Rolfe Winkler

FDIC closed 9 banks late last night, with a combined $19.4 billion of assets all of which were owned by one holding company and sold to US Bank in Minnesota. From Robin Sidel, WSJ:

Banking regulators seized nine related community lenders in California, Illinois, Arizona and Texas, representing the collapse of one of the nation’s largest privately held bank holding companies that grew through a string of acquisitions dating back to the savings-and-loan crisis of the 1990s.

The nine small banks represented the holdings of FBOP Corp., based in Oak Park, Ill., and owned by a banker who had plowed into real-estate lending around the country.

#107-#115

• Failed banks: Bank USA, Phoenix AZ; California National Bank, LA CA; San Diego National Bank, SD CA; Pacific National Bank, SF CA; Park National Bank, Chicago IL; Community Bank of Lemont, Lemont IL; North Houston Bank, Houston TX; Madisonville State Bank, Madisonville TX; Citizens National Bank, Teague TX.
• Acquiring bank: US Bank, Minneapolis MN
• Vitals: as of 9/30, $19.4 billion of assets, $15.4 billion of deposits
• DIF damage: $2.5 billion

US Bank has been highly acquisitive during this failure cycle. They also picked up Downey Savings and Loan and PFF Bank and Trust last November. Those two had $12.4 billion and $3.7 billion of assets when they failed.

From Alison Vekshin:

Barney Frank, chairman of the U.S. House Financial Services Committee, reversed course and will support requiring financial firms to prepay into a fund the government will use to unwind large firms after they fail.

If Frank’s legislation passes, there will be an explicit taxpayer guarantee backing the high risk activities of the big banks.

Why? Because there’s no way banks could fund the cost of even one systemic resolution. How much has AIG set back taxpayers? $182 billion so far. And we’ve promised $200 billion each for Fannie and Freddie. Banks complained about the $5.6 billion special assessment on FDIC. We expect them to pre-fund sufficient scarol to fund the next AIG?

David Reilly made this point very cogently a couple days ago.

Will creditors and shareholders actually have to absorb meaningful losses? As reader Ralph DG points out the creditors and counterparties of the banks are … other banks and insurance companies, systemically-important themselves.

Losses can’t be forced on them without causing the kind of systemic “domino effect” this whole scheme is trying to prevent.

Bottom line: when the bill comes due, taxpayers will pay it.

In the meantime, banks will benefit from their new protected status.

In a spot of good news for the economy, banks continued to rebuild their capital cushions in the third quarter. But are they doing so fast enough? One risk going forward may be the size of their securities portfolios, which could expose them to significant interest rate risk when the Federal Reserve finally taps on the brakes.

(Click table to enlarge in new window)

Measured by tangible common equity, the biggest banks are levered 20 to 1, a solid improvement from last quarter’s 24 to 1 and a giant leap from 30 to 1 in the third quarter a year ago. (These figures exclude off-balance sheet assets, which will increase leverage when they are consolidated beginning next year).

Tangible common equity is the crucial measure of bank capital because it is the primary cushion banks have to absorb losses. When it gets too low, creditors panic and bank runs ensue. From a systemic risk perspective, it’s great that banks are rebuilding this cushion.

The crucial question is how they’ll fare in a less favorable monetary environment. While consumer prices show little sign of inflating, asset prices are another story. Interest rates near zero have encouraged investors to chase risky assets. If that trend continues, the Fed may have to unwind its balance sheet and raise rates sooner than it would like, putting banks in a tough position.

FBR Capital Markets points out in a recent note to clients that many banks have poured excess liquidity into their securities portfolios, “which could present significant interest rate risk” when the Fed reverses course.

Compared with last year, the top 10 commercial banks have increased the size of their securities portfolios nearly 40 percent, with JPMorgan Chase’s rising over 150 percent.

And while securities prices are more immediately sensitive to monetary policy, loan portfolios would be impacted as well. Early next year, after the Fed turns off its printing press and after the home-buyer tax credit expires, real estate prices could resume falling. This will put more owners upside down on their loans, keeping default rates high.

