Matrix Blog

It’s becoming apparent that several of the large institutions that are in the vortex of bailoutdom are teetering: namely AIG and Citi. They were deemed too big to fail, bit now we are wondering if they are too far beyond saving.

I am struggling with this concept and am rambling here, but now is the time to fix things for the long term benefit. I am sick of quick fixes.

The Too Big to Fail policy is the idea that in American banking regulation the largest and most powerful banks are “too big to (let) fail.” This means that it might encourage recklessness since the government would pick up the pieces in the event it was about to go out of business. The phrase has also been more broadly applied to refer to a government’s policy to bail out any corporation. It raises the issue of moral hazard in business operations.

The top 5 banks are showing significant signs of weakness.

Citibank, Bank of America, HSBC Bank USA, Wells Fargo Bank and J.P. Morgan Chase reported that their “current” net loss risks from derivatives — insurance-like bets tied to a loan or other underlying asset — surged to $587 billion as of Dec. 31. Buried in end-of-the-year regulatory reports that McClatchy has reviewed, the figures reflect a jump of 49 percent in just 90 days.

The industry never thought macro enough to consider systemic risk – as in “What happens if it all goes wrong?” Seems pretty basic.

The Federal Reserve appears to be trying to reform its ways and perhaps even the concept of too big to fail. Fed Chairman Bernanke just spoke to the Council on Foreign Relations…

Until we stabilize the financial system, a sustainable economic recovery will remain out of reach. In particular, the continued viability of systemically important financial institutions is vital to this effort. In that regard, the Federal Reserve, other federal regulators, and the Treasury Department have stated that they will take any necessary and appropriate steps to ensure that our banking institutions have the capital and liquidity necessary to function well in even a severe economic downturn. Moreover, we have reiterated the U.S. government’s determination to ensure that systemically important financial institutions continue to be able to meet their commitments.

…while former Fed Chairman Greenspan has been attempting to re-write history.

David Leonhardt, in his piece “The Looting of America’s Coffers” said:

The investors had borrowed huge amounts of money, made big profits when times were good and then left the government holding the bag for their eventual (and predictable) losses.

In a word, the investors looted. Someone trying to make an honest profit, Professors Akerlof and Romer said, would have operated in a completely different manner. The investors displayed a “total disregard for even the most basic principles of lending,” failing to verify standard information about their borrowers or, in some cases, even to ask for that information.

The investors “acted as if future losses were somebody else’s problem,” the economists wrote. “They were right.”

Last week, Sheila Bair of FDIC told 60 Minutes she would like to see Congress attempt to set boundaries for banks to remain as banks. In other words, they grow beyond a certain level, they become some other entity but can’t be bailed out if something goes wrong. Perhaps this implies a higher risk which is understood by investors, forcing the institution to decide whether it can afford to be bigger.

Let’s get our act together real quick or we also too big to fail?

Aside: Why make billions, when you can make millions? – Austin Powers

Tags: FDIC, Citibank, Alan Greenspan, Ben Bernanke, Bailout Nation

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60 Minutes had a good segment this Sunday called Your Bank Has Failed: What Happens Next? which was perfect timing because a number of people seem to be worried about their own banks failing.

I bank at one of the national firms in the headlines and, while the thought has crossed my mind, I still place a lot of faith in FDIC’s handling of the problem. Of course, the fact that FDIC could run out of money is a growing concern. Let’s hope our the message from elected officials doesn’t weaken confidence at a time of growing bank failures.

The clip discusses the too big to fail concept. In most cases, the failure of a small bank has limited if any impact on the depositors in those institutions, but it can wipe out investors in those institutions. Sheila Bair, FDIC chairman and one of the consistent voices of competency in Washington, suggested that lawmakers may consider some sort of cap on size – giving some definitions toward the “too big to fail” concept.

The larger exposure to mortgages over the past decade by most lenders in search of larger profits is a key factor here aside from the recessionary environment.

UPDATE – something I shared last week but thought I’d insert again because it was so good. Think banking, bailouts and “loser mortgagees.” Good grief.

Tags: CNBC, FDIC, Sub-Prime, Bailout Nation

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I thought it was time to check back in with the pace of bank failures. The FDIC began publishing a list of bank failures in October 2000:

The top 3 years with the most failures were:

• 2009 – 14 failures in first 1.5 months – thats 104 annualized.
• 2008 – 25 failures.
• 2002 – 14 failures immediately after the 2001 recession – 9/11.

