To those of you who have been checking this out, supporting me, and hopefully learning a bit along the way- I have created a new, more dynamic site for your enjoyment and use. Please go to:
www.frontlinefinancials.com
There you will find the same perspective, all my old posts, and some great new posts! I'm also providing useful links and a much more interactive interface. Let me know what you think!
Friday, May 29, 2009
Friday, May 22, 2009
Obama Makes a Smart (Unnoticed?) Move
Amid all the bad news that keeps getting sloshed around, a couple of days ago there was a VERY important bright spot that went largely unnoticed. For those of you who believe that President Obama is the second coming of Jesus, his pedestal just got a little higher. For those of you who think he's Satan's spawn, this is a classic "blind squirrel finding a nut" moment. For the rest of us, it's just one more piece of a large effort to ensure the stability of our banking system.
In October of last year, President Bush increased insurance coverage per individual from $100,000 to $250,000. This was done, essentially, to prevent a sweeping run on all banks. It was a brilliant move to build confidence that really cost taxpayers nothing (so far).
On May 20th, 2009 President Obama signed into law a continuation of the enormous increase in FDIC coverage. This additional coverage was set to expire on December 31 of this year. The new law extends the coverage through the end of 2013.
Here at my bank, we had already fielded several calls from concerned CD customers about this potential loss of coverage. One man went so far as to request something in writing from me stating that he would be allowed to pull his money if the coverage reversed back to $100,000, and we had done nothing to otherwise insure his funds. We were already developing a game plan to combat a run on our tiny little bank if the coverage had reverted. Depositors would have taken money out in droves to accommodate for the reversal of insurance. This could have been very bad not only for us, but for the system in general. We might have had a situation similar to the one I've discussed in a related blog post below.
So this is your good news headline of the day: "President Obama Averts Potential Run on the American Banking System, Seven Months in Advance"
Kudos Obama.
For more information on the extension, please see the following website:
http://www.fdic.gov/deposit/deposits/changes.html
Friday, May 15, 2009
The Death of a Bank: A brief explanation
Nearly every person has worried about what happens if their bank goes out of business. I field calls and get asked in person almost on a daily basis what a bank failure actually means to customers. What happens to my money? Can I access my funds? And, my favorite, “If the bank fails, do I get to stop paying on my loan???”
I thought this would be the perfect platform to briefly describe the most likely scenarios for a bank shutting down, what you can and can’t do following your bank failing, and where to find important information.
Here are the three most common (though not all-inclusive) scenarios.
1. Your bank fails and the FDIC takes it over without finding another bank to buy it.
2. Your bank fails and the FDIC finds a buyer of the deposits.
3. Your bank fails and the FDIC finds a buyer of the whole bank.
Scenario 1
Your bank is known to all regulators and bankers as the ugly, fat, annoying girl. Not only does it have a huge amount of problems on the surface, but it’s made up of such useless deposits and loans that nobody- not even the drunkest guy at the bar- will take her home.
If you have your deposits at this bank and they’re under the FDIC insurance limit, you’ll probably be sent a check for the balance of your account on the Monday following the Friday that the bank closes. If any part of your deposits is over the FDIC limit, you lose that amount of money (ONLY the amount that exceeds the limit). Over the weekend, the FDIC will contract with a big bank like Bank of America or SunTrust to allow transactions on the accounts to post as they normally would. You’ll have to open up another account at another bank immediately.
If you have a loan at this bank, you keep paying your loan, but might have to change where you send your payments. You will be strongly encouraged or flat out told to find another bank to take over your loan. If the loan is unsecured, you might be required to pay it immediately or find another bank to take it over. This is a bad scenario for people with loans, because the FDIC simply doesn’t have the right staff to service the accounts. It will get rid of them as fast as possible or sell them to another bank/private company. This doesn’t always turn out badly for loan customers, but it’s the worst scenario for you.
Scenario 2
To use a similar analogy, bankers and regulators think of you as a really attractive person but you have an STD. You’re hot, but they wouldn’t touch your assets even if you paid them.
If you have a deposit account with this bank, you’re perfectly fine. You won’t have to do anything but get used to a new bank’s name on your checks, debit cards, statements, etc. You’ll probably even get to work with the same staff with which you’re used to working. You’ll see the same smiling faces and hopefully get the same great service. Your accounts will also continue to be fully insured and you’ll have the peace of mind that comes with a stronger bank.
The only downside in this scenario is that the rate you’re currently paid on things with variable rates (money markets, savings accounts, checking with interest, etc) might be changed to a much lower rate. CD rates should be honored until maturity, but you will probably not be paid nearly as well when they renew.
