Is gold going to $6,300? Dylan Grice, an analyst with Societe Generale, says it’s possible, given the decline in central bank credibility. But investors need to keep one thing in mind: Gold is merely a vehicle to protect the purchasing power of money.

Gold is surging because investors see that the Federal Reserve — more concerned with deflation and unemployment than sound money — may be trapped in a never-ending cycle of monetary accommodation.

Ben Bernanke says he won’t monetize debt, but he already has. His Fed has bought $300 billion of Treasuries and is on pace to buy $1.45 trillion of government-backed mortgage debt all of which is being salted away indefinitely on the Fed’s balance sheet.

Why indefinitely? Because the Fed has no intention of unwinding its balance sheet so long as the economy is stressed. Witness comments this week from Bernanke, Fed Vice Chairman Don Kohn and San Francisco Fed President Janet Yellen all suggesting that the Fed’s “extended period” of low interest rates can be measured in years, not months. Today St. Louis Fed President James Bullard said rates aren’t going up till 2012.

So long as deficit spending continues, if the Fed wants to avoid deflation, it will be forced to monetize more debt.

[Elsewhere, capital controls are being erected in emerging economies like Brazil, Taiwan, and possibly Indonesia in order to keep speculative waters at bay. As Hong Kong's chief executive remarked last week, a dollar carry trade spawned by low rates threatens to inflate dangerous asset bubbles in emerging markets the same way low Japanese rates did in the '90s.]

Exploding debt throughout the developed world means other central banks face similar pressure.

(Click chart to enlarge in new window, reprinted with permission)

So confidence in paper currencies is waning.

Some people say it is absurd to buy gold; the metal has no intrinsic value. That may be. But is it any less absurd to hold paper? The best that can be said for paper is that if you lend or invest it, tomorrow someone will give you more paper in return. This is fine so long as its purchasing power is maintained. But it isn’t. A 2009 dollar is worth a 1914 nickel.

Eventually the value of all the paper you’ve accumulated goes to zero. The trick is to turn that paper into tangible assets with tangible value.

Gold may be volatile, but at least it maintains its real value:

(click chart to enlarge in new window, reprinted with permission)

Grice contends that the price of gold could reach $6,300 an ounce. He explains: “The U.S. owns nearly 263 million troy ounces of gold (the world’s biggest holder) while the Fed’s monetary base is $1.7 trillion. So the price of gold at which the U.S. dollar would be fully gold-backed is currently around $6,300. Gold is very cheap — at current prices, the USD is only 15 percent gold-backed.”

Absurd you say? It happened 30 years ago. President Nixon ended the Bretton Woods global monetary system and his compliant Fed Chairman Arthur Burns let inflation run wild. So by 1980 gold spiked to a level at which the dollar was “overbacked” according to Grice.

Did gold overshoot in 1980? Sure, but only because Paul Volcker was willing to hammer the economy to re-establish the Fed’s credibility. Today’s Fed has been very clear that it isn’t willing to put up with a recession of any kind in the service of sound money.

All of that said, investors should be careful. Grice’s chart shows that, over the long run, gold is likely to do no better than protect your purchasing power. An ounce of gold today buys a good men’s suit; in 100 years, it is likely to buy the same.

So gold won’t make you rich. But it may protect you from becoming poor.

Rick Bookstaber announced on his blog yesterday that he will joining the SEC’s “Division of Risk, Strategy and Financial Innovation.”

This is a welcome development. Bookstaber is the author of A Demon of Our Own Design: Markets, Hedge Funds and the Perils of Financial Innovation.

He was part of an Oxford-style debate on that very subject at the Economist’s Buttonwood Gathering last month. I was lucky to be in the audience. Below is the video. (Here’s a link too…..go to “debate on financial innovation.”)

Watch it through just to see Jeremy Grantham. He was on fire. (His first comments being a third of the way in.) His rhetoric successfully flipped the audience from being 80:20 in favor of the proposition that “financial innovation boosts global growth” to a similar margin against.

