Let's Not Face It - The Banks are Bankrupt

Is there any bank that is not dead walking? If the FDIC is bankrupt where can we put the little savings we may have?

Roubini is in the business of selling proprietary fear. All that matters is that the Treasury continues to sell bonds - the 10 Year is rallying today. The problem with the "effectively bankrupt" claim is that they aren't BK until they are BK. Once the markets turn around here (and it looks like that is happening), the pensions will be able to allocate, which will in turn increase liquidity on the debt side, which will in turn incentivize banks to originate. It will be slow, and painful discovering the new risk standards but it will happen. Certainly doesn't mean housing is about to turn any corner here but it's a good time to be going long in equities.

On the money. Nothing more needs to be said except That the big N word is coming more into play. I think it is inevitable.

Honestly, I dont think they know what to do. I dont think they have any idea of the scope of the toxic assets, the level of performing loans that will go bad in the near future, the level of severity this recession will ultimately be, or what any effect of stimulus will be or how long it will take to occur.

I dont even think the CEOs of these banks have an idea. I think everyone is reacting in fear of doing nothing right now, and that is kind of what scares me because everyone wants stocks / housing to rebound, no matter the cost!

Just hot MY NET WORTH BACK UP!

Noah - doesn't the bad bank get at the heart of the matter regarding real loss severity and put a structure in place to work the assets out?

Brian - what's the big 'N' word? Nationalization? Do you write for the NYT? What I love about these folks who scream the sky is falling is they have no clue how solid the US economy is relative to everywhere else. All those idiots who spent the last 8 years claiming the US was passe and spent, are now eating crow and will be for sometime. You even have Putin at least putting on the proverbial face of cooperation, knowing full well that his country is screwed because they lost all of their pricing power and have zero internal economy.

Fred - what about the assets NOT considered BAD at the time, kept on the books, yet become non performing as this recession growls on?

Wait until you see some of the data Jeff will write about soon, regarding charge off rates, and delinquencies. I can tell you right now there are not nearly enough bids for the amount of toxic assets that are trying to be sold right now. The bad bank will solve that, but what about performing loans that turn sour?

The problem is accelerating in terms of deterioration, not stabilizing. Its actually getting worse, at a faster pace.

Thanks Noah - I totally agree that as we get deeper into loss severity (jumbos and commercial mortgages to name a few) that it will seem like it's getting worse. But let's take Roubini's numbers: he expects additional loss of 13% on the bank's unsecuritized loans; the XLF is trading at roughly 70% of BV for the group. How is that a wipeout? The real question is has the market discounted the banks sufficiently? Today's action seems to confirm that they are oversold but that is not to say we aren't going to be bouncing around some pretty low valuations for a while as this stuff gets worked out in the system. As you correctly point to often, price discovery is just waiting to happen, so there is liquidity out there. But I just think that with the Fed backstopping the entire system, implicitly so at least, and the creation of a bad bank, the risk of total loss in the common shares is minimal. The only way out of this is to float the pensions to higher ground. It's the dumb money that got us into this not the bankers nor the politicians. Its the pension guys who wanted to be superstars and produce excess alpha. They didn't understand risk. Clearly, the banks should have stopped when the pensions stopped buying back in early 2007 but by that time, it was a monster truck careening out of control. You can't deny that the preferred yields on financials are pretty compelling at these levels? Beats the carp (sic.) out of illiquid overpriced Manhattan condos.....anyway, thanks for your blog, you do an awesome job and is always a great read! J

ooops ... my comment was sent to the general mailbox it looks like. Sorry about that!

chris - I dont see it in JUNK?

which general mailbox? the online form? or other email?

Not sure ... the message said it was held for consideration by the owner of the site. If you can't find it, I'll re-draft it from memory. Sorry again

Fred - While I understand what your saying, I work on the desk at our firm, I dont agree. even though credit spreads are in, people in general wont borrow, and that ultimately is the problem. Nationalization is a far cheaper alternative then to keep dumping money into insolvent banks. You have to seperate the good banks from the bad banks and seperate the good/bad assets before anyone comes in again. The loss severity on lots of MBS products is widening and defaults are increasing. We have not even hit any option ARM reset/recasts yet. As for the Us being done, I dont think so, I think other markets are far worse, so I think, on a global scale, we are the best of the worst. I do think our policies will be constricted by the amount of debt and obligations we have going forward. It will be a different world.

chris - sorry, its not in junk folder. Can you redraft?

Brian - can you confirm that there are not anywhere near enough bids for cdo's and other toxic securities compared to the amount of that is being offered?

To say the FDIC is bankrupt is nonsense.

It may/will run out of funds as bank failures continue, but, and this is a very BIG BUT, it is backed by the Treasury of the US and Congress will allocate more funds if necessary. FDIC obligations are backed by the full faith and credit of the US (such as it is).

