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FDIC Ads: Should We Be Worried?

Leafing through the June 30 issue of Time magazine, I stumbled upon an advertisement from the Federal Deposit Insurance Corporation, or FDIC…

For those readers not familiar with the FDIC, their mission, according to their website, is to preserve and promote public confidence in the U.S. financial system by insuring deposits in banks and thrift institutions for at least $100,000; by identifying, monitoring and addressing risks to the deposit insurance funds; and by limiting the effect on the economy and the financial system when a bank or thrift institution fails.

Now, the FDIC says the ads were meant to commemorate the seventy-fifth anniversary of its creation as an “independent agency” of the U.S. government. However, some suspect there may be an ulterior motive for the ad program. Keep in mind that back on February 26, I discussed in a post how the fourth quarter of 2007 was the worst bank and thrift performance since the fourth quarter of 1991, whereas the FDIC classified 76 banks as “problem” institutions for the quarter (up from 65 a quarter earlier). In addition, it was revealed that the FDIC was looking to bring back 25 retirees from its division of resolutions and receiverships. Many of these agency veterans likely worked for the FDIC during the late 1980s and early 1990s, when more than 1,000 financial institutions failed amid the savings-and-loan crisis.

Additional justification for the FDIC to roll out a “reassurance campaign” appeared in the following months. On June 5, John Poirier of Reuters talked about an appearance by Federal Deposit Insurance Corporation Chairman Sheila Bair on Capitol Hill, and wrote:

An increasing number of banks face high exposure to deteriorating conditions in commercial real estate and construction lending, Bair told a Senate Banking Committee hearing on the state of the banking industry.

“There is also the possibility that future failures could include institutions of greater size than we have seen in the recent past,” Bair said. “Uncertainties in today’s economic environment continue to pose significant challenges for the banking industry, households, and bank regulators.”

So far this year, four small U.S. banks with deposits insured by the FDIC have failed, up from three in 2007. The agency last week boosted its list of troubled banks to 90, which have a combined $26 billion in assets.

Ironically, the FDIC ad I came across featured a photo of the $100,000 Series 1934 Gold Certificate featuring the portrait of President Wilson, the largest denomination of currency ever printed by the Bureau of Engraving and Printing. Nothing more comforting than seeing the words “insuring” and “protecting” next to the image of a U.S. gold certificate with the phrase “one hundred thousand dollars in gold payable to bearer on demand as authorized by law.” Too bad those dollars sitting in banks across the United States haven’t been backed by the precious metal since 1971, when President Nixon abandoned the Bretton Woods Agreement and effectively took the U.S. off the gold standard. As the U.S Treasury says on its website:

Federal Reserve notes are not redeemable in gold, silver or any other commodity, and receive no backing by anything.

Oh, Tricky Dick, what another fine mess you’ve gotten us into…

Source:

“UPDATE 1-Bigger U.S. bank failures may be coming – FDIC”
John Poirier
Reuters, June 5, 2008

Fannie And Freddie Meltdown Could Cost Up To $1.1 Trillion

Here’s something to think about. According to CNN Money yesterday, credit rating agency Standard & Poor’s recently estimated that a financial meltdown at mortgage financing giants Fannie Mae and Freddie Mac could require a taxpayer bailout costing $420 billion to $1.1 trillion. CNN Money senior writer Chris Isidore noted that this staggering amount dwarfs the cost ($250 billion in today’s dollars) of the savings and loan crisis bailout. S&P added that saving Fannie and Freddie might cost so much that the AAA credit rating of the U.S. government might even be jeopardized. Should this happen, all federal government borrowing would become more expensive.

Victoria Wagner, a S&P credit analyst who worked on the report, told CNN Money’s Isidore that she and other analysts are concerned about more problems in the mortgage market because both Fannie Mae and Freddie Mac “have become increasingly important to the health of the industry.” Wagner pointed out that at the end of January, 82% of all mortgages in the United States were backed by one of these firms, up from only 46% in the second quarter of 2007. And the roles of both in the mortgage and real estate markets are likely to grow, as Congress recently allowed them to back larger mortgages (up to $729,750), up from the previous limit of $417,000. The Office of Federal Housing Enterprise Oversight (OFHEO), which regulates both firms, also recently lowered the capital requirements for Fannie and Freddie in an effort to pump $200 billion more into the credit markets. Isidore wrote:

The new loan limits will increase the risks and losses for Fannie and Freddie, said Wagner and other experts. The high priced markets where homeowners and buyers need larger loans are now the ones seeing steep home price declines. And the default rates on larger loans are greater than the smaller loans that had previously been the core of their business.

Fannie Mae posted a $2.1 billion loss in 2007, while Freddie Mac lost $3.1 billion last year.