It’s highly ironic that Myron Scholes was chosen to argue for the proposition. An inventor of the Black-Scholes options pricing model, he was also a partner at LTCM, the famous hedge fund firm that blew itself up mixing mathematical hubris with leverage.

Scholes’s life story should be a cautionary tale AGAINST the idea that financial innovation creates great wealth. Yet here he is, having learned nothing.

Not that it’s unexpected. Nothing encourages cognitive dissonance quite like the absence of consequences. Bailed out bankers on Wall Street who feel they’ve “earned” the bonuses they plan to pay themselves this year are just the latest example…

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….

No bank failures last night, folks. Sheila took the night off…

“The deadline for Peace Prize nominations is Feb. 1, meaning the president was nominated after being in office for just 11 days.” (ABC) I really feel for the guy, being anointed before he’s really accomplished anything. Managing expectations is tough, Obama hasn’t done that very well…

What are these Fed Presidents up to? (Free Exchange) The comment from John Jansen is one I agree with wholeheartedly, it’s why I argue we need Fed fire drills, an argument first made by George Cooper. The Fed means well when it tries to telegraph its moves, but in doing so, it encourages excessive risk-taking via leverage.

The Democritization of credit is over; now it’s payback time (WSJ) A good article, but not nearly enough focus on the biggest chunk of debt owed by the person profiled. It happens to be a student loan.

The Lost Generation (BusinessWeek) Peter Coy writes about young people being ravaged by the recession. Looks like those ridiculously expensive college degrees they borrowed to pay for will end up albatrosses around their neck. See again, above.

Berlusconi “most persecuted man” (BBC) The quotes from this guy are priceless. To wit: “I am without doubt the person who’s been the most persecuted in the entire history of the world and the history of man.”

Controlling healthcare costs the American way: Not doing it (McArdle) We can learn some valuable lessons from the healthcare experiment in Massachusetts.

Asia steps in to support the dollar (FT) Lucky us. The Fed won’t do the job, so the Asians will do it for them.

VIDEO: Simon Johnson and Marcy Kaptur on Bill Moyers (PBS) This is an important interview to get a sense of how a prominent, well-meaning Democrat views the financial crisis. She’s absolutely right to be pissed about how banks have handled themselves during the crisis. My problem with her, and with other Democrats like Dick Durbin who complain that bankers “own” Congress, is that they can’t handle the truth. They say they want to cut banks down to size, but they refuse to grapple with the consequences of doing so. Breaking the banks, which is to say recapitalizing their balance sheets, is absolutely necessary as part of a general de-leveraging of the economy. But it will hammer us in the short run. Hundreds of billions of dollars of paper wealth will be wiped out, with all the attendant consequences for the real economy. Until Congress is prepared to make the American people take their medicine, nothing will be accomplished.

Girl scouts (imgur)

Another ingenious animal rescue…

Wells Fargo fires exec over Malibu house scandal (Reuters)

Warren: “Until we have a credible liquidation threat, we don’t have capitalism in America” (HuffPo) Yeah, we need better resolution authority for big financials, but we should break up banks so that they aren’t large enough to pose a systemic risk in the first place. By the way, for all the folks out there that think the government “made money” when Goldman bought back TARP warrants at a small profit, Warren reminds us that they still have $13 billion of your money that was passed through AIG.

Citigroup explores bid to pare U.S. stake (WSJ) Speaking of the canard that we’re “making money” on the bailout, it’s unfortunate this piece ends by noting that taxpayers are up $9.8 billion on their Citi stock. The reason the equity has positive value is because the rest of the capital structure is being supported by taxpayers. And the ultimate cost of that support is likely to be significant.

Johns Hopkins student kills intruder with samurai sword (Baltimore Sun) Quentin Tarantino eat your heart out.

Study faults Bush’s reliance on daily intelligence brief (WaPo)

The Devil’s Dictionary, Financial Edition (WSJ)

Kids send Marcus the lamb to slaughter (Reuters) They voted 13-1

Comedian Eddie Izzard runs 43 marathons in 51 days (BBC)

11 Craziest Kim-Jong-Il moments (11points.com)

I’ve seen the between-the-legs volley before…but never one this good.