There is zero worry about getting your money if FDIC insured. The dollars may be worthless because we'll just print money to fulfill the FDIC's obligations (which are obligations of the US Government), but you will get your dollars.

There are more than enough genuine problems without people creating stupid ones like this.

A bunch of issues here. Let me try to take them one at a time. The losses that are already being booked on a mark-to-market basis look like they will wipe out required regulatory bank capital, that's hard to argue. Do the losses get even worse with GDP plummeting at a 5-6% rate? maybe, maybe not, no one knows. I would suggest though that at least the mark to markets are not over-done as people have been telling themselves since Bear Stearns. I was previously a believer that actual losses would be lower than the mark to market predictions, which is why I have been tracking actual loan delinquency trends. When we get the loan delinquency data in a few weeks it will be abominable as suggested by the big banks reporting earnings recently. It will show that the pricing of CMBSs wasn't far off of actual charge-offs.

The government can certainly print dollars out of thin air to paper all this over and we all know they will. But it will eventually cause either inflation, or much higher rates (and lower growth). Essentially, we need to steal economic growth (rents) from the future to cover the current losses, we give that back in inflation or very slow longer-term growth. I go with the latterer beacuse this was a bubble in fixed assets with 30 year lives, they will hang around and depress prices for a long-time to come. The dot com bubble was a bubble in assets with short lives (the funding the companies had) so after it burst and we printed too much money we had inflation (commodity & housing booms).

A bad bank strategy will allow losses to be recognized more quickly without causing a run on the banks. This will however, hit GDP harder short-term and causing even more collateral losses, but the whole situation will get cleaned up faster and the sustainable growth after the clean-up will be faster, because people will start to lend again.

I think stocks may rally for a while on the bank bail-out plan, but could get hit again on the final credit writeoff reckoning. My prediction is eventually stocks will slowly quietly levitate on the prospects of years of very slow inflation free growth. Small cap growth and small cap emerging markets will be the place to be - beacuse they will be the only areas with growth.

In the mean time the biggest risk is that other nations decide they are tired of our worthless stinky government paper and they jack rates for us....then we are Argentina. But that is mutually assured destruction, so I have hope that it won't happen....and a small stash of gold.

The banks are up today but still down from their highs. The news of the "bad bank" will be welcome news for the finacial sector and I think we may see a new direction and banks once this bad bank ideas goes through.

I would like to pick up on Jeff's comments about 'phony' balance sheets of banks, which is a theme also touched on by Jim Rogers's blog referenced to.

I found an interesting insight on this in John Paulson's investor letter of December 2008. (Incidentally, Paulson & Co's credit fund had a net performance of +18.83% during 2008). His view on banks is that the most meaningful analysis is based on a ratio of expected losses / tangible common equity ("TCE"). To calculate TCE, you elimate goodwill and deferred taxes. Banks that have high a ratio of losses to TCE, some as high as 682% (!), are at a high risk of failure, or in the best case, need to raise highly dilutive equity (if available at all), in either case causing their stock to drop shaly. Using this metric, the portfolio manager was able to determine early in 2008 that Freddie and Fannie were insolvent. If you exclude goodwill, mark the assets to market, eliminate deferred taxes, Freddie for instance had a NEGATIVE common equity of $65 billion compared to reported 'regulatory capital' of $37 billion ... We all know what happened later on, Freddie's stock got wiped out. In conclusion, it seems that arbitraging the spread between the current market valuation of a bank and the expected value once the bank needs to realise losses on their assets continues to be an attractive trade. Another conclusion is that the concept of 'regulatory capital requirements' is not very meaningful in this market ...

Lars - nonsense? I wouldnt say that. Of course the treasury will allocate more funds to FDIC, just like it will to C & BAC, but does that mean C & BAC is technically solvent too?

I think you miss the point of Jeff's discussion. FDIC last quarter statement included:

"The Deposit Insurance Fund balance decreased by 23.5 percent ($10.6 billion) to $34.6 billion during the third quarter of 2008, a decrease of 33.2 percent compared to a year ago. This decrease is primarily the result of an $11 billion increase in estimated losses for future failures recorded in the third quarter."

And that was 3Q of 2008. We know how 4Q was, way way worse. So we got 34BLN in the insurance fund to take care of how many trillions?

We all know that they wont let a big bank fail, and whether its a bad bank, nationalization, or whatever, at least we can say that the FDIC in their current state, is not healthy.

This isnt creating a stupid problem, its acknowledging reality, something that the American Public has not done much of the past 12-18 months and certainly not something that corporate America and specifically the banks/IB CEO's have NOT acknowledged throughout this crisis.