Source:

“The trillion-dollar mortgage time bomb”
Chris Isidore
CNN Money, April 21, 2008

Tough Times For U.S. Banks And Thrifts

Earlier today, data compiled by the Federal Deposit Insurance Corporation showed profits at federally-insured banks and thrifts plunged to a 16-year low in the fourth quarter as these institutions set aside a record-high amount to cover losses from bad mortgages. According to Associated Press business writer Alan Zibel, profits declined as major Wall Street banks wrote down asset values on mortgage-related investments. Zibel wrote:

Profits at the 8,544 FDIC-insured institutions between October and December dropped by 83.5 percent to $5.8 billion, hampered by soaring loan defaults and provisions for loan losses, the FDIC said. A year ago, these banks recorded $29.4 billion in profits.

It was the worst bank and thrift performance since the fourth quarter of 1991. Money set aside to cover loan losses totaled a record of $31.3 billion, up from $9.9 billion in the same quarter a year ago and $16.7 billion in the third quarter.

While losses accounting for more than half of the total decline in profits were concentrated in six large institutions, Zibel added:

However, FDIC officials said problems were also seen in community banks, with more than half of all banks insured by the FDIC reporting lower fourth-quarter earnings and half reporting growth in troubled loans.

According to a post today by Damian Paletta in the Wall Street Journal’s Economics Blog, the FDIC classified 76 banks as “problem” institutions for the fourth quarter of 2007 (up from 65 a quarter earlier), showing that a growing number of financial institutions are under strain. Paletta defined problem institutions as “those under closer regulatory scrutiny, as the banks are more likely to have weak capital cushions to prevent against failure.” He added that the FDIC never identifies which institutions are on the list, “as it could lead customers to rapidly withdraw funds from the bank.”

Paletta also wrote an article in the Journal today in which he said the Federal Deposit Insurance Corporation “is taking steps to brace for an increase in failed financial institutions as the nation’s housing and credit markets continue to worsen.” In “FDIC to Add Staff as Bank Failures Loom,” Paletta wrote:

The FDIC is looking to bring back 25 retirees from its division of resolutions and receiverships. Many of these agency veterans likely worked for the FDIC during the late 1980s and early 1990s, when more than 1,000 financial institutions failed amid the savings-and-loan crisis.

FDIC spokesman Andrew Gray said the agency was looking to bulk up “for preparedness purposes.”

While there have only been four bank failures in the past 12 months, FDIC Chairman Sheila Bair, Comptroller of the Currency John Dugan, and Office of Thrift Supervision Director John Reich have all warned of a pickup in bank failures, according to the Wall Street Journal. Jaret Seiberg, Washington policy analyst for Houston-based financial services firm Stanford Group, told the publication that:

Regulators are bracing for well over 100 bank failures in the next 12 to 24 months, with concentrations in Rust Belt states like Michigan and Ohio, and the states that are suffering severe housing-market problems like California, Florida, and Georgia.

An independent agency of the federal government, the Federal Deposit Insurance Corporation was created by Congress in 1933 in response to the thousands of bank failures that occurred in the 1920s and early 1930s. At the end of 2007, it had $52.4 billion in its fund that backstops the nation’s insured deposits, according to the Journal.

Grantham: ‘Most Important U.S. Financial Crisis Since World War Two’

Jeremy Grantham, chairman of global investment management firm Grantham, Mayo, Van Otterloo & Co. and overseer of $157 billion, had a stark warning for Bloomberg readers Wednesday (much obliged, Financial Armageddon). He warned, “This is the most important U.S. financial crisis since World War II.” The crisis stems from a global credit crunch brought on by the U.S. housing slowdown and ensuing subprime debacle. As a result, Grantham said that the U.S. economy is likely to enter a recession. He added that present conditions are worse than the savings and loan crisis of the eighties, which cost U.S. taxpayers more than $160 billion. The money manager explained:

The S&L crisis was parochial in comparison. This is the first one that is global; it has tentacles everywhere.

Furthermore, Grantham said credit problems are likely to spread beyond subprime mortgages to commercial real-estate loans and debt used to finance private equity transactions. As quoted by Bloomberg:

Private-equity deals will be in trouble. They were under-researched and overleveraged, and we had reached a level where the junkiest possible companies were selling at high prices.

Grantham wrote in his latest quarterly letter to investors that private equity “is the most underappreciated risk of all and is likely to be the center of another phase in the crisis.”

Because of the crisis, the head of the Boston-based firm told Bloomberg readers to shun stocks and switch to cash. From his Boston office, Grantham warned:

Don’t be a hero. Move to cash and let the other guys fish around for the bargains in the wreckage.

“Don’t be that guy!”

The 69-year-old money manager said he expects stocks to reach a bottom in 2010.

Grantham correctly predicted the crash in technology stocks two months before the bubble burst in March 2000. Back on June 13, 2007, I talked about the legendary value investor, who wrote to shareholders back then that we are now witnessing the first global bubble in history, covering all asset classes. He said:

From Indian antiquities to modern Chinese art; from land in Panama to Mayfair; from forestry, infrastructure and the junkiest bonds to mundane blue chips; it’s bubble time!