Warren Buffett is back as the nation’s financial conscience, publishing an op-ed in yesterday’s NYT lamenting the dangers of too much monetary and fiscal stimulus. As regular readers of this blog are aware, that’s a message with which I wholeheartedly agree. My problem with Buffett’s piece is that he makes a good argument and then totally undercuts it in his conclusion:

Our immediate problem is to get our country back on its feet and flourishing — “whatever it takes” still makes sense. Once recovery is gained, however, Congress must end the rise in the debt-to-G.D.P. ratio and keep our growth in obligations in line with our growth in resources.

This have-your-cake-and-eat-it-too approach is typically what we get from Paul Krugman: Yeah, debt is a problem and has to be dealt with long-term, but in the meantime we should jack up deficit spending in order to boost growth. To paraphrase St. Augustine, make us fiscally and monetarily prudent, just not yet. Ben Bernanke said something of that sort in a speech. He was trying to be funny.

The problem, it seems to me, is that rising GDP and employment—i.e. “recovery”—is not compatible with de-leveraging, which is what Buffett is talking about.

When consumers try to cut debt and boost savings, the economy goes into a deflationary spiral that Keynesians argue must be counteracted with fiscal and monetary stimulus.*

Consumers de-lever, government re-levers.

Private consumption and government spending now drive something like 80% of GDP. It can’t keep rising unless consumers, the government or both continue borrowing huge sums.

The goldilocks economy Buffett describes, in which we can have “recovery” without increasing debt, is a fantasy.

My point is that in order to reduce debt we have to endure some sort of deflationary recession. The alternative is to spend and print perpetually, which Buffett points out is the worse option.

What Buffett should have said? Suck it up folks, we’ve no choice but to learn to live with less.

——

P.s.: I think Buffett actually knows this, but being asset-rich, he’s boxed in. Deflation hammers the value of all non-cash assets, so he has to support monetary/fiscal stimulus in order to preserve his own and his shareholders’ wealth.  Hence the opening of the piece, which lauds the “wisdom, courage and decisiveness” of the Bush and Obama administrations in the face of collapse, and the end of the piece, which says their emergency measures continue to be necessary. He maligns the effects of stimulus, but he’s stuck supporting it.

*The “Paradox of Thrift” this is called, a particularly problematic economic theory used to justify heavy government borrowing.

FDIC Chairwoman Sheila Bair is right now testifying in front of the Senate Banking Committee on “establishing a framework for systemic risk regulation.”  This is of course hugely important.  How do we end “too-big-to-fail?”  And how do we resolve failures that are so big they pose a systemic risk?

There’s so much valuable stuff in this testimony, readers should really see all of it.  To help you get through all 30 pages, I’ve highlighted key passages and provided commentary (in pink italics…I didn’t choose pink, btw, Scribd just read my formatting that way!).

Bair clearly knows what’s wrong with the system, and she articulates it more clearly than any other policymaker in Washington.  She really does want to put the screws to big banks in order to end too-big-to-fail.  She would do so by establishing a Financial Services Oversight Council to, among other things “actively control” leverage. She would also beef up resolution authority so policymakers could wind down bloated behemoths like Citi.

Right now they can’t resolve anything.  Regulators’ choice is between bankruptcy and taxpayer-funded life support.  Bankruptcies don’t work with systemically important institutions.  This we learned from Lehman.  Taxpayer subsidies only allow failed companies to keep operating on the public dime.  Neither is desirable.

My chief worry in what she’s proposing is that whoever ends up becoming the systemic risk regulator may not have the same cojones she does.  Who’s to say they will actually put the screws to the firms being regulated?

If they don’t, its sheer presence may backfire, especially if–as she proposes–there’s an “insurance fund” backing its resolution authority.  Private market players will then misinterpret the systemic risk regulator as an implicit government guarantee that protects them from risk.  Exhibit A is OFHEO with Fannie and Freddie.  Exhibit B is FDIC itself and its Deposit Insurance Fund.  Investors and/or depositors in these federally-backed institutions take MORE risk that creates BIGGER systemic problems than if there was a credible possibility they’d eat their own losses.