If you have a loan with this bank, you’re in the same boat as Scenario 1 customers. The FDIC wants to get rid of you, and it doesn’t particularly care how it does it. See Scenario 1 for the breakdown.
Scenario 3
Keeping with the theme, your bank is as hot as Miss America (or Brad Pitt, for the ladies), has a great personality, and unfortunately was dumb enough to swallow a gallon e coli bacteria. With the proper penicillin, this will once again be an awesome bank.
If you have a deposit account with this bank, just like in Scenario 2, you’re perfectly fine. Go ahead and go on that weekend trip and don’t worry about your debit card working. Again, your accounts are fully FDIC insured immediately.
If you have a loan with this bank, you’re in luck. The new bank wants you and values you. They might give some customers a hard time, but they want to keep the vast majority of them. If you’re a bad loan customer (Don’t act like you don’t know you are), you’ll probably be harassed until you go away, get foreclosed on, or agree to some kind of painful workout. If you’re a good customer, just write the new bank name on your loan payments and keep rolling along merrily.
Important Information:
If your bank fails (or you think it might have failed), it is absolutely critical that you go to the following website:
www.fdic.gov
In the upper left hand corner, you will see something that says “Bank Closing Information – (Day the bank Closed)” and underneath, it will list the closed banks for that week. Click on your bank name and read EVERYTHING on each page. This will tell you exactly what you need to know regarding your accounts and what changes to expect, if any. It will also give you some interesting information detailing the transaction that took place and the loss to the FDIC fund.
The FDIC will also post information on every door and drive through window of every branch immediately upon closing the bank. This will basically detail the same information that you can find on the website.
Finally, always remember that your accounts, no matter how ugly or attractive your bank is, are fully insured up to the FDIC limit if they have a sign that says “FDIC Insured” posted in the lobby. There is absolutely no reason to worry about your money if you keep it under this limit. You will ALWAYS be paid that money…unless of course, the FDIC and US Government fall… but let’s not get into that just yet.
I thought this would be the perfect platform to briefly describe the most likely scenarios for a bank shutting down, what you can and can’t do following your bank failing, and where to find important information.
Here are the three most common (though not all-inclusive) scenarios.
1. Your bank fails and the FDIC takes it over without finding another bank to buy it.
2. Your bank fails and the FDIC finds a buyer of the deposits.
3. Your bank fails and the FDIC finds a buyer of the whole bank.
Scenario 1
Your bank is known to all regulators and bankers as the ugly, fat, annoying girl. Not only does it have a huge amount of problems on the surface, but it’s made up of such useless deposits and loans that nobody- not even the drunkest guy at the bar- will take her home.
If you have your deposits at this bank and they’re under the FDIC insurance limit, you’ll probably be sent a check for the balance of your account on the Monday following the Friday that the bank closes. If any part of your deposits is over the FDIC limit, you lose that amount of money (ONLY the amount that exceeds the limit). Over the weekend, the FDIC will contract with a big bank like Bank of America or SunTrust to allow transactions on the accounts to post as they normally would. You’ll have to open up another account at another bank immediately.
If you have a loan at this bank, you keep paying your loan, but might have to change where you send your payments. You will be strongly encouraged or flat out told to find another bank to take over your loan. If the loan is unsecured, you might be required to pay it immediately or find another bank to take it over. This is a bad scenario for people with loans, because the FDIC simply doesn’t have the right staff to service the accounts. It will get rid of them as fast as possible or sell them to another bank/private company. This doesn’t always turn out badly for loan customers, but it’s the worst scenario for you.
Scenario 2
To use a similar analogy, bankers and regulators think of you as a really attractive person but you have an STD. You’re hot, but they wouldn’t touch your assets even if you paid them.
If you have a deposit account with this bank, you’re perfectly fine. You won’t have to do anything but get used to a new bank’s name on your checks, debit cards, statements, etc. You’ll probably even get to work with the same staff with which you’re used to working. You’ll see the same smiling faces and hopefully get the same great service. Your accounts will also continue to be fully insured and you’ll have the peace of mind that comes with a stronger bank.
The only downside in this scenario is that the rate you’re currently paid on things with variable rates (money markets, savings accounts, checking with interest, etc) might be changed to a much lower rate. CD rates should be honored until maturity, but you will probably not be paid nearly as well when they renew.
If you have a loan with this bank, you’re in the same boat as Scenario 1 customers. The FDIC wants to get rid of you, and it doesn’t particularly care how it does it. See Scenario 1 for the breakdown.
Scenario 3
Keeping with the theme, your bank is as hot as Miss America (or Brad Pitt, for the ladies), has a great personality, and unfortunately was dumb enough to swallow a gallon e coli bacteria. With the proper penicillin, this will once again be an awesome bank.