The value investor added:

Everyone, everywhere is reinforcing one another. Wherever you travel you will hear it confirmed that “they don’t make any more land,” and that “with these growth rates and low interest rates, equity markets must keep rising,” and “private equity will continue to drive the markets.”

Wall Street Write-Downs Approach $100 Billion Mark

Earlier today Wall Street Journal bloggers reported that write-downs related to the U.S. subprime mortgage meltdown have reached $96 billion after Citigroup announced another $17.4 billion in write-downs. A post in the Deal Journal predicted that this amount is expected to top $100 billion by the end of the week.

According to the blog, when you add Citigroup’s latest write-down to the $14.6 billion already lost by the bank, “Citigroup’s total hit to date related to the subprime-mortgage meltdown is $32 billion, the largest by any investment bank and one-third of the total written down across the entire sector.”

Deal Journal bloggers predict that the “write-downometer” from the Dow Jones-owned Financial News will surge to $112.1 billion by the end of this week after J.P. Morgan Chase and Merrill Lynch announce their fourth-quarter results. Analysts predict J.P. Morgan Chase to announce an additional $3.4 billion, while Merrill is expected to write-down somewhere between $15 billion to $22 billion.

Before the holidays, the financial blog Calculated Risk talked about the potential total losses from the growing number of write-downs. From their December 23 post entitled, “Barclays: Losses May Reach $700 Billion”:

Goldman Sachs caused shock last month when it predicted that total crunch losses would reach $500bn, leading to a $2 trillion contraction in lending as bank multiples kick into reverse. This already seems humdrum.

“Our counterparties are telling us that losses may reach $700bn,” says Rob McAdie, head of credit at Barclays Capital. Where will it end? The big banks face a further $200bn of defaults in commercial property. On it goes.

UPDATE: My main interest in this article was the quote from Barclays Capital. There has been a growing agreement that the mortgage credit crisis would result in losses of perhaps $400B to $500B; this is the first estimate I’ve seen significantly above that number.

I noted last week that a $1+ trillion mortgage loss number is possible if it becomes socially acceptable for the middle class to walk away from their upside down mortgages. And that doesn’t include losses in CRE, corporate debt and the decrease in household net worth.

The S&L crisis was $160B, so even adjusting for inflation, the current crisis is much worse than the S&L crisis…

Vanguard Founder Says Recession Odds At 75 Percent

Earlier today, CNN Money posted the answers to questions Fortune readers asked of John Bogle, the 78-year-old founder of mutual fund giant Vanguard. With $1.3 trillion in assets, Vanguard is now the second-largest mutual fund company. Bogle talked about the odds of a U.S. recession, the U.S. housing market, the subprime crisis, and challenges to the U.S. economy, among other issues.

What are the odds of a recession right now?

I would put the odds of a recession at 75 percent. This economy is very much consumer-based, and I believe that 70 percent of the GDP is consumer spending. That’s a very high number. Two things are happening there: Consumers have fewer resources because from 2001 to 2005 they took $5 trillion out of real estate. That will not recur. This is a big drop. We also see weakness in auto sales and retail spending - we even see it at companies like Starbucks. There is another, equally important factor in consumer spending, and that is confidence. Consumers are not going to spend if they are worried about the future.

Will the real estate market improve anytime soon?

It doesn’t look so good. I really don’t see it improving soon. At some point homes will have to be built. But right now there is not much incentive to build new places when there are so many old places on the market. When those lines cross I don’t know. It’s complicated by the fact that many people have gotten into ARMs [adjustable-rate mortgages] who didn’t know what they were doing. I don’t know what is going to happen to those people when lenders foreclose. When banks were community banks, they were more careful. But when banks sell loans in a bundle, they are clearly not going to be concerned about mortgage quality. So we have to have a better system in the future to make sure we have a much better element of credit quality in mortgages.

How does the U.S. subprime mess compare with other crises you have seen in your career?

I’d say the most similar example was the S&L crisis of the late ‘80s and early ‘90s. The issues were somewhat the same: Institutions borrowed short and lent long.

The immediate concern for most investors is the subprime market, but over the long term what do you see as the biggest challenges facing the U.S. economy?

Externally, we are faced with $1.5 trillion already poured into Iraq and Afghanistan. So you have enormous expenditures in a corner of the world that is important to us, but it is very unwise to think we can bring democracy to a place that doesn’t share our values. There are also the challenges from low cost production in China and India. At home, we have a tremendous future financial problem with the federal deficit. We’ll have to take action on Social Security someday. Government spending has gotten to the point where we will have to either cut spending or raise taxes. Another problem is this deadlocked Congress. And I see the quality and caliber of our presidential nominees, and I am not impressed.

It raises the question of whether this country is even able to run itself anymore.