Banks are extending loans, pretending that asset prices will recover past peaks, an unlikely prospect if the Fed does its job.

Now it’s up to regulators to deliver higher capital requirements so that banks can withstand the end of government support. After all, 20 to 1 leverage is still very high. It only looks prudent against the insane levels reached last year.

Recently Yves Smith over at Naked Capitalism posted snippets of Rob Johnson’s testimony before the House Financial Services Committee. The testimony he tried to give anyway. Johnson’s commentary was rather trenchant, so I thought I’d click over to get the full version. But it wasn’t where it was supposed to be on the Committee’s website.

Ken Silverstein is on the case and he says it’s “an object lesson in governmental failure.” Turns out Johnson was asked to testify at the last minute and wasn’t able to submit testimony at the hearing. Later when he tried to get it posted to the Committee’s website, at first they dithered and then they refused.

But I’ll let Ken tell the story. He’s a great writer.

As for Johnson’s full testimony, you can read it here. Print it out. Keep it on file. Explains in great detail why, in Johnson’s words, the derivative reforms legislation is “too tepid, too weak, too late…Very industry influenced. We had a crisis and they are pandering to the perpetrators.”

(ht Walker T.)

(Reader note: from here on out, instead of citing the publication in which a piece appears, I plan to cite the writer….where possible anyway.)

Goldman sends back some collateral to AIG (Liam Pleven) Interesting. Recall that AIG served as a slush fund through which the Fed sent money to banks that had been AIG’s counterparties. Goldman was the biggest recipient of this cash with $13 billion (though as Barry Ritholtz would be quick to point out, they got additional collateral before the government takeover). With asset prices climbing, some of the collateral has returned to AIG.

A three-way split is most logical (John Gapper) A very good column adding color to the argument that banks need to split according to their various functions: commercial banking, investment banking (and trading), asset management. Also insurance should be separated probably.

San Francisco Fed sees FHA reviving subprime (Diana Golobay, ht ML)

Motor Vehicles add 1.66% to Q3′s 3.5% growth (EconompicData) A very interesting chart…

Mutual funds getting in on TALF party (Miles Weiss) Like the PPIP program sponsored by FDIC (which never really got off the ground), TALF provides non-recourse debt to investors that want to buy toxic assets. Investors can put up a sliver of equity and take a flier on some busted assets. If it doesn’t work out, the Fed is left holding the bag. As of 9/30, the Fed had lent $43 billion under the program.

And then there were none… (NY Fed) After today’s purchase of $1.9 billion, the Fed has completed its program to buy $300 billion worth of Treasuries. Quantitative easing isn’t done, however. There’s still plenty of agency MBS and agency debt left to buy.

The $10 phone bill (Scott Woolley) Fighting to deflate your cell phone bill.

It may be BYOB as fewer firms plan holiday parties (Ian Sherr)

How basketball star blew $100 million (Shira Springer) “Bankrupted Boston Celtics player kept entourage of 70, spent wildly on cars, watches, gambling, mansions.”

Do you think we should establish a government-backed insurance fund for big banks’ risky trading activities? Probably not. But that’s precisely what the administration and Congress agree should be done. Today Sheila Bair proposed her own variation on the theme. At first glance her idea sounds better, but it’s just as bad as the others.

From Alison Vekshin at Bloomberg:

Federal Deposit Insurance Corp. Chairman Sheila Bair, breaking with the Obama administration, said U.S. financial companies should prepay into a fund the government would use to unwind large failed firms.

Congress should set up a Financial Company Resolution Fund and force institutions with more than $10 billion of assets to pay before a firm collapses, Bair said in testimony prepared for a House Financial Services Committee hearing today. Investors in failed companies also should take losses, she said.

As I noted in my column yesterday, Barney Frank’s legislation would have taxpayers front money for systemic bailouts while large financial firms would be on the hook to pay the money back.

Of course that would never happen. Banks would never pay. Look how hard it’s been to get banks to replenish the Deposit Insurance Fund. Anyway, Sheila agrees that ex-post funding is a bad idea.