If you have a deposit account with this bank, just like in Scenario 2, you’re perfectly fine. Go ahead and go on that weekend trip and don’t worry about your debit card working. Again, your accounts are fully FDIC insured immediately.
If you have a loan with this bank, you’re in luck. The new bank wants you and values you. They might give some customers a hard time, but they want to keep the vast majority of them. If you’re a bad loan customer (Don’t act like you don’t know you are), you’ll probably be harassed until you go away, get foreclosed on, or agree to some kind of painful workout. If you’re a good customer, just write the new bank name on your loan payments and keep rolling along merrily.
Important Information:
If your bank fails (or you think it might have failed), it is absolutely critical that you go to the following website:
www.fdic.gov
In the upper left hand corner, you will see something that says “Bank Closing Information – (Day the bank Closed)” and underneath, it will list the closed banks for that week. Click on your bank name and read EVERYTHING on each page. This will tell you exactly what you need to know regarding your accounts and what changes to expect, if any. It will also give you some interesting information detailing the transaction that took place and the loss to the FDIC fund.
The FDIC will also post information on every door and drive through window of every branch immediately upon closing the bank. This will basically detail the same information that you can find on the website.
Finally, always remember that your accounts, no matter how ugly or attractive your bank is, are fully insured up to the FDIC limit if they have a sign that says “FDIC Insured” posted in the lobby. There is absolutely no reason to worry about your money if you keep it under this limit. You will ALWAYS be paid that money…unless of course, the FDIC and US Government fall… but let’s not get into that just yet.
Tuesday, May 12, 2009
We’re out of Bullets
I was having a conversation the other day with an independently wealthy, good ‘ole southern man who was absolutely irate that he couldn’t sell one of his gas stations. This man explained to me that he had a very eager buyer and a property that easily generated profit to cover finance costs PLUS leave the new owner a fair amount of income.
He told me all this in order to try and get my bank to rethink doing the financing for the new buyer and asked me flat out why on earth we would turn it down. The answer was pretty simple. I told him, “We’re out of bullets.”
Knowing that he was both a Vietnam veteran and an avid hunter, I knew that he could understand this concept more easily than talking about things like capital ratios, liquidity, shrinking the balance sheet, etc. Instead of all that, I stuck to this analogy. The deal he wanted to get done was like seeing a 10-point deer right when you get up in the stand. It was like being able to take over a town in a war that is essential to enemy supply lines, but has no real protection. We would love to shoot it down…take it over… close the deal, but we don’t have any damn bullets. Now…maybe if you had a deal that was more like a duck we could strangle… or a peasant cart we could ambush and take over without a shot… that kind of deal we could look at doing. We do still have rocks and sling-shots.
For many banks (but by no means the majority), this story rings true every day. No matter how great a deal looks, banks simply do not have enough cash or capital (bullets) to do the deal. It has nothing to do with the borrowers. It’s not meant to be an insult. We just flat out can’t do it unless somebody pulls off a Normandy-like invasion to bring us fresh ammo.
He told me all this in order to try and get my bank to rethink doing the financing for the new buyer and asked me flat out why on earth we would turn it down. The answer was pretty simple. I told him, “We’re out of bullets.”
Knowing that he was both a Vietnam veteran and an avid hunter, I knew that he could understand this concept more easily than talking about things like capital ratios, liquidity, shrinking the balance sheet, etc. Instead of all that, I stuck to this analogy. The deal he wanted to get done was like seeing a 10-point deer right when you get up in the stand. It was like being able to take over a town in a war that is essential to enemy supply lines, but has no real protection. We would love to shoot it down…take it over… close the deal, but we don’t have any damn bullets. Now…maybe if you had a deal that was more like a duck we could strangle… or a peasant cart we could ambush and take over without a shot… that kind of deal we could look at doing. We do still have rocks and sling-shots.
For many banks (but by no means the majority), this story rings true every day. No matter how great a deal looks, banks simply do not have enough cash or capital (bullets) to do the deal. It has nothing to do with the borrowers. It’s not meant to be an insult. We just flat out can’t do it unless somebody pulls off a Normandy-like invasion to bring us fresh ammo.
Saturday, May 2, 2009
Meaningful Conversations
I thought it might be helpful following the extensive FDIC post last week to follow up with a conversation I just had with one of our customers. I was explaining to him a bit about how the FDIC works and why the government bailout was actually the "least costly" approach to saving the Financial World. Here's a snippet:
Him: "You know, if the government just keeps handing money over to banks that do nothing but hoarde it and lose more money, we're never going to get out of this..."
Me: "Well, believe it or not, banks are making a ton of loans still, and the bailout was necessary because of the huge amount of money that it would have taken for the FDIC to make good on its insurance promise."
