Who’s the FDIC Gonna Call?

Is Your Bank Safe (part 3 of 3)

The FDIC, which insures virtually every bank deposit in this country, is rapidly digging itself into a $500 billion hole. Here’s how.

Three banks failed in 2007. 25 banks failed in 2008. Two Fridays ago, the FDIC shut down seven banks in Florida, Georgia, Illinois, Minnesota, and Wisconsin, bringing the 2009 total to 106. This past Friday the FDIC shut down nine banks in Arizona, California, Illinois, and Texas. That is the largest number of bank closures ever in one day. This year we’ve reached 115 failed banks.

In September, the number of “at risk” banks rose from 305 to 415. Now, unnamed government officials are saying 1,000 of the 8,100 FDIC member banks could fail over the next three years. According to the Wall Street Journal last week J.P. Morgan/Chase CEO, James Dimon, said he expects “several hundred additional smaller regional-based banks to not make it.”

The FDIC is running out of money to help failing banks, not because it needs to cover customer deposits (i.e., bank “liabilities”), but because it is spending large amounts of money to buy up bank “assets,” many of these, “toxic” assets. The FDIC has entered into “loss-sharing” agreements with surviving banks and with hedge funds to take over ownership of failed bank assets.

Already the FDIC has spent $50 billion on closeouts of around 135 banks since the financial crisis began in 2008. In addition, the FDIC said this past Friday’s closings would cost its insurance fund $2.5 billion alone.

In its latest loss-sharing deal, he FDIC and the U.S. Bank of Minneapolis agreed to share losses on about $14.4 billion of the combined purchased assets of $18.2 billion from last Friday’s nine failed banks.

As a result of all of its takeovers and loss-sharing arrangements for assets of failed banks, the FDIC has fallen below its statutory minimum for holding reserves to cover customer losses.

A Run On The Bank?

While we have not had a bank run yet, other countries have. In September the Dutch government seized DSB Bank NV, one of the biggest banks in the Netherlands after a run on deposits. Depositors were given three days to take their money out via ATMs at other banks. Even ING and four other big Dutch banks could not buy out this collapsing Dutch bank. In fact, ING is now divesting itself of both its US ING Direct bank and its insurance business in order to pay back some of the loans it received from the Dutch government.

Could this happen to us?

The primary causes of bank failures in the US have not ceased. Along with buying toxic assets like derivatives from investment banks and insurers, banks paid out loans, both secured and unsecured, that are now “underwater” or “nonperforming.” Bank failures have come largely from declines in the housing market, credit cards, and commercial loans.

According to CNN Money.com (Oct 15, 2009), RealtyTrac reports that the number of foreclosure filings is at a record high in the third quarter of this year. CNN’s headline blares, “They were the worst three months of all time.”  The statistics:  almost 1 million homes (I.e., one in every 136 homes) received a foreclosure letter during the last quarter of the year.

Many of those homeowners in foreclosure are working people with good credit who have lost their jobs as businesses downsize. Some small businesses even closed because they could no longer get needed loans from banks. Banks are too busy raising capital and writing off bad loans from the past to make many new loans. CIT Group, lender to nearly a million small and midsize businesses couldn’t raise enough capital to cover losses. It just filed for Chapter 11 bankruptcy, leaving taxpayers likely to hold a bag filled with a now-worthless $2.3 billion dollar TARP bailout investment in CIT stocks.

As foreclosures mount up, some banks are trying creative arrangements. One of these is similar to a reverse mortgage except the bank doesn’t pay anything to the underwater owner. The bank simply lets an older owner continue living in the home the bank now owns. When the bank’s customer dies, their heirs can choose whether or not to buy back their relative’s home by paying off the debt owed on it to the bank. In the fiercely competitive world of banking, this kind of losing arrangement is unprecedented.

Bank credit cards are also taking a hit as more and more people stop paying on them. Even JP Morgan Chase is losing money on its cards. Congress is cracking down on credit card fees next year. Calls are coming in for regulation of bank overdraft fees as well. But most worrisome to banks, the Fed, and the FDIC are commercial mortgages. This market is in far worse shape than the home mortgage market. Along with smaller banks that failed from making commercial loans, Capmark Financial Group, one of the biggest lenders for commercial development projects, just filed for Chapter 11 bankruptcy this past week.

What The FDIC Already Tried

The FDIC has taken steps to replenish its insurance fund. Last spring it levied a $5.6 billion emergency fee on member banks. This fall it requested Congressional approval to collect member bank fees in advance for the next few years. These steps have enabled the FDIC to keep up with extraordinary losses to its insurance fund so far this year.