But pre-funding is an equally terrible idea. If there’s a fund somewhere that’s supposed to protect the system, that will codify TBTF and reinforce moral hazard. Not only will investors know some firms are TBTF, they’ll see there’s a pile of cash to protect them. This would put TBTF firms at an advantage in the marketplace.

Now, some would argue that it would penalize the firms because they’d have to pay capital into the fund. Perhaps in the short-term. But soon enough everyone will be content that the system is “safe,” people will be making money and Congress will tell the regulators to lay off.

This is not just a hypothetical. Look at our experience with the Deposit Insurance Fund. From 1996-2006, FDIC was prevented by statute from collecting insurance premiums. Congress, in its infinite wisdom, had determined the DIF didn’t need any more money because the system was firing on all cylinders.

The S&L crisis–which cost $150 billion to resolve–taught us the moral hazards of government insurance funds for bank creditors. Because their money iss guaranteed, depositors don’t care what kind of risky activities their bank are engaged in. They just go to the bank that offers the highest interest rate.

We’re reminded of this fact by GMAC today, whose subsidiary Ally Bank is able to attract billions in deposits by offering high interest rates. And read the Puget Sound Biz Journal’s article on WaMu. They were so desperate for funding amid a bank run last fall that they started offering 1-yr CDs at 5%.

And think about what’s being insured here. Trading. In derivatives, stocks, bonds, forex, commodities …. all of it with leverage. Trading + leverage = high risk!

Despite the moral hazards of deposit insurance, we insure commercial banks because the functions they provide (managing the payment system, turning savings into loans) are important to society. In the fullness of time, I have my doubts that even this makes sense. But arguments supporting it are at least defensible.

This new scheme that Bair is proposing would insure investment banks, and all the risky trading activities they engage in.

Again, we’re acting to protect the needs of TBTF banks rather than protecting the needs of society. What we should be doing is getting trading activities out of the banks to begin with.

The repeal of Glass Steagall essentially put the Wall Street Bull inside the China Shop we call the commercial banking system. We’re surprised when he trashes the place every few years?

But instead of kicking him to the curb, we’re expending all this effort putting the China in bubble wrap…..which in the long-run is no match for the Bull….

A fantastic piece from the Puget Sound Business Journal’s Kirsten Grind. It documents WaMu’s final months, noting that the bank suffered two large bank runs that management successfully hid from the press at the time. See chart below.

[On a related note: Have you ever wondered why WaMu's failure -- $307 billion of assets, $188 billion of deposits -- never cost the Deposit Insurance Fund a dime? One reason was that FDIC moved relatively quickly. More importantly, losses on assets were forced onto shareholders and creditors. Common and preferred equity was wiped out, as were subordinated debtholders. Reader Andrew points out in the comments that there was a large buffer of capital (debt and equity) to absorb losses ahead of depositors.  (More on that from Kevin LaCroix)]

(Click image to enlarge in new window)

Grind also includes this interesting tidbit:

Each day, Brinks Security trucks pulled up to replenish WaMu ATMs across the country. Before the crisis, the trucks delivered about $30 million in cash a day nationwide, Freilinger said. During the September bank run, they delivered as much as $250 million a day.

WaMu was certainly seeing larger deposit outflows than most, but plenty of folks in “healthy” banks were pulling money out to stuff in their mattress. I wonder how much cash was being delivered to ATMs and bank branches nationwide last September and October…

GMAC sold more FDIC-backed debt today… (Reuters)

General Motors Acceptance Corp on Wednesday sold $2.9 billion in three-year government-guaranteed notes, according to a market source familiar with the sale. The 1.75 percent notes were priced at 99.991 to yield 1.753 percent, or 31.6 basis points over comparable U.S. Treasuries.

The notes are guaranteed under the Federal Deposit Insurance Corp’s temporary liquidity guarantee program.

GMAC has permission to sell up to $7.4 billion of FDIC-backed debt, in addition to the $12.5 billion of TARP money already received and the $2.8-$5.6 billion of additional TARP cash they’re negotiating for.