Him: "It wouldn't have cost nearly as much for the FDIC to just shut down all the bad ones and let the good ones survive!"
Me: "Well, let's just pretend that this bank went out of business, ok? You have a few CD's with us that total about $50,000... and you're fully FDIC insured. Sound right so far?
Him: "Yep"
Me: "Alright, so we have about 6,000 customers who are in a similar position as you...and we're a very small bank, Agreed?"
Him: "Yep"
Me: "If we went out of business today, the FDIC would lose anywhere from 50 to 100 million dollars because of just us going out of business."
Him: "That's a lot of money!"
Me: "Right. Now if you think about a Bank of America or Citibank, they do business with something like 100 million people just like you... and are each about 100 times as big as we are. Can you imagine what the loss would be if they went under?"
Him: "Holy hell!"
Me: "And if they went out of business, do you think people would think their money was safe ANYwhere?"
Him: "No, I'd probably pull my money out and hide it under my mattress..."
Me: "That's exactly why they had to bailout the system. To make sure you, and 100 million other people, didn't do that exact thing."
Him: "Oh... well i guess that makes a lot of sense."
Him: "You know, if the government just keeps handing money over to banks that do nothing but hoarde it and lose more money, we're never going to get out of this..."
Me: "Well, believe it or not, banks are making a ton of loans still, and the bailout was necessary because of the huge amount of money that it would have taken for the FDIC to make good on its insurance promise."
Him: "It wouldn't have cost nearly as much for the FDIC to just shut down all the bad ones and let the good ones survive!"
Me: "Well, let's just pretend that this bank went out of business, ok? You have a few CD's with us that total about $50,000... and you're fully FDIC insured. Sound right so far?
Him: "Yep"
Me: "Alright, so we have about 6,000 customers who are in a similar position as you...and we're a very small bank, Agreed?"
Him: "Yep"
Me: "If we went out of business today, the FDIC would lose anywhere from 50 to 100 million dollars because of just us going out of business."
Him: "That's a lot of money!"
Me: "Right. Now if you think about a Bank of America or Citibank, they do business with something like 100 million people just like you... and are each about 100 times as big as we are. Can you imagine what the loss would be if they went under?"
Him: "Holy hell!"
Me: "And if they went out of business, do you think people would think their money was safe ANYwhere?"
Him: "No, I'd probably pull my money out and hide it under my mattress..."
Me: "That's exactly why they had to bailout the system. To make sure you, and 100 million other people, didn't do that exact thing."
Him: "Oh... well i guess that makes a lot of sense."
Thursday, April 23, 2009
Smoke and Mirrors
There are a large and growing number of people that are absolutely fed up with the government continuing to bail out banks (and auto companies, but that's beyond my circle of competence). To back up just a little, there were a large amount of people who were not in favor of the bailout from the beginning. It is for this huge segment of the population that I am compelled to write a somewhat apologetic justification for the massive amount of government intervention in the financial system.
There is something very well known, but not fully appreciated about the basic concept of banking. Here's what happens: you put your money in a bank, and that evil banker goes out and invests your money, pretending it's his own, to make a profit. In exchange for your money the banker either pays you some interest rate or at least supposedly gives you safe and continuous access to your funds, so that you don't have to have a personal safe and your own monetary system. The key to all of this is the belief that your money is actually safe and accessible. But banking is all one big hoax; David Copperfield has nothing on your average banker. Your money isn't actually there. It's invested somewhere else, which the banker may or may not be able to get quickly in the event that you actually do want all of your money at once.
For the most part, this is rarely a problem. You fully believe that your money is not only there today, but will also be there tomorrow and 30 years from now. The banker keeps plenty of cash on hand to supply what he thinks will be enough to make customers happy and to ensure that your Starbucks purchase isn't declined. The issue comes when you no longer believe that your money is safe.
This confidence problem caused economic disasters throughout the history of the world. The Great Depression is the most glaring example in modern history, but there were "panics" (in America) starting in 1785 and happening every 15-20 years or so up until 1929. These are what I refer to as true "panics." People started to look up under Copperfield's stage and realize that maybe he didn't actually make the elephant levitate - and it scared them to death. They pulled money out of banks in droves and on most occasions, caused the entire economy to completely fail.