All of this would be much easier if the Fed just exercised its authority over bank reserve requirements.  Requiring banks to hold significantly more capital in reserve, and preventing them from hiding risk off their balance sheets, would solve just about every problem we face.

(For ease of reading, click on the top right button to toggle to full screen.  If that doesn’t work, click on the link at the top to go directly to Scribd.)

Sheila Bair Systemic Rist Testimony 072309

NEW YORK, July 20 (Reuters) - Why did shares of CIT rally as much as 100 percent today? Presumably investors saw headlines with the word “rescue” and thought it made sense to take a flyer. This is foolish.

CIT is highly leveraged and its assets are deeply troubled. Even if CIT is “saved” through a restructuring, there’s no prospect that the equity will have any value. The only hope is a backdoor bailout, and that’s highly unlikely.

To understand why CIT’s stock is essentially worthless, all you need to know is one equation: Assets = Liabilities + Equity. For a financial company like CIT, assets are the loans it makes to borrowers. Its liabilities are the dollars it borrows from lenders and depositors to fund those loans. Shareholder equity is what’s left over.

As the economy has deteriorated, so has the value of CIT’s assets. But the value of its liabilities remains fixed. Equity acts like a buffer to protect the value of liabilities as asset values fall. In other words, stock investors eat losses so that lenders and depositors don’t have to.

Lenders see the value of CIT’s assets has declined and, consequently, aren’t interested in lending anymore. This leaves CIT facing the same type of liquidity emergency that led to the failures of Bear Stearns and Lehman Brothers. And any lender-sponsored “rescue” would divvy up what remains of CIT’s assets amongst themselves, leaving equity holders with nothing.

Under its “base case” stress test scenario, ratings firm CreditSights estimates that CIT may face as much as a $4.6 billion capital shortfall. A more severe economic environment could leave CIT facing a $7.6 billion shortfall. Unsecured senior and subordinated debt holders face “a significant haircut” and preferred shareholders are likely to see “diminutive returns.” There isn’t enough pie for creditors to split, so shareholders shouldn’t expect anything left over for them.

So why take a a gamble on the stock? Maybe investors think Ben Bernanke will successfully reflate the economy, or perhaps CIT will find a buyer. As long as the company can kick the can down the road, there’s always hope, right? Actually no. With unemployment headed towards 10 percent, the underlying default rate on CIT’s assets will get worse before it gets better.

The other possibility is a bailout. True, FDIC has denied CIT’s request to access its debt guarantee program and yes, Treasury is unwilling to extend additional credit after losing the $2.3 billion of TARP money it already invested in CIT.

But an implicit bailout may still be available: FDIC-insured deposits. CIT Group has an FDIC-member subsidiary, CIT Bank. If CIT can’t convince the Feds to back its debt directly, maybe it can persuade them to allow an asset transfer from the holding company to the bank subsidiary in order to access more FDIC-insured deposits. Compare the 13 percent interest rate CIT is likely to pay bondholders to “rescue” its business with the two percent interest rate it would likely pay on one-year CDs guaranteed by FDIC and you understand why deposits are a preferable funding mechanism.

But it will take much regulatory forbearance to make that happen. Both the Federal Reserve and FDIC would have to sign off. We already know that Sheila Bair isn’t a fan of CIT’s business model. She didn’t grant them access to the ebt guarantee program because she clearly does not want to expose her agency to more losses. Thankfully for taxpayers, who ultimately stand behind insured deposits, it’s a safe bet she won’t let CIT raise any more.

With no bailout on the horizon, CIT’s balance sheet will continue to deteriorate, which means its shares are worthless. Investors should stay away.

Some helpful data from Thomson Reuters regarding debt issuance under FDIC’s Temporary Liquidity Guarantee Program.  This is as of July 16th, and it’s only for longer maturity debt.  It excludes commercial paper, of which Goldman has about $6 billion out and GE has $20 billion out, for instance.  Total issuance according to FDIC was $339 billion at the end of June.