In exchange for upping GMAC’s TLGP allowance, Sheila Bair supposedly extracted concessions on the interest rates GMAC will be able to advertise for deposits.

On BankRate, they’re still listed as #3 for 1-yr CDs.

While we’re on the subject of auto bailouts, John Stoll and Sharon Terlep of WSJ are reporting that GM dipped into its bailout fund from Treasury to help rescue supplier Delphi:

General Motors Co. by the end of the week will outline plans to draw down more U.S. government money it will use to aid Delphi Automotive LLP and also give an update on a closely watched escrow account of its bailout funds, according to several people familiar with the matter.

GM’s additional borrowing will mostly be limited to Delphi’s funding needs and is expected to be north of $2.5 billion, based on prior announcements.

According to the article, the U.S. has committed $50 billion to the GM bailout, $30.1 billion of which was committed when the company filed for bankruptcy. Much of that amount went into an escrow account GM can tap as needed.

Apollo shares plunge on government inquiry (Bloomberg) The for-profit education industry is shady in the extreme. Fully 86% of Apollo’s revenue comes from student loans financed by the government. It’s a great scam. Find a warm body that qualifies for federal student aid, and then sell ‘em as much education as they’re willing to borrow against. And when the government offers to increase aid, companies like Apollo (and private universities) just raise their prices, forcing students to take on more debt for the same education. In the end, its taxpayers that take the hit when student loans default…

Stressful jobs that pay badly (CNN, ht Rej) #2 has a funny anecdote.

Goldman’s lies of omission (Janet Tavikoli, ht Jesse)

Couple alive after car pins them to bed for almost an hour (CNN)

Extension of homebuyer tax credit not a done deal (CR)

A drop in the wrong bucket (David Leonhardt) Pandering to seniors.

Cell size and scale (Utah.edu) Ultracool. Zoom in slowly by scrolling to the right.

Schwarzenegger vetoes bill, sends message to Cali legislature (imgur)

Jaws (Telegraph) A larger predatory fish?? Wow.

The new legislation unveiled by Representative Barney Frank doesn’t end “too big to fail” — it codifies it. It also puts taxpayers on the hook for a large portion of future bailouts.

Frank should go back to the drawing board. Per the recommendation of Bank of England Governor Mervyn King, he should split banks in half, sending trading operations off into the wilderness so banks can get back to basics.

The need for resolution authority stems from regulators’ arguments that they didn’t have the tools to shutter big firms last year. They knew losses properly belonged to shareholders and creditors. They just didn’t have the power to execute such a plan.

Color me skeptical.

Just as likely, they were terrified that shuttering a systemically important financial institution would cause financial markets to panic, that the daisy chain of derivative counterparties would break, collapsing the system.

If it’s so difficult to wind down large bank holding companies that it requires new, complex resolution authority, common sense tells us such institutions shouldn’t exist in the first place.

The goal should be to prevent banks from getting into danger, to get them out of risky activities that pose systemic risks. Bank regulators already have broad powers to do this, yet they’ve shown little willingness to use them.

Some argue they were stymied by regulatory shopping, so this legislation would give more power to the Fed. But will the Fed use it?

Last week, it installed as its top regulator Patrick Parkinson, long an advocate of a hands-off approach to derivatives: “Counterparties typically are quite adept at managing credit risks,” he testified in 1999. Whoops.

In any case, codifying institutions as too big to fail is likely to backfire by signaling to the market that such banks are the safest place for capital.

Advocates of this legislation say that won’t happen, that “Tier 1 Financial Holding Companies” will face capital and leverage requirements that put them at a disadvantage. But that’s not in this legislation; those new rules are to be written and enforced by regulators who have shown a remarkable lack of fortitude to date.

Advocates also say the legislation puts bank investors in line to absorb losses. But aren’t they already? The reason too-big-to-fail is a problem is that the capital structure is so big and complex that forcing losses onto investors causes a systemic event.

Naturally, then, taxpayers will front the money to fund a good chunk of these resolutions. Supposedly banks with more than $10 billion of assets will pay taxpayers back. If you believe that, I’ve got a bridge in Brooklyn I’d like to sell you.