In the 1930's, though, the government decided that something absolutely had to be done in order to stop panics, and consequently Depressions, from happening. For this reason, they not only set up a strong regulatory frame work to oversee banks, but they more importantly set up the Federal Deposit Insurance Corporation. In doing so, they decided that to make people feel more safe, they would essentially guarantee most citizens' deposits in banks. If your bank goes out of business, no big deal! Uncle Sam will write you a check for your funds. The importance of this "invention" is enormous. For 70+ years, there were no true financial panics, and many thought there never would be one again. This allowed the economy to grow at an unbelievable rate over time without being interrupted and thrown back 30 years because of a stampede of irrational human fear. Loans and capital flooded into the economy thanks in large part to the simple belief money in banks was and would continue to be backed by the full faith and credit of the U.S. government, which hadn't been questioned since the early 1800's.
That brief walk through history brings me to the modern crisis. To put it mildly, the Great Depression would have had nothing on what would have happened had the American government and subsequently nearly every other major world government not stepped in to stem the effects of the atomic bomb that was the U.S. Housing Market Collapse. The FDIC is the key to the argument, and because politicians and regulators are scared to death to tell you the real reason for the bailout, I'll go ahead and show you Copperfield's trick.
The U.S. Government would have bankrupted if there had not been a bailout. This would have caused every other major economic world player to also collapse, since everyone holds owns some of our debt. Great Britain would have yearned for the days of the Battle of Britain in lieu of 30-50% unemployment. China would have reverted back to a 3rd world country. The U.S. would no longer be a superpower. There would be an enormous world-wide power grab and populist movement, not unlike the situation that led to the rise of Hitler. We would be in a nuclear winter without ever having dropped a real bomb.
The reason that the government would have bankrupted is simple. Citigroup would have played a large role in this and is just one of many institutions that would have led to this enormous problem. The company, at one time, had nearly 3 trillion dollars in assets. That's a loose term for where bankers "invest" the money that people give them. A substantial portion of the money people trusted to Citigroup were FDIC guaranteed. The FDIC only had about 50 billion dollars in funds at the time, and Citigroup was well on its way to becoming insolvent. There is simply no way that the FDIC could have covered the cost of its guarantee. To be sure, they have an open line of credit with the Treasury, but once Citibank goes... then the real panic sets in. That's when Regions, Fifth/Third, Bank of America, and any number of other major players also start to see deposits leaving in droves. At that point the loss to the FDIC becomes so large that the government has to issue trillions more in debt just to fund the FDIC's lifeline. We're running at a huge deficit already, but can you imagine what it would be like if the FDIC essentially had to write a check for every insured dollar in the country? While some banks would surely have survived, as has been the case in past panics, the government simply would not have been able to sell enough debt at cheap enough levels to sustain the FDIC guarantee. Without that, there is no banking system. There are no loans. There are no debit card or check purchases. The economy is thrown back to the 1800's for 20-30 years provided that the government somehow manages to keep the country together and maintain power.
Because that situation was not only plausible but highly likely, Uncle Sam had to do some extraordinary things to ensure that he didn't have to make good on the FDIC promise to the entire country. The 750 billion dollars in hard bailout money is just a drop in the bucket of what the total economic cost of a collapse would have been. The government had to maintain the illusion that your guarantee is still good without having to actually prove it in a large way. I'm generally very against anything resembling a government hand out, but this exception simply had to be made. Sometimes in war, you have to make very hard decisions, and that's what this is- a war. You got drafted back in September 2008 without ever being properly notified. We have all made a huge sacrifice today so that our children and grandchildren can (hopefully) enjoy peace and a standard of living in excess of our own. It's true that we've also burdened them with even more debt, but to summarize Warren Buffett, sometimes it's better to have to pay for a lunch later than to have no lunch at all.
There is something very well known, but not fully appreciated about the basic concept of banking. Here's what happens: you put your money in a bank, and that evil banker goes out and invests your money, pretending it's his own, to make a profit. In exchange for your money the banker either pays you some interest rate or at least supposedly gives you safe and continuous access to your funds, so that you don't have to have a personal safe and your own monetary system. The key to all of this is the belief that your money is actually safe and accessible. But banking is all one big hoax; David Copperfield has nothing on your average banker. Your money isn't actually there. It's invested somewhere else, which the banker may or may not be able to get quickly in the event that you actually do want all of your money at once.
For the most part, this is rarely a problem. You fully believe that your money is not only there today, but will also be there tomorrow and 30 years from now. The banker keeps plenty of cash on hand to supply what he thinks will be enough to make customers happy and to ensure that your Starbucks purchase isn't declined. The issue comes when you no longer believe that your money is safe.
This confidence problem caused economic disasters throughout the history of the world. The Great Depression is the most glaring example in modern history, but there were "panics" (in America) starting in 1785 and happening every 15-20 years or so up until 1929. These are what I refer to as true "panics." People started to look up under Copperfield's stage and realize that maybe he didn't actually make the elephant levitate - and it scared them to death. They pulled money out of banks in droves and on most occasions, caused the entire economy to completely fail.
