners with all mortgage types hit a new record… But that's not the worst of it…. A record 5.4 million American homeowners with a mortgage of any kind, or nearly 12 percent, were at least one month late or in foreclosure at the end of last year, the Mortgage Bankers Association reported. That's up from 10 percent at the end of the third quarter, and up from 8 percent at the end of 2007.”

Some other soothsayers think that the government is so mired in the banking system – that it is already the real party-in-interest (hence we really already live in a world where banking has effectively already been nationalized) – and that the government might as well hit the “reset button,” before we reach a “Great Depression level collapse” where they believe this economy is truly headed based on numbers like those above, and forgive all home mortgage and consumer credit card debt, which will do more to “restart” our economy than a litany of continuing and escalating government bailouts.

What’s my opinion? Folks are complaining that I point out all of the issues, but I am short on solutions. OK… Let me start with a simple set of what I perceive to be essential steps that the government can and must take to restore credit and solidify the financial sector.

1. Keep those bank examiners working on the stress test, and apply the most vigorous analysis, avoiding the banks’ emphasis on “tier 1” plus “tier 2” assets. Take a good hard look at “assets” (like derivatives) that are carried at one value by bank A and at a vastly reduced value by bank B. Let the banks that are going to fail meet their maker as soon as possible. Shore up the remaining banks, and stop worrying about whether you are “nationalizing” any of them. The government has effectively owned or controlled banks for quite a while now, particularly since the meltdown. This is a huge financial commitment, probably over $1 trillion, but if this does not take place, the “bad of the now” will look pleasant well before this time next year.

2. For a period of at least 6 months, maybe even a full year, guarantee interbank lending among and between FDIC lenders. This encourages loan syndication, necessary to provide cash flow to larger American businesses (we call them “employers”).

3. Don’t throw the baby out with the bath water, but begin a new set of banking regulations making credit ratings real, allow banks to create securitized loan packages under strict new standards (and require that originating banks keep at least 15-20% of these loans so they always have “skin in the game”), but give business and the public confidence that you are really regulating!

4. Understand that with rising unemployment, sinking real estate values, falling sales and consumer activity and a seriously-impaired stock market, there are virtually no qualified borrowers or solid assets left under relatively conservative lending practices that are sufficient for banks to consider loans (under normal credit analysis parameters) even when they have money. So the government needs directly to fund (or at a minimum guarantee) loans based on temporary set of reduced standards that effectively would allow credit with reasonable risks taking into consideration that everybody is “impaired” in this environment. In short, the government has to focus as much on borrowers as it has on lenders.

I’m Peter Dekom, and there are answers!