Click on the table to enlarge in new window

(Updated 9:45PM) Four bank failures tonight, including two with over $1 billion of assets.  There have now been 57 bank failures so far in 2009.  Tonight’s damage to the Deposit Insurance Fund is estimated at $1.1 billion.

#54 — This is the 15^th bank failure in Georgia.

• Bank:  First Piedmont Bank, Windsor, GA
• Acquirer: First American Bank & Trust, Athens, GA
• Vitals:  As of July 6^th … assets $115 million,  deposits $109 million
• DIF Damage:  $29 million

#55

• Bank:  BankFirst, Sioux Falls, SD
• Acquirer: Alerus Financial, grand Forks, ND
• Vitals:  As of April 30^th … assets $275 million,  deposits $254 million
• DIF Damage:  $91 million

#56

• Bank: Vineyard Bank, Rancho Cucamonga, CA
• Acquirer: California Bank & Trust, San Diego, CA
• Vitals:  As of March 31^st … assets $1.9 billion,  deposits $1.6 billion
• DIF Damage:  $579 million

#57

• Bank:  BankFirst, Sioux Falls, SD
• Acquirer: Alerus Financial, grand Forks, ND
• Vitals:  As of May 31^st… assets $1.5 billion,  deposits $1.3 billion
• DIF Damage:  $391 million

Rounding out this Friday’s BFF post, an odd factoid regarding CIT Bank (ht frog).  At the bottom of the bank’s FDIC info page, we see it has “total unused commitments” of $54.5 billion, 101x the Bank’s Tier 1 capital of $540 million.

For comparison, the multiple of total commitments to Tier 1 cap for two other troubled banks, Corus and Guaranty, is just 4x and 3x respectively.

To me, “unused commitments” sound like credit lines for which the bank may be contractually obligated.  If that’s what these are, then theoretically, the bank’s assets could swell exponentially.

But something doesn’t add up.  The company’s 10-Q (page 64) lists financing, purchasing and LOC commitments at $11.3 billion.

If any readers understand the discrepancy, please post a comment….

Another vulture is swarming Corus’ carcass.  Meanwhile Guaranty late last week announced a major management shakeup.

CORUS

Heavily invested in condo loans, the Chicago lender missed its June 18th deadline to raise capital and is on the verge of being seized by FDIC.  Today WSJ reported that Starwood Capital is the latest private equity player to enter the fray.  WSJ:

“We’re bidding on a bank,” Mr. Sternlicht said during a conference call with investors in Starwood funds on Monday. Without naming the bank, he said it is heavily concentrated in real-estate lending and has more than 110 construction loans. People with knowledge of the matter identified the bank as Corus.

Starwood is one of several companies that have shown interest in Corus, concentrated heavily on condominium construction lending in South Florida and other now-troubled housing markets. Investors don’t appear to be interested in buying the entire bank, but instead are looking at buying the bank’s assets out of receivership if regulators take over.

New York developer Related Companies, and private equity firm, Colony Capital, have also indicated interest in Corus.  With $7.6 billion of assets and $7.2 billion of deposits, Corus would be the largest bank failure since BankUnited.

GUARANTY

Meanwhile, Guaranty Bank, last Friday announced a major management shakeup.  Guaranty, which missed its May 21st deadline to raise capital and has been discussing open bank assistance with FDIC, dumped the news late Friday.  The changes announced include….

• Interim Chairman and CEO John Stuart loses those two roles and will revert to being a company director
• Board member Robert Kavanaugh retires
• SVP/CFO/CAO Ronald Murff resigns
• Kevin Hanigan, the former President and COO, becomes Chairman of Board, CEO and stays as President
• Treasurer Steven Raffaele replaces Murff

All of these changes are being made with regulator approval, a condition of the company’s cease & desist order.

With $14.4 billion of assets and $11.7 billion of deposits, Guaranty would be the biggest failure of the year.

As CIT hangs by a thread, some news outlets are reporting that it would be the biggest bank to fail since WaMu.  Measured by total firm assets this is true, but measured in terms of deposits, CIT is a fraction of WaMu’s size.  That’s why Sheila Bair is willing to let CIT go under.  And she’s right.