In the 1930's, though, the government decided that something absolutely had to be done in order to stop panics, and consequently Depressions, from happening. For this reason, they not only set up a strong regulatory frame work to oversee banks, but they more importantly set up the Federal Deposit Insurance Corporation. In doing so, they decided that to make people feel more safe, they would essentially guarantee most citizens' deposits in banks. If your bank goes out of business, no big deal! Uncle Sam will write you a check for your funds. The importance of this "invention" is enormous. For 70+ years, there were no true financial panics, and many thought there never would be one again. This allowed the economy to grow at an unbelievable rate over time without being interrupted and thrown back 30 years because of a stampede of irrational human fear. Loans and capital flooded into the economy thanks in large part to the simple belief money in banks was and would continue to be backed by the full faith and credit of the U.S. government, which hadn't been questioned since the early 1800's.
That brief walk through history brings me to the modern crisis. To put it mildly, the Great Depression would have had nothing on what would have happened had the American government and subsequently nearly every other major world government not stepped in to stem the effects of the atomic bomb that was the U.S. Housing Market Collapse. The FDIC is the key to the argument, and because politicians and regulators are scared to death to tell you the real reason for the bailout, I'll go ahead and show you Copperfield's trick.
The U.S. Government would have bankrupted if there had not been a bailout. This would have caused every other major economic world player to also collapse, since everyone holds owns some of our debt. Great Britain would have yearned for the days of the Battle of Britain in lieu of 30-50% unemployment. China would have reverted back to a 3rd world country. The U.S. would no longer be a superpower. There would be an enormous world-wide power grab and populist movement, not unlike the situation that led to the rise of Hitler. We would be in a nuclear winter without ever having dropped a real bomb.
The reason that the government would have bankrupted is simple. Citigroup would have played a large role in this and is just one of many institutions that would have led to this enormous problem. The company, at one time, had nearly 3 trillion dollars in assets. That's a loose term for where bankers "invest" the money that people give them. A substantial portion of the money people trusted to Citigroup were FDIC guaranteed. The FDIC only had about 50 billion dollars in funds at the time, and Citigroup was well on its way to becoming insolvent. There is simply no way that the FDIC could have covered the cost of its guarantee. To be sure, they have an open line of credit with the Treasury, but once Citibank goes... then the real panic sets in. That's when Regions, Fifth/Third, Bank of America, and any number of other major players also start to see deposits leaving in droves. At that point the loss to the FDIC becomes so large that the government has to issue trillions more in debt just to fund the FDIC's lifeline. We're running at a huge deficit already, but can you imagine what it would be like if the FDIC essentially had to write a check for every insured dollar in the country? While some banks would surely have survived, as has been the case in past panics, the government simply would not have been able to sell enough debt at cheap enough levels to sustain the FDIC guarantee. Without that, there is no banking system. There are no loans. There are no debit card or check purchases. The economy is thrown back to the 1800's for 20-30 years provided that the government somehow manages to keep the country together and maintain power.
Because that situation was not only plausible but highly likely, Uncle Sam had to do some extraordinary things to ensure that he didn't have to make good on the FDIC promise to the entire country. The 750 billion dollars in hard bailout money is just a drop in the bucket of what the total economic cost of a collapse would have been. The government had to maintain the illusion that your guarantee is still good without having to actually prove it in a large way. I'm generally very against anything resembling a government hand out, but this exception simply had to be made. Sometimes in war, you have to make very hard decisions, and that's what this is- a war. You got drafted back in September 2008 without ever being properly notified. We have all made a huge sacrifice today so that our children and grandchildren can (hopefully) enjoy peace and a standard of living in excess of our own. It's true that we've also burdened them with even more debt, but to summarize Warren Buffett, sometimes it's better to have to pay for a lunch later than to have no lunch at all.
The Financial Crisis- A Year in Review
This is a paper I wrote at the end of 2008, but I think a lot of the points are still salient.
As we enter what will be the second year of the U.S. recession, a lot has been done in an attempt to ensure that the current environment does not turn into a depression. Governments and central banks both in the U.S. and around the globe have pumped massive amounts of funds into the financial system in response to commercial banks’ and investment houses’ near refusal to lend to anybody, including each other. In the U.S. alone, some estimate that the cost of the current bailout has already reached over eight trillion dollars (Casey Research 2008). While the sheer dollar size of the government intervention has been large, it is worth taking a step back and looking at the efforts so far to assess them at what is likely the midpoint of the economic downturn/recovery. It is very clear that there are weaknesses not yet addressed as well as many lessons to learn for future generations to avert this disaster.
