Run on the Bank 2008 - Indymac

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video for this posting can be found at: http://www.youtube.com/watch?v=NqBhR1kkWHY.

Indymac was a large savings and loan that had split off from Countrywide, the largest mortgage provider in the United States, in 1997. Both were heavily involved in granting mortgages in the real estate bubble markets of the southwestern United States. Countrywide itself experienced a run on the bank in August 2007 in the earliest phase of the subprime crisis. Only an emergency cash infusion from Bank America, arranged by the Federal Reserve, kept it afloat. This was only a stopgap measure however and Bank America agreed to take over Countrywide in early 2008. This deal was also apparently secretly arranged by the Fed, although Bank America vehemently denied it despite the fact that it seemed to have the unusual term that Bank America wasn't responsible for Countrywide's debts (so who was?).

Although Indymac may not have been too big to fail like Countrywide, it was quite possible that the Fed would have arranged a bailout for it too, if it had had enough warning. Even though the chairman of the Senate banking committee had written a letter in late June to Indymac about its possible insolvency and the information in this letter inadvertently wound up in public hands, the FDIC seemed to be unaware of the precarious state of the bank. The FDIC is in charge of monitoring the health of the U.S. banking system and keeps a list of troubled banks. Indymac was not on that list at the time of its disastrous failure. This forced the FDIC to back peddle and claim that Indymac had really been on the list, but had only been put on it shortly 'before' its failure and that is why no one else seems to have known about it. This after the fact claim was inevitable since missing a bank failure that required the second biggest bailout in U.S. history would indicate that the FDIC hadn't the slightest idea of what was going on in the American banking system. .

The death blow to Indymac was a run on the bank which included long lines of suffering elderly and angry account holders who got so out of control that the police had to be called in. The similarities to bank runs in 1930s Depression U.S. were quite obvious. Banks failed then just as Indymac did in 2008 because they were insolvent. Contrary to popular belief, a run does not mean a bank will go under. U.S. banking history has numerous cases of banks surviving runs because their finances were in good shape. Insolvency is what destroys a bank, not the visible run that frequently gets the blame. Indymac management tried to take advantage of this mistaken belief to deflect blame for the banks failure by citing the letter from the chairman of the senate banking committee as the cause. Certainly they weren't going to say it was management incompetence that granted huge numbers of mortgages to people who were unlikely to ever pay them back that destroyed Indymac's finances..

One of the first things the FDIC did when it took over Indymac was stop foreclosures on its bad housing loans. Putting more of them on the books would make Indymac's finances look even worse. How this action was going to be paid for wasn't clear. It was already estimated that the Indymac failure would use up between 10% and 18% of the FDIC's $53 billion deposit insurance fund. One bigger bank failure, such as Wachovia or Washington Mutual, or a number of smaller ones, would wipe this fund out completely. Considering that financial rot permeated the U.S. banking system, nothing was more inevitable than the FDIC itself would require a future government bailout because of its own insolvency.

NEXT: Exposing Fannie Mae and Freddie Mac - Origins

Daryl Montgomery

Organizer, New York Investing meetup

http://investing.meetup.com/21

Subprime Housing Leads to Subprime Financial Institutions

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

The housing reports released in October 2007 which indicated the state of the market in September were even more dismal than those of the prior month. Nationally, foreclosures had doubled year over year and they had gone up as much as 500% to a 1000% in the worst hit bubble areas of the housing market. Existing Home Sales were down 23% nationally. Although also down substantially, New Home Sales were nevertheless reported as increasing (huh?).

The September 2007 New Home Sales report was a classic example of how the financial media frequently reports bad news as good and hopes people only read the headlines and not the fine print. The New Home Sales report originally indicated that there had been 795,000 houses sold in August. The report then indicated 770,000 houses sold in September. This drop of 25,000 was heralded by the media as a increase of 4.8%. This happened because the sales figures for August were revised downward to 735,000 (by almost 8%, an incredible error for a statistical report) and the September figure was above this number, so this indicated that sales were going up! The first thought of any rational person should of course have been, 'if the numbers for August were actually much lower, why shouldn't the ones for September be much lower as well?' Even a casual look inside the September report lent substantial support that this was indeed the case. Sales in the West, probably the worst hit housing area in the U.S., were supposedly up 38% - a completely absurd number and an indication that the September numbers were being overstated just as the August numbers had been.

Despite the complete devastation in housing sales., median house prices were reported up 2.5%. The statistical tricks that led to this impossible outcome were discussed previously in this blog in the posting, "Housing Market Collapses, but the Statistics Hold Up".

House sales were falling off a cliff because mortgage money was disappearing. By October 2007, 183 mortgage lenders had already closed their doors since the previous December. One that didn't was Countrywide, the largest mortgage lender in the United States and therefore presumably too big to fail. What kept Countrywide afloat was a $2 billion capital infusion in August from Bank of America. Barron's reported that there were rumors that this bailout had been secretly arranged by the U.S. federal government. If so, it would only be the first of many bailouts that the Feds would have to arrange to prop up failing American financial institutions. Shortly thereafter, one of the major British mortgage lenders, Northern Rock, experienced a run on the bank - the first in England since the 19th century. Northern Rock had been known for it 125% mortgages and when word got out that it needed an emergency loan from the Bank of England, depositors queued up for blocks desperate to get their money out. While the Bank of England directly provided capital to keep Northern Rock going, this approach would prove to be no more successful than the more circumspect American one. Both Countrywide and Northern Rock would barely survive into 2008.

Next: What Banks and Enron Had Common

Daryl Montgomery
Organizer, New York Investing meetup

For more about us, please go to: http://investing.meetup.com/21