U.S. Financial System Gets Its Own Stress Test

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Banks failures kept climbing and the Asset Back Security market completely froze up. While it sounds like a grim description of the height of the Credit Crisis, it was actually the week of July 19th.

In little reported news, there was no issuance of asset backed securities (ABS) last week. Large companies rely on this type of financing to fund their short term needs. The collapse of this market in the fall of 2008 was one of the key reasons that economic activity ground to a halt. Recently, everything looked OK for the ABS market. During the ten weeks prior to July 19th average issuance was $1.83 billion per week. Then suddenly it was zero.

The overnight disappearance of funding was an unintended consequence of the new financial 'reform' bill. One of the provisions of the bill made the rating agencies liable for their ratings - a laudable idea. However, there was no provision on the other side that prevented them from taking money for their ratings and then refusing to have them made public, which the rating agencies promptly did in the ABS market. Companies were already required by law to have their ABS paper rated before financial reform - essentially giving the ratings agencies a government enforced duopoly. So without ratings nothing could be sent to market. Even Ford Motor had to pull a major offering. To unfreeze the market, the SEC promptly ruled that ABS paper could be sold without a rating for the next six months. This too could have unintended consequences.

The Credit Crisis was also being revisited with a U.S. banking system that still looks shaky. So far this year, 103 U.S. banks have failed compared to 65 at the same time last year. At the current rate, failures could exceed 200 in 2010. This is roughly on par on a percentage basis with the worse period of the Savings and Loan Crisis. However, the FDIC, which insures bank deposits, didn't go under during the Savings and Loan Crisis. This will happen this time. There are even rumors that the FDIC is delaying taking over insolvent banks to delay its own insolvency. These rumors are probably not true because doing so wouldn't buy the FDIC that much time. Expect the federal government to bail it out with a 'loan' or some other 'line of credit'.

The problems that surfaced during the Credit Crisis have obviously not all been solved. Investors should assume that the after effects will have to be dealt with for years to come. Government solutions for dealing with these problems may themselves in turn cause other problems. The corruption in the system certainly hasn't gone away. The ratings agencies gave baskets of subprime loans triple A ratings and now they have refused to let their ratings be used for asset backed securities because of potential liability. So how accurate do think their ratings are now?   And why does the U.S. government force companies to pay them for the ratings if companies aren't guaranteed anything in return for their money?  If this type of activity took place between two businesses, it would be called an extortion racket. The FDIC forcing banks to prepay three years of deposit insurance premiums could be viewed the same way.

Disclosure: No positions.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Bank Failures Driving FDIC to Insolvency

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


In December of 2009, the FDIC ordered U.S. banks to make three years of prepayments to its deposit  insurance fund. It looks like the FDIC has already blown through the $15.33 billion it collected at the end of last year and will soon be needing its own bailout.

As of July 16th, 96 U.S. banks have failed. The total was 86 at the end of the first six months of the year. A simple doubling of the number would indicate that there will be 172 failures this year. Estimates though are for around 200. More failures took place in the second half of the year in 2009. Total failures for 2009 were 140 compared to only 25 in 2008 and 3 in 2007. There is no question that the number of failures will be greater once again in 2010.

The FDIC maintains a troubled bank list and there are 775 banks on that list as of the end of the first quarter. That was up from 702 in the fourth quarter of 2009. Since failed banks are removed from the list, this indicates that more banks are getting into trouble than the number failing. As long as this continues to happen, the U.S. banking system is deteriorating further. Commercial loans going sour are now being added to the problem of too many bad residential real estate loans.

Investors should not be fooled by comparisons of current U.S. bank failures with the number of failures in the past. In the early 1900s, there were a very large number of small banks in the country. Over the last 80 years, U.S. banks have become much larger and far fewer in number so only a percentage comparison makes any sense. During the Great Depression, 9146 banks failed. That would represent over 100% of the 7932 banks that now exist. Even during the Savings and Loan Crisis there were more than twice as many banks in business than there are now. The total number of failures for the Depression and Savings and Loan Crisis are also for a period of up to 15 years. So we will have to wait until 2023 to see if banking failures are or aren't as bad now as they were during past crises.

We are not likely to have to wait very long however to see if the FDIC needs a government bailout for the first time. The FDIC states very clearly on its website that its operations are funded through member banks and it doesn't require taxpayer money. Well accepting a "loan" from the federal government or whatever they will call the bailout is taking help from the taxpayer. For a long time, I have been predicting that this event will be taking place in the fall of 2010. As of now, it looks like the FDIC may have trouble holding off insolvency even until then.

Disclosure: No positions.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

As U.S. Banks Deteriorate, Obama Proposes New Regulation

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


President Obama proposed placing new limits on the size and activities of big U.S. banks on January 21st. The new plan, known as the Volcker Rule, would effectively prevent banks from owning hedge funds and private equity funds and seeks to place curbs on the market share of liabilities for any given firm. It follows last weeks proposed new tax on the big banks to recoup losses from the 2008 bailout. The administration apparently hadn't informed Wall Street about the impending news. The U.S. market was caught off guard and predictably sold off sharply with the banks leading the way. The European and Asian markets sold off in sympathy.

Recent earnings on the big banks have shown that their loan portfolios are continuing to deteriorate. Fourth quarter regional bank earnings confirm that little if any improvement has taken place since the depths of the Credit Crisis. BB&T (BBT) earnings fell 36% last quarter and its provision for credit losses were $725 million versus $197 million in the fourth quarter of 2008. Huntington Bancshares (HBAN) losses on its commercial real estate portfolio were $258 million in the fourth quarter versus $169 million in the third quarter. SunTrust (STI) non-accrued loans are now $5.40 billion, down $42 million from the previous quarter, still very high and barely getting better.

While it is possible something may eventually come from the Obama proposals, investors shouldn't expect that they are a done deal.  In his signature, it's not my job approach, the president appeared to be leaving crucial details for his bank oversight plan to be hashed out by Congress - an institution that is perennially dysfunctional and which is viewed almost universally unfavorably by the American electorate (one recent poll found that only 21% of voters view congress favorably). This is how Obama handled his intended health care reform, which has turned into a giant boondoggle for the administration. Obama has also taken this tack with his proposed consumer protection agency that has gotten caught in partisan wrangling on the Hill. If Obama's intention is to just talk about something, but make sure nothing ever happens, he seems to have found the magic formula.

Obama took office right after the lowest point of the Credit Crisis. Like any new president, he had enormous political capital at that moment, but did very little with it. He was president for a year before he said in his press conference proposing new bank regulation that the banks nearly wrecked the economy by taking "huge, reckless risks in pursuit of quick profits and massive bonuses."  Unfortunately, we are still suffering from the after-effects of the Credit Crisis and this will be the case for some years to come. Mortgage defaults are still a major problem for the banks and a burgeoning commercial loan crisis is now taking place. In 2009, 140 U.S. banks went under, the largest number since the Savings & Loan Crisis. The administration's efforts to handle banking problems so far have been ineffective at best. It would be preferable if the Obama administration solved the current serious problems first rather than concentrating on some distant future situation.

Disclosure: None

NEXT: The Case Against Reappointing Ben Bernanke

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.