One of the key points of the Emergency Economic Stabilization Act of 2008 was the allowance for a suspension of “mark-to-market” accounting, specifically FAS 157 (HR 1424 2008). This is a point that has gone completely overlooked on the priority list of almost everyone involved in major policy decisions. Mark-to-market accounting and any derivations thereof need to be suspended temporarily for all asset classes until normal market conditions become prevalent and are sustained. While there might be some unsettling effects in the short term on stock markets, banks would no longer have to sock away larger and larger portions of their capital in order to make accounting charges to their reserves and continue write downs on their illiquid assets. These assets, in the vast majority of cases, are performing. They might not be performing exactly as expected, but they are certainly performing. The huge deleveraging of the financial markets caused many securitizers and other intermediaries to lack proper funding to ensure the normal flow of these assets to their final ware houses. This created a need to fire sale them, which is being used as the “mark” on the assets. Those who still have them are not likely to sell them until markets return to normal, so why should they be forced to write down their value? Were normal market conditions present, these reserves and write downs would not be necessary. This was the initial reason for buying troubled assets- to give everyone a sense of where the bottom would be. Since the government has elected not to buy the assets, it should return to its original intent to suspend mark-to-market.
The problem is not just a big bank problem. While these larger institutions have huge exposures to complex financial instruments for which there are no liquid markets, community and regional banks have large exposures to real estate and other similar assets that are similarly not being accurately priced in the current market. This was all caused by the problems at larger banks, despite these smaller institutions lack of direct exposure to the complex instruments that initially caused the market to crash. One of the extensions of FAS 157 is in reserve analysis methodologies and specifically those related to FAS 114 (FASB 1993). This extension has caused a great number of banks, particularly at the community bank level, to revalue their real-estate assets to an “as-is” or “mark-to-market” value when there is no intention by those bankers to sell these assets until a more viable market returns. Because of illiquidity in these markets and ongoing efforts by regulators to enforce “mark-to-market,” “as-is,” and “fire sale” valuations, the community banking industry is seeing its capital base erode just as quickly as its larger counterparts while seeing very little of the government help that was promised. Without spending a single dollar, governments and regulatory bodies around the world could at least provide a temporary relief to the huge amounts of pressure on capital levels at all financial institutions. Not doing so has been a major issue.
Another problem that will need to be addressed before the banking industry can be made truly safe and sound again is addressing the massive problems with the current regulatory structure. Secretary Paulsen has offered a large number of suggestions on this subject, but so far those efforts have been a waste. Just prior to the massive meltdown in the global economy the Treasury Department published the following:
The U.S. regulatory structure does not serve American as well as it could, and modernization is inevitable. It has been largely knit together over the last 75 years, put into place for particular reasons at different times and in response to circumstances that may no longer exist. The current U.S. regulatory framework for financial services providers includes:
Five federal depository institution regulators in addition to state-based supervision.
One federal securities regulator, additional state based supervision of securities firms, and self-regulatory organizations with broad regulatory powers.
One federal futures regulator
Insurance regulation that is almost wholly state-based, with 50+ regulators. This structure also has an international dimension that can be inefficient, costly and harmful to U.S. competitiveness. (Paulsen 2008)
Clearly, this is a highly ineffective regulatory structure, particularly given the evolution of the financial world over the last sixty to seventy-five years. Now, many are crying out for more regulation because of the obvious fraud and intense leveraging that went on for the last eight years. However, prominent bankers like Ken Lewis of Bank of America argue that any new regulation shouldn’t “impose heavy new burdens that harm the competitiveness of American companies” (Fitzpatrick 2008).
The current regulatory framework has become overly burdensome and highly redundant. Many banks, specifically, have at least three primary regulators: the FDIC, Federal Reserve Bank, and either their State Banking regulator or the Office of the Comptroller of the Currency. All of these currently serve very similar functions and perform very similar audits. This is absolutely unnecessary. Beyond the redundancy, this framework creates a highly combative environment between the regulators. On numerous occasions, and particularly recently, the agencies appear to have different opinions on methodology, procedures, and policy. This has caused undo stress, confusion, and has exacerbated an already strained relationship between banks and those regulating them. Governments must be sure to regulate properly and avoid the “witch hunt” mentality that they normally display during knee-jerk reactions to crisis. After all, their last knee jerk was Sarbanes-Oxley, which is widely believed to be incredibly ineffective as evidenced by the constant pushing back of compliance timelines.
In order to ensure that smaller institutions are not the fodder of those larger institutions being propped up by TARP, there needs to be a requirement of some of the funds from the TARP capital injection to the larger and regional banks to be used to extend lines of credit to smaller banks and bank holding companies (BHC’s). These lines would be senior debt and, in the case of BHC’s, secured by the stock in the bank. This would allow capital markets to get flowing again for smaller institutions, which would in turn allow for a more a fundamentally sound economy both on a very broad and localized scale.