The conventional wisdom that bank failures should be more of a concern than other types of firms in a weakening economy may not be entirely correct.

However, correlate the failure rate with banks’ rise of excessive exposure to mortgage lending and it makes sense.

After I did my chart, I came across a CNN/Money story expressing the same concerns.

About 150-300 banks are projected to fail during this recession. The last big surge of bank failures was in the late 1980s.

Tags: FDIC

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Time magazine is starting to kick some online posterior these days reversing a slow erosion into irrelevance. I think it started with Justin Fox of Curious Capital and their expansion online has been worth following. (No, I am not a shareholder).

The financial crisis we are enduring is systemic and there is no one specifically to blame because nearly everyone is to blame, including my 2 cats, the mailbox and my old ipod. Rather than individuals, I think its better to look at the problems by industry and agency.

Still, it feels good to point the finger.

Here’s my take on it as ranked by overall impact. Nothing scientific here.

1. Rating Agencies
2. Investment Banks [Tie]
3. Subprime Lenders [Tie]
4. SEC
5. American Consumer
6. Investors of CDOs
7. Bush Administration [Tie]
8. US Treasury [Tie]
9. Congress [Tie]
10. Fannie Mae/Freddie Mac
11. Commercial Banks/Mortgage Banks
12. Federal Reserve
13. Mortgage Brokers [Tie]
14. Real Estate Appraisers [Tie]
15. Clinton Administration
16. FDIC, OTS, OCC
17. Real Estate Brokers [Tie]
18. Developers [Tie]
19. Big Media
20. Blogosphere

Did I miss anyone?

In their 25 People to Blame for the Financial Crisis piece, Time readers can vote for their favorites.

To vote for your favorites to blame as listed by Time.

To see the rankings from the Time survey.

Tags: FDIC, Sub-Prime

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The Federal Reserve just released the Beige Book, at 2pm today which provides anecdotal commentary on the economy nationally and across the regions of its member banks.

Here’s real estate and mortgage excerpts from the overall report.

Nearly all Districts reported weak housing markets characterized by reduced selling prices and low, but stable, sales activity.

Real Estate and Construction

Residential real estate continued at a slow pace nationwide. Sales were down in most Districts, but mixed activity was noted in the Boston, Atlanta and Minneapolis Districts. Boston, New York, Cleveland, Richmond, Atlanta, Chicago, Minneapolis, Kansas City and Dallas noted decreases in housing prices. Inventories of unsold homes remained high in the New York, Atlanta, Kansas City and San Francisco Districts, but declined in Chicago and Minneapolis. Philadelphia, Richmond, Chicago and Kansas City reported relatively stronger demand for lower- and middle-priced “starter homes.”

Commercial real estate markets weakened broadly. Vacancy rates rose in Boston, New York, Richmond, Chicago, Kansas City and San Francisco, but were mixed across markets in the St. Louis District. Leasing activity was down in almost all Districts. Rents fell in the Boston, New York and Kansas City Districts. Despite reductions in construction materials costs, commercial building activity declined in many Districts with tighter credit conditions as a factor.

Banking and Finance

Business and consumer lending activity continued to slow in most Districts. New York reported weakening loan demand in all categories, while Kansas City and San Francisco also witnessed substantial lending declines. Lending activity in other Districts was mixed among loan categories. In contrast, Philadelphia indicated that its banks saw loan volume rise in November, and some regional banks reported picking up new business borrowers. Cleveland reported that business loan volume has been steady to higher, and some bankers reported actively marketing their loan business.

Credit standards rose across the nation, with several Districts noting increases in loan delinquencies and defaults, especially in the real estate sector. Credit conditions remained tight. Chicago reported that FDIC actions and Federal Reserve lending had improved liquidity and slowed deposit outflows. Dallas indicated that government capital investments have led larger institutions to feel less constrained in their lending, while some smaller banks reported that scrutiny from regulators was making new deals more difficult to forge.

Here’s the NY District perspective from you know who.