CIT Group’s balance sheet is plenty big ($76 billion of assets as of 3/31/09), but it’s funded primarily with debt, not deposits.  If the firm goes boom, investors will lose, not FDIC’s deposit insurance fund.

So from FDIC’s perspective, CIT clearly isn’t too big to fail, which is likely why it doesn’t want to give the company access to TLGP.  The debt guarantee program is a bit of a scam to rescue the deposit insurance fund, which would buckle if most of the big banks it protects went under.  The ones FDIC can’t handle closing, those that are “too big to fail” it offers an implicit guarantee against failure.  CIT Bank isn’t in that category.

The argument that CIT needs to be rescued because small businesses rely on its lines of credit is a bad one.  Similar arguments are made in favor of prospective homebuyers who are judged good risks, but who can’t get credit to buy a house.

The issue isn’t creditors, it’s lenders.  Lenders like CIT simply don’t have sufficient capital to make new loans.  Creditors that complain they can’t get other people’s money to fund their operations are missing the point:  Other people don’t have money to lend.

If businesses actually are good credit risks, then they shouldn’t have a problem securing a line of credit from another, stronger lender.  If they can’t get another line of credit despite being a “good” risk, it’s because the system doesn’t have enough capital to support the creation of new loanable funds.

Business models that rely totally on borrowing in order to fund working capital aren’t as robust as those that can fund themselves with cash from earnings.  Many will, and should, fail.

————-

*For more details, do a quick search for “CIT Bank” in FDIC’s bank find tool.  You’ll find CIT Bank on page 2 of the search results.

Not much news on the bank failure front.  Just one this week, and it was a small one:

#53

• Bank:  Bank of Wyoming, Thermopolis, WY
• Buyer:  Central Bank and Trust, Lander, WY
• Vitals:  As of 6/30/09, assets $70 million & deposits $67 million
• DIF Damage:  $27 million

What is interesting here is the hit to the deposit insurance fund relative to the bank’s assets/deposits.  Pound for pound, this failure is pretty expensive.

The long weekend will give FDIC extra time to clean up this week’s failures.  So far they’ve announced two, three, six, seven.  Last Friday’s total of five bank failures had been the largest number so far this year.

Six of tonight’s failures are in Illinois.  The seventh announced failure is a big one, with nearly $1.0 billion of assets.  As the evening progresses, I expect there will be more failures in the Mountain and/or Pacific time zones. Looks like tonight’s total will stay at seven.  A record day so far this cycle!

Bank Failure #46 for 2009

• Bank:  John Warner Bank, Clinton, IL
• Buyer:  State Bank of Lincoln, Lincoln, IL
• Vitals:  At 4/30/09, assets of $70 million and deposits of $64 million
• DIF Damage:  $10 million

#47

• Bank:  First State Bank of Winchester, Winchester, IL
• Buyer:  First National Bank of Beardstown, Beardstown, IL
• Vitals:  At 4/30/09, assets of $36 million and deposits of $34 million
• DIF Damage:  $6 million

Insert funny Beardstown Ladies joke here.  Yes, they still have a website, though it doesn’t appear to have been updated in awhile.

#48

• Bank:  Rock River Bank, Oregon, IL
• Buyer:  Harvard State Bank, Harvard, IL
• Vitals:  At 4/30/09, assets of $77 million and deposits of $75.8 million
• DIF Damage:  $27.6 million

Since the beginning of 2008, ten banks have failed in Illinois.  Georgia still claims the top spot with 14.

6:20 update: Wow.  Three more bank failure notices just hit my inbox, bringing the total to six for the evening.  And five of them are in Illinois! I thought FDIC might take advantage of the long weekend, but jeez.  Doesn’t Sheila Bair plan on catching any fireworks?