Seeing that the FDIC could be in deep trouble next year, this past March Sheila Bair went to Christopher Dodd, chair of the Senate banking committee, and requested an increase in the FDIC’s emergency line-of-credit from the US Treasury. She got a $500 billion line of credit.

In May FDIC staff estimated that bank failures would run the FDIC a total of $70 billion between 2009 and 2013.

In August, Bair reluctantly set in place a program of loss sharing with hedge funds who buy failed banks. This set a new precedent at the FDIC. Four members of the FDIC board voted to set a new precedent, while the fifth board member remained completely opposed the idea of letting hedge funds buy banks.

Bair wanted hedge funds to agree to keep “Tier One” capital reserves of 15% on hand, but after pension funds from several states as well as the hedge funds complained, the FDIC board lowered the capital reserves rate to 10% for hedge funds. The FDIC also wanted hedge funds to be “a source of strength” for banks and be available to provide extra support, but this requirement was dropped also because of the need to acquire extra capital to support failing banks.

The fact is that hedge funds have also been failing, and now the largest are selling off their investments. Blackstone, a well-known private equity group, is planning to sell five companies and is listing eight others. Many hedge funds will need to raise new capital within the next couple years. A consulting group in Boston is estimating that 20 percent of the largest 100 private equity groups will fail in that endeavor and will simply vanish within a couple years.

In September, FDIC staff estimated the cost of bank failures between 2009 and 2013 would run about $100 billion. Bair briefly considered drawing on her Treasury line-of-credit, but opted for requesting advances of up to $45 billion in fees from FDIC member banks instead.

With the blessing of Treasury head, Tim Geithner, the FDIC also announced its intention to end its Debt Guarantee Program after October. The FDIC began this program under pressure from the Bush Treasury during the start of the financial crisis in 2008. This program aimed to increase the liquidity of banks by having the FDIC guarantee short-term debt that large banks issued. The FDIC reaped almost $10 billion for fees for this guarantee and as of yet had lost no money.

The biggest users of this $310 billion FDIC program are large retail banks such as Citigroup, GMAC and General Electric. In September the three said they were able to issue debt without any more government guarantees. But now these banks are in trouble. The FDIC had to extend its Debt Guarantee for another six months. Today the FDIC guaranteed $7.4 billion of new debt for GMAC, while the Treasury injected $7.5 billion into this tottering bank.

There is a very real danger that larger retail and regional banks that bought smaller banks will themselves fail or need more help from the FDIC. For example BT&T, a regional bank in North Carolina considered to be very stable, entered into a $7.7 billion dollar  “loss-sharing” arrangement with the FDIC for the purchase of the assets  (mostly commercial loans) of Colonial Bank of Alabama this past summer. On October 20th a Wall Street Journal headline reported that BB&T reported a net decline in value of 58% for the bad loans it now owns.

This “house of cards” the FDIC is building with bank and hedge fund partners reminds me of the Thanksgiving/Christmas/New Year holiday season I sat biting my nails. I’d maxed out all my credit cards, taken a loan from my condo board, and borrowed on my insurance to fix up my wrecked home for sale just as the housing market began sliding down into the pit it’s now mired in. When Bair begins using her $500 billion line-of-credit she will be in the same boat. I was lucky in selling my home before it went underwater. But we’ve all seen what has happened to other borrowers recently. How will it go for Bair and the FDIC?

The FDIC’s estimate that bank failures between 2009 and 2013 would cost the FDIC a total of $100 billion looks utterly shortsighted at this point. The FDIC has already spent over $52.5 billion on around 135 failing banks since the crisis began just over a year ago and it’s now looking at losing as many as 1,000 member banks by 2013.

That $500 billion line of credit from the Treasury looks much more likely to be needed by the FDIC and soon!

But here’s the hitch. Unlike TARP bailout funds, the FDIC’s $500 billion line-of-credit has to be paid back to the Treasury Department, which itself going deeply into debt. How will the FDIC repay such a large amount when it has already tapped out its members for years ahead?

Bair, normally a sensible government bureaucrat, has been forced by extraordinary circumstances to assume the kind of risk usually only a private entrepreneur takes on. Will the toxic bank assets Bair is gambling with in her loss-sharing bank deals recover their full value? Or even part of their value? Ever?

Next time:  “The Treasury:  $14 trillion, and what’d do we get? Another minute older, and deeper in debt”

Copyright © 2009 Nancy K. Humphreys