A major residential appraisal firm reports substantial deterioration in New York City’s housing market over the past two months: prices of Manhattan co-ops and condos are reported to have fallen by 15 to 20 percent since mid-summer, though it is hard to get a clear handle on prices due to thin volume–much of the recent activity is reportedly from desperate sellers. Transaction activity has dropped off noticeably, and there has been a large increase in the number of listings. Some buyers that had signed contracts for units under construction earlier this year are having trouble getting financing at the contract price now that market values have dropped.

(I actually said 15%, ranging from 10%-20%)

Here’s the map (shades of beige, of course) in WSJ

Tags: FDIC, Beige Book

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It’s been a while since I linked out to bloggers whom I follow and admire. A large scale hat tip, so to speak. I also throw in news items and other tidbits that make me want to curl my cap.

This week’s theme: Change we can sort of believe in.

Political Fear and Loathing on Wall Street [XBroker]

The Option ARM Non-Bomb? [Infectious Greed]

From TARP to BARF [Curious Capitalist]

FDIC coupons [WallStreetJackass]

Love, Jobs & 401(k)s [NYT]

When couples split, the home is a hot potato [Miami Herald]

Failing Home Economics [NYT]

Word A Day: exurb [A.Word.A.Day]

Just doing my job [Seth’s Blog]

Rich Cut Back on Payments to Mistresses [Wealth Report]

Yuppie insurance [Free Exchange]

They Are Still Selling This Stuff? [Blown Mortgage]

Tags: FDIC

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In many ways, the free market financial/mortgage system, without regulatory oversight could be described as Nasty, brutish and short:

Nasty, brutish and short aren’t a firm of particularly unpleasant lawyers but a quotation from Thomas Hobbes’ Leviathan, or the matter, forme, and power of a commonwealth, ecclesiasticall and civill, 1651. The fuller quotation of this phrase is even less appealing – “solitary, poor, nasty, brutish, and short”. Hobbes described the natural state of mankind (the state pertaining before a central government is formed) as a “warre of every man against every man”.

I was struck by a recent case of massive number numbness that was inflicted upon me when I saw the Fannie and Freddie losses for the 3rd quarter:

Fannie Mae: ($29B)
Freddie Mac: ($25B)

For perspective, Fannie Mae and Freddie Mac each averaged a $2B loss per quarter in the preceding three quarters. The GSEs were bailed out in early-September and represented the last 3 weeks of 3Q. I know the Freddie loss just reported included a $14B non-cash charge so it lost about $12B cash-wise.

The current administration is leaving still advocating free markets, which a disconnected concept when compared to the situation we find ourselves with – day late and a few trillion short. Dismal Scientist calls it right.

I remember when President Bush decided to call a summit 3 weeks ago, during a crisis which needed daily attention:

The first decision I had to make was who was coming to the meeting. And obviously I decided that we ought to have the G20 nations, as opposed to the G8 or the G13.

hmmm…what flavor of free market thinking will work going forward that didn’t work before?

One of the things we did, we spent time talking about the actions that we have taken. The United States has taken some extraordinary measures. Those of you who have followed my career know that I’m a free market person — until you’re told that if you don’t take decisive measures then it’s conceivable that our country could go into a depression greater than the Great Depressions. So my administration has taken significant measures to deal with a credit crisis. And then we worked with Congress to deal with the credit crisis, as well.

Call me crazy, but how about simple common sense oversight? Despite the actions of the administration, I find that Congress is finally starting to make some sense.

Here’s a series of plans to fix housing summarized by Capital Commerce.

What worries me about much of this is that government has a hard time “thinking big” which should not be confused with “spending big.” Evidence of this is found with Treasury’s foreclosure plan versus FDIC’s Blair. Bair wants to think big.

Tags: FDIC, GSE, Bailout, Bailout Nation

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Click here for full sized graphic.

Regulation grew faster in the current administration as measured by annual increases, than in any since administration since the 1960s. That seems to be counter to the mantra:

Less government enables the free market to do its thing – self-regulation via market forces weeds out the weak?

One of the key issues of election campaign and the credit crunch was the lack of relevant regulatory oversight during the mortgage boom. Certain members of the public (ahem) complained, blogged, cajoled, and even…gasp…resorted to rolling their eyes and sighing.