Just look how hard it has been to replenish the Deposit Insurance Fund. Banks threw a tantrum about a special assessment that raised all of $5.6 billion. Sheila Bair, the FDIC chairman, was forced to resort to accounting gimmickry to squeeze more cash out of them.

We could make banks tithe their profits for years and we would recover a fraction of the total cost of recent bailouts.

New resolution authority is nice to have, but it won’t resolve the problem. What we need to do is shrink and simplify banks so they don’t pose a systemic risk in the first place.

Mervyn King and Paul Volcker have both put ideas forward to do that. We’d be better served if Frank and his staff fleshed those out.

The guys at Variant Perception make a great point. Some reform plans for the banking sector (so-called “narrow banking” being the most extreme) would have banks invest more deposits in government paper in order to keep them safe. To the degree such plans get traction, that could keep a lid on yields despite rising government spending.

The following chart shows how the US 10yr yield has disconnected from the price of commodities. We believe yields are not reflecting the future risk of inflation, and the fiscal situation of many sovereign issuers. However, there are no limits to what governments may do to support their debt. In the UK, a recent ruling was announced by the FSA forcing banks to increase their holdings of government bonds. In India a similar initiative has just been announced. In Japan, already over 50% of outstanding JGBs are owned by public sector institutions. In the US, only 0.9% of commercial banks’ assets are treasuries; in 1994 it was as high as 8.7%, so there’s great scope for it to increase. Mandated purchases of government bonds by banks and other financial institutions – crypto-quantitative easing – could persist long after official QE comes to an end, keeping bond markets supported for longer than many think.

Nevertheless, we think longer-term yields will move higher. Sell rallies.

The government has already poured $12.5 billion into GMAC since last December, and now the company is negotiating for $2.8-$5.6 billion more. Oh, and FDIC will allow the company to max out its borrowing capacity under TLGP, bringing the total there to $7.4 billion.

Yet another argument against those who say we “made money” on TARP because Goldman, AmEx and a few others bought back their warrants at a small premium. All the profits from those warrants wouldn’t add up to the amount we’ve already poured into GMAC, never mind this latest infusion. There’s also the small matter of $100 billion+ we’re never getting back from AIG….

Readers may recall that FDIC was rather peeved at GMAC for previously offering high rates on deposits. This is the ultimate moral hazard of deposit insurance. Depositors aren’t willing to impose discipline on the bank — taking their money out — because they know it’s guaranteed. GMAC knew this and, through its subsidiary GMAC Ally Bank, offered the highest deposit rates in the nation for a time.

In order to sell more government backed debt under TLGP program, FDIC struck a deal by which GMAC will “keep its [deposit] rates at certain amounts,” according to WSJ.

One would think a change of management might be in order. Well, it’s not gonna happen. CEO Alvaro de Molina — formerly CFO at Bank of America — will stay on.

The real reason behind this bailout is GM. In an age when cars are still purchased on credit, someone has to front the money if automakers are going to move inventory. For GM, that means GMAC, which in turn means taxpayers.

Taxpayers are lending themselves money to buy cars (via GMAC). To buy houses (via Fannie, Freddie and very soon FHA). To buy anything and everything that has to be financed.

My question: When are we actually going to pay for any of it? Also: When we realize we can’t, what’s going to happen to the economy?

New York Fed’s Secret Choice to pay for swaps hits taxpayers (Bloomberg) Remember the $13 billion that Goldman got via AIG after the government takeover? Turns out the NY Fed instructed AIG to pay out 100¢ on the dollar. Just another fact to keep in mind next time someone says the banks are “earning” their way through this crisis.

Senate Dems reach deal on homebuyer credit (Reuters) Realtors everywhere rejoice! Details coming later, but it appears the credit will shrink slightly and the expiration date will be pushed out to the middle of next year.

The tax breaks that ate America (Salon) The first-time homebuyer credit is just a drop in the bucket.