#49

• Bank:  Elizabeth State Bank, Elizabeth, IL
• Buyer:  Galena State Bank and Trust, Galena, IL
• Vitals:  At 4/30/09, assets of $55.5 million and deposits of $50.4 million
• DIF Damage:  $11.2 million

#50

• Bank:  First National Bank of Danville, Danville, IL
• Buyer:  First Financial Bank, National Association, Terre Haute, IN
• Vitals:  At 4/30/09, assets of $166 million and deposits of $147 million
• DIF Damage:  $24 million

Illinois now up to 12!

#51

• Bank:  Millennium State Bank of Texas, Dallas, TX
• Buyer:  State Bank of Texas, Irving, TX
• Vitals:  At 6/30/09, assets of $118 million and deposits of $115 million
• DIF Damage:  $47 million

#52

• Bank:  Founders Bank, Worth, IL
• Buyer:  The Private Bank and Trust Co., Chicago, IL
• Vitals:  At 6/30/09, assets of $962.5 million and deposits of $848.9 million
• DIF Damage:  $188.5 million

A big one.  And another in Illinois.  One more to go to catch Georgia!

– Rolfe Winkler is a Reuters columnist. The views expressed are his own –

NEW YORK, June 30 (Reuters) - When it comes to taxpayers’ money, the chutzpah of banks knows no bounds. Take Guaranty Financial Group, a Texas savings and loan, which said in a filing last month that there was “substantial doubt” that it can continue as a going concern. Now it is calling for an unusual government lifeline.

Guaranty said in an SEC filing on Monday that it has approached the Federal Deposit Insurance Corporation over “open bank assistance,” a method by which FDIC subsidizes “too-big-to-fail” banks in order to avoid absorbing their toxic assets.

If GFG’s primary bank subsidiary, Guaranty Bank, collapses, it would be the largest bank failure so far this year. With $14.4 billion of assets and $11.7 billion of deposits, it would be a very big fish to swallow at a time when FDIC is already choking on illiquid assets received from other failed banks.

FDIC prefers to resolve failed banks via purchase and assumption transactions, whereby a healthy bank buys part of a failed bank’s balance sheet while FDIC takes the remaining assets into receivership.

Typically this is least disruptive for bank customers and it has the attendant benefit of wiping out shareholders and some creditors. What’s left of the failed bank’s franchise value accrues first to depositors and secondly to the Deposit Insurance Fund, which is ultimately backed by taxpayers. Between 1980 and 1994, 73 percent of bank failures were handled this way.

Deposit payoff transactions are a second option and made up 18 percent of bank resolutions between 1980 and 1994. Here the bank’s assets are essentially liquidated. From a market discipline perspective, this is the superior solution. Shareholders, creditors and uninsured deposits are wiped out. No moral hazard here.

A third, if rarely used option, is open-bank assistance. It is intended for larger banks whose failure poses a systemic risk or that FDIC is badly equipped to resolve. FDIC prefers to avoid this method — only 8 percent of 1980-94 resolutions were handled with OBA — because of the obvious moral hazard implications. Shareholders are largely wiped out, but uninsured depositors and general creditors are made whole.

With its SEC filing, Guaranty management now acknowledges it can’t survive its portfolio of toxic mortgage-backed securities and loans, not without OBA, an FDIC bailout as it were. Without it, the bank will no longer be able to maintain the accounting fiction that it has the “ability to hold” toxic assets to maturity, forcing it to increase estimated losses for 2008 from $444 million ($8.84 per share) to $2.2 billion ($39.92 per share).

Fortunately for taxpayers, Sheila Bair isn’t keen on bailouts (if you exclude the subsidized debt offered to banks and “nonbanks” like GE Capital, General Electric’s financial services business, through the Temporary Liquidity Guarantee Program.)  She turned down BankUnited’s request for OBA last month.

Indeed, her agency is typically the last refuge of market discipline for the banking sector. Every Friday evening the FDIC forces more failed banks to meet their maker (45 seizures so far this year). This is the proper way to resolve failed financials: recapitalization whereby shareholders are wiped out and creditors are forced to absorb their share of losses. In the case of Guaranty, she needs to stick to her guns.

If only the government would impose similar recaps on the biggest busted banks — Citigroup and Bank of America for starters — we might finally achieve a solid financial foundation for sustainable economic growth.