But no one was listening. The administration told us everything was fundamentally sound. This commentary has been occurring since at least 2004 when all the lending snafus began to gain momentum. Frank, Dodd, Bush, Greenspan, Bernanke, Syron, Mudd, Paulson et al have told us things were fine until as recently as a few months ago.

I suspect most of them actually believed “the fundamentals were sound” and the real problem was that they were not fully informed or had an understanding of systemic nature of the crisis.

Be careful what you wish for. The sleeping giant in Washington has been awakened and it’s ready to eat. This weekend I took my family to DC for my high school reunion and a few days of rampant tourism whose highlight (for me) was going through an airport-like security screening process to eat mac & cheese at the Department of Agriculture’s employee cafeteria (ok, so offbeat cafeterias are my thing). I was struck by the enormity of the facility and the wildly inefficient service and presentation.

I shudder to think that this energy will now be channeled into regulatory oversight (hopefully not at the expense of good mac ‘n cheese for USDA employees).

We are now going to see a cultural shift toward more regulation, no matter who is elected in November. You can see it in the press releases and “on top of it” like responses from all the agencies – FDIC, OTS, FRB, FHFA et al. Once that stops, it’ll take years to reign in.

Why can’t there be a middle ground rather than extremes? Do we only feel comfortable at the margins, on the edge?

We don’t need more regulation – we need smarter and ultimately less regulation. A reasonably level playing field where regulations set the boundaries, rather than direct specific actions is what allows free markets to work.

Case in point: The tennis courts at our town’s new high school have a 6 inch slope from end to end to promote drainage. The slope is so exaggerated you can clearly see it. Good for drainage, sucks for tennis.

Next thing you know, mac ‘n cheese won’t be as yellow as it used to be at the USDA cafeteria but at least their cups will be biodegradeable.

Tags: FHFA, FDIC, Alan Greenspan, Ben Bernanke

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The agencies who watched the US Treasury bail out the GSEs issued a joint statement including:

• Board of Governors of the Federal Reserve System
• Federal Deposit Insurance Corporation
• Office of the Comptroller of the Currency
• Office of Thrift Supervision

Now everybody (the regulators) is starting to act together like a family. The statement sounded like motherly advice to the children at dinner time after a long day…

All institutions are reminded that investments in preferred stock and common stock with readily determinable fair value should be reported as available-for-sale equity security holdings, and that any net unrealized losses on these securities are deducted from regulatory capital.

In other words, I am saying this nicely, but if you make the same mistake Frannie made, you’re going to be spending a lot of time in your room.

Tags: FDIC, GSE

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I noticed that banks seem to fail on Fridays. Every bank failure in 2008 failed on a Friday.

It gives the regulators a chance to take over the institution over the weekend so it’s back to business on Monday.

Here’s a great article on this phenomenon in Slate’s Exlainer column..

On the Friday of a typical takeover, the FDIC arrives on-site with a large team to manage the transition. (When a large bank fails, this might include upward of 100 people.) The team has two main priorities. First, it must figure out which customers’ deposits are insured and which are not. This can be a tangle, since customers can sock away money in a variety of accounts to ensure that their deposits fall under FDIC-insured limits. The second priority is getting the bank ready to open under new ownership by Monday. That involves discarding any material with the old bank’s name on it—like posters, cashiers’ checks, and marquee signs—and putting the new bank’s paperwork, advertisements, and employees in place. Specialists from other departments, such as facilities, human resources, IT, public relations, and accounting, round out the FDIC’s team. Officials once even hired a hypnotist to help a bank employee remember a vault code.

Tags: FDIC

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I turned on the TV this morning to catch an update on the hurricane in New Orleans, hoping it was better. Thank goodness no deja vu, the storm appeared to be less intense than originally feared. I flipped the channels and saw Geraldo Rivera holding an anemometer counting off the wind speed. It reached 70mph, and thought, this is simply perverse.

Despite all the coverage and worry, the FDIC has reported only 10 bank failures so far this year. Granted, there were only 3 in 2007, 4 in 2004, 3 in 2003, 12 in 2002, 4 in 2001 and 2 in 2000, but from all the coverage, I would have expected 50 by now. Of the failures this year, Indymac was the only biggie.

The watch list has grown from 90 to 117 (and Indymac wasn’t on the watch list).