With that said, I am NOT pulling any money out of banks, but rather spread myself out to stay within the insured limits.

elementaryfinance, the IMF and Goldman Sachs estimate the total US credit losses in this cycle to be $2.1 trillion, compared to realized credit losses to date of $1 trillion. Indicating perhaps that we are only half way through the crisis. I am sceptical about the idea that a 'bad bank' could absorb all this ...

elementaryfinance, the IMF and Goldman Sachs estimate the US credit losses in this cycle to be $2.1 trillion - as compared to realized losses of $1 trillion. This suggests we are only half way through the crisis as of yet. I doubt very much that a 'bad bank' can absorb all this ... and that a stock market rally based on the 'bad bank' idea is likely to be short-lived.

Noah,

Any concern about FDIC insurance is nonsense. Sorry.

Banks failing is NOT nonsense, but to get people ginned up about their money (assuming it is under FDIC limits) is creating panic where it doesn't exist.

Want to worry about the credit rating of the US government, and the value of the dollar, as it bails out all the insolvent banks... I am right there with you, but no one will not get their dollars back (no matter how worthless they may be) because the FDIC is backed by the full faith and credit of the US.

Just to be perfectly clear, I agree that the US banking system, as a whole, is bankrupt. The only thing keeping the banks a float is infusions from the US government.

Lars,

I'm not trying to aarm anyone. of course we will print money to cover over all the losses and backstop any bank runs. But the printing of money not backed by economic growth/taxing power has consequences. So you can through in that the US Government is bankrupt but its taxing authority over citizens....who thankfully on the whole do have a bunch of mone....will save the day. We will however, all be significantly poorer, whether directlly through higher taxes or higher interest rates or below capacity economic growth. The real theme of my piece was. DON'T EXPECT BANKS TO LEND (except to borrowers who don't really need the money) EXPECT THEM TO SURVIVE or BE MERGED. Additionally expect heads to start rolling in underwriting as the actual delinquencies start and puking of loans into the secondary market will begin.

Lars - but that is the point, no one is sounding an alarm that the FDIC will fail and not back up their insurance requirements. You said that Jeff said that. I dont think he did. And I certainly didnt say that

If I truly thought the FDIC was bankrupt or wont get funding or insurance is BS, I would not have said:

"I am NOT pulling any money out of banks, but rather spread myself out to stay within the insured limits. "

Jeff even said: "the FDIC, which is insuring all these deposits, would be effectively bankrupt IF they ever had to deal with the insolvency of these large banks."

Thats all. But we all know they wont let a large bank fail. Saying the FDIC is outright bankrupt today, wont get any more funding, and that your deposit insurance is all bullshit, would be sounding an alarm. Clearly that was not in the discussion.

Noah - I dont work with CDO's, Im in the ALT A world, which is toxic enough for me. I can say however that if its very clean prime paper, it moves, but anything less then that is not going. not much. There are certainly a lack of bids for junk paper, but even when there is a bid it may not get done. Banks just dont want to writedown more of their paper. The bid comes in to low. Lots of banks are very secretive about opening up their books to the public for toxic assets. Level 3. Front paying prime bonds, there are plenty of bids and at hig prices, even 90 cents on the dollar, but anything outside of that is a crapshoot.

Jeff - I certainly agree with your sentiment that if other countries get tired of our debt, game is over.

Noah - I dont work with CDO's, Im in the ALT A world, which is toxic enough for me. I can say however that if its very clean prime paper, it moves, but anything less then that is not going. not much. There are certainly a lack of bids for junk paper, but even when there is a bid it may not get done. Banks just dont want to writedown more of their paper. The bid comes in to low. Lots of banks are very secretive about opening up their books to the public for toxic assets. Level 3. Front paying prime bonds, there are plenty of bids and at hig prices, even 90 cents on the dollar, but anything outside of that is a guess.

Jeff - I certainly agree with your sentiment that if other countries get tired of our debt, game is over.

If the FDIC is bankrupt where can we put the little savings we may have?

Posted by julanbi | January 28, 2009 9:47 AM

Noah and Jeff,

The very first post on this thread was by julanbi. Read it. It was to readers like this that I was responding to.

I understand full well that Jeff's concerns are not that the FDIC will go bankrupt, but that it is being forced to cover ever greater losses, and the consequences for the US for following such policies.

BUT, many readers will not understand the underlying concern, like julanbi, and simply worry about their money in banks.

Moreover, the link that reads "FDIC to Go Bankrupt by 2009" adds fuel to the fire.

I have no fundamental disagreement with Jeff, or his conclusions.

Clearly, julanbi was alarmed and it was to him, and others, I was "speaking".

gothca! I enjoy your comments Lars, always have! Thanks

Thank you Lars, Jeff, Noah. I have no clue about economics, my mind is the simple mind of a surgeon that spent his life training to perform difficult procedures in very sick people just to reach the moment to cash in at the wrong time, it seems. Thank you for the education I am receiving and for the extra effort to make it understandable to lay people like myself. It is a pleasure to take the advantage of your knowledge.

great post - I had this same thought just had not done the research like you did. everything is far worse than what the news says and the are pretty doom and gloom these days. I try not to watch it or think about it any more