Death of the soul of capitalism (Paul Farrell, ht Winks) Farrell is always an interesting read. Like Ambrose Evans-Pritchard, but more shrill.

Tax refugees staging escape from NY (NY Post)

Case-Shiller shows fourth monthly increase (CR) But what will prices do when government support — both lending and low rates — go away? I don’t know, maybe they never will, see again link #2…

For runaways, sex buys survival (NYT)

Decorating…

Timothy Geithner wants to lock in low rates for the government while he can, extending the maturity of Treasury debt to 72 months from 49, a 26-year low.

It’s a smart move — if he can pull it off.

To do so, he’ll have to increase longer-term issuance by 40 percent, to $600 billion, according to FTN Financial estimates cited by Bloomberg. That could put pressure on interest rates, nipping the recovery in the bud.

It’s a risk he should take. The bigger risk is that the government continues to fund itself at the short end of the curve, requiring Treasury to roll over its obligations more frequently.

With short-term rates near zero, Treasury has drastically reduced interest costs by selling so much short-term debt. At a certain point it may have to do so in a less receptive market.

This week, Treasury plans a record $123 billion worth of issuance. A big buyer, meanwhile, is leaving the market: The Federal Reserve will exhaust its $300 billion purchase program for Treasuries once it buys another $2 billion.

Still, demand remains healthy. Monday’s 5-year, $7 billion auction of TIPS was well received. And at 3.52 percent, the current yield for the 10-year remains near historic lows.

Yet demand won’t be this strong forever.

For one, there’s demographics. As boomers age, more Treasury securities will be sold to finance retirements. The Social Security trust fund, the largest holder of U.S. government debt, will exhaust its surplus by 2016.

At that point, the fund will cash in its IOUs, forcing Treasury to borrow more. That sounds like a long way off, but those estimates assume an optimistic increase in employment and payroll taxes.

At the same time, recent Treasury data point to slowing demand for U.S. debt among foreigners (although a report from Barclays analyst Anshul Pradhan last week suggested that the data understate Chinese holdings by as much as $100 billion).

Retail investors, hedge funds and banks have stepped in to absorb much of the supply this year. But as tolerance for risky assets returns, even they might lose their appetite.

Staying at the short end of the curve also makes Ben Bernanke’s job more difficult. If inflation picks up or if an asset bubble arises, he may want to raise rates or sell securities to shrink the Fed’s balance sheet. Will he hesitate if Treasury is still flooding the market with paper?

So Geithner is right to seek balance sheet flexibility, and he should move quickly on his plan to extend the maturity of debt.

In the long run, however, what matters is getting spending under control. Confidence in the dollar will evaporate if we continue borrowing 5 to 10 percent of GDP every year.

Detroit house auction flops (Reuters) “Despite a minimum bid of $500, less than a fifth of the Detroit land was sold after four days.” The article notes that “total vacant land in Detroit now occupies an area almost the size of Boston.”

Underpricing risk: Rescuers fear Yuppie 911 (MSNBC) A parable for risk management in the modern age. Since the government has proved itself adept at rescues, folks across the investing spectrum end up in sticky situations they were never prepared to handle on their own. What happens when so many people end up in the same situation that the government’s rescue facilities are overwhelmed? What happens when contingent liabilities break the federal government’s balance sheet?

Rally fueled by cheap money brings sense of foreboding (FT) One of Gillian Tett’s correspondents thinks October ’08 may just have been a dress rehearsal for the crash to come…

The “benefit” of Somali pirates (channel4) Somali’s get to catch their own fish…

Great Depression-esque bad debt at US banks (Alphaville) A great post from Tracy Alloway, using Moody’s data.

Reckless strategies doomed WaMu (Seattle Times, ht CR) Part 1 of 2.

Geithner wides bills-to-bonds gap with new sales (Bloomberg) Smart. The average maturity for Treasuries had reached just 49 months recently as Treasury sold more short-term debt. Better to lock in low rates now to reduce rollover risk.

Installing Windows (imgur)

More U.S. children being diagnosed with Youthful Tendency Syndrome (The Onion)

Super cool…(funnier the second time through)