The Federal Deposit Insurance Corporation, or FDIC, insures bank deposits of up to $100,000 at nearly 8,500 of the nation’s banks and also keeps a watch list of banks that it considers in trouble.

Thanks to a collapsing housing market and a weak economy, a growing number of banks are struggling to stay afloat, with not enough cash on hand to cover losses from bad loans.

At the beginning of the year, 90 banks were on the FDIC watch list. There are now 117, FDIC chairwoman Sheila C. Bair announced at a news conference this afternoon. That is the highest number in five years, but some analysts expect the list to grow even more in coming months.

This is supposed to be one of the biggest financial catastrophes in US history, no? In the 1980s FDIC removed nearly 2,000 institutions and S&L from the face of the earth. I remember the unbelievable stuff we saw as appraisers, performing workouts for RTC and FDIC in the early 1990s. Incredible stupidity abound.

Because it’s not all about the traditional banks…

It’s about the investment banks and the investors. Banks were able to shift the risk to third parties via securitization.

Tags: Hurricane, FDIC

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Ok, now we are getting somewhere, albeit slow as molasses.

Treasury Secretary Paulson is pushing for covered bonds as a financial instrument to create more liquidity for US mortgages.

From my perspective, these are the types of things that have to happen for the US to see our way out of this credit crunch.

Covered bonds are debt securities backed by cash flows from mortgages or public sector loans. They are similar in many ways to asset-backed securities created in securitization, but covered bond assets remain on the issuer’s consolidated balance sheet.

The key here is recourse. In other words, if the bank goes under the bond holder has “recourse.” A basic concept but became obsolete during the securitization hay day because as it turned out, the bond holders had little recourse since the asset was split into so many pieces, it was very difficult to track down the asset.

Covered bonds are big in Europe.

Paulson issued best practices guidance (is that corporate speak or what?) to try to get the market jump started and was joined by FDIC, OTS and OCC as well as Bank of America, Citigroup, JP Morgan Chase, and Wells Fargo (WaMu and B of A have experience in these instruments). I wonder if WaMu didn’t attend because they are simply trying to survive?

Bankers involved in the field reckon that a US covered bond market could ultimately outstrip the roughly €2,000bn European market. However, it faces limitations in the near term due to restrictions placed on the bonds’ treatment by the FDIC, which importantly has oversight of banks if they become insolvent.

For example, the FDIC said banks should be restricted from using covered bonds for more than 4 per cent of their funding in order to avoid depleting the assets available to repay ordinary depositors and other unsecured creditors if a bank failed.

In the US, the cost of issuing covered bonds and the FDIC restrictions mean they could lie low in the pecking order of banks’ funding preferences, at least initially, according to analysts at Citigroup. Funding through Fannie and Freddie or through the Federal Home Loan Banks both appear more attractive for now, the analysts said.

FDIC created an expedited procedure for recourse for bond holders in the spring. Covered bonds are capped at 4% of total liabilities so its not a major fix, but it’s a start.

Here’s a better explanation, in the way that only Felix Salmon can provide.

The investors have to be brought back into the fold.

I repeat:

“Covered” seems to be a synonym for collateralized, but it also has other meanings that may be appropriate in this effort to salvage the housing market. Think of covered wagons, which can be circled in times of crisis. With banks reluctant to lend their own money for mortgages, and the private securitization market quiescent if not dead, the cost of mortgage loans has been rising even as housing prices fall, making a bad situation worse. At best, a covered bond market would provide a cheaper source of financing for banks while reassuring investors that their money is safe.

Essentially investors would buy into a pool of mortgages that would be kept on the balance sheet of the bank that made the loans. These would be high-quality loans, and at the first sign of trouble in the underlying mortgages, those mortgages would be replaced in the mortgage pool. Thus, investors would be assured of repayment unless the underlying mortgages suffered major losses and the issuing bank failed. That might make investors burned by existing mortgage securities more willing to return to the market.

At best, a covered bond market would provide a cheaper source of financing for banks while reassuring investors that their money will be safe. It is highly unusual for the government to take such a major role in getting a market established, but Treasury officials said their action was needed to get more money into housing loans.

Paulson may not be a good public speaker, but he brought something tangible to the table.

And credit for his move is covered. (ok, sorry)

Tags: Europe, FDIC

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