The capital injections into financial institutions have failed to get lending going again because these banks are not only shoring up their own balance sheets, but also simply waiting for mounting liquidity and capital pressures at smaller institutions to finally force those banks to shut down and be placed into receivership at the FDIC. In a recent letter to Secretary Paulsen, Lynn Westmoreland charges that unless these banks are effectively forced grant lines of credit to smaller institutions, they will simply lay in wait for smaller banks, who are the obvious intended losers in this bailout, to fail (Westmoreland 2008). They’ll then buy deposits and assets at severely depressed prices, wiping out shareholder interest, and allowing them to rapidly expand their businesses without effectively stimulating local economies and small businesses. This will only add to the mounting pressure on the FDIC fund, to continue the ongoing, systemic flight of depositors from small to large banks, and to lead to a destruction of the community bank model. It seems as though the government allows that shareholders of the largest institutions who engaged in the most risky behavior (Citigroup, Freddie, Fannie, AIG, Wachovia, Washington Mutual, National City, etc) are going to be propped up by government funding, while those of community banks and small businesses, in large part, are left as fodder for those in the Treasury Department’s inner circle.
Further complicating problems at small bank is the fact that cheap funding sources and credit lines at government enterprises such as the Federal Home Loan Bank and the Federal Reserve Discount Window are drying up. Banks are either being cut off from anymore borrowings or forced to put up greater amounts of collateral, which heavily impacts liquidity positions in a negative manner. The question has to be raised whether or not this is part of a larger effort by the government to effectively leave the banking industry in the hands of a few major players. The Federal Reserve pumps trillions of dollars into markets that money center banks access, but does very little for smaller institutions without paying a heavy penalty. Larger banks and former investment houses routinely borrow huge sums of money to fund their daily operations, but when smaller institutions attempt to do the same, they are penalized heavily. There seems to be an obvious line in the sand drawn between these “too-big-to-fail” institutions and their smaller counterparts. This line is being turned into a giant crevice thanks to an inability of smaller institutions to receive funding when they need it most.
While it is true that the government programs, both in the U.S. and abroad, have had some impact in at least temporarily stabilizing markets, it is unclear how effective the response has been. There are seemingly obvious fixes that were never addressed, such as the suspension of mark-to-market. The government has chosen to start from the top and work its way down in addressing the needs of financial institutions. Whether or not this approach is in the financial system’s best interest remains to be seen. It seems to go against everything that capitalism stands for when companies are simply too big to fail, yet our government is, intentionally or not, encouraging this type of size. Funding sources for the vast majority of business and financial institutions are still dry, and the TARP program has failed to address this key issue thus far. Capital injections so far have appeared to only allow institutions to shore up their own balance sheets or snap up liquidity from failed competitors. This, too, seems to lack a sort of fairness. Finally, and perhaps most importantly after the world economy gets back on its feet, the regulatory framework has become an afterthought. Each day, however, the Federal Reserve, FDIC, State Regulators, etc all are vying for who will come out on top when the battle is over. They are all doing very nearly the same thing, but are increasingly having to be less willing to work with institutions in an effort not to be seen as the regulator that failed to regulate properly. The government appears to have done a decent job in avoiding a depression, but it is clear that they have not done everything possible.
As we enter what will be the second year of the U.S. recession, a lot has been done in an attempt to ensure that the current environment does not turn into a depression. Governments and central banks both in the U.S. and around the globe have pumped massive amounts of funds into the financial system in response to commercial banks’ and investment houses’ near refusal to lend to anybody, including each other. In the U.S. alone, some estimate that the cost of the current bailout has already reached over eight trillion dollars (Casey Research 2008). While the sheer dollar size of the government intervention has been large, it is worth taking a step back and looking at the efforts so far to assess them at what is likely the midpoint of the economic downturn/recovery. It is very clear that there are weaknesses not yet addressed as well as many lessons to learn for future generations to avert this disaster.
One of the key points of the Emergency Economic Stabilization Act of 2008 was the allowance for a suspension of “mark-to-market” accounting, specifically FAS 157 (HR 1424 2008). This is a point that has gone completely overlooked on the priority list of almost everyone involved in major policy decisions. Mark-to-market accounting and any derivations thereof need to be suspended temporarily for all asset classes until normal market conditions become prevalent and are sustained. While there might be some unsettling effects in the short term on stock markets, banks would no longer have to sock away larger and larger portions of their capital in order to make accounting charges to their reserves and continue write downs on their illiquid assets. These assets, in the vast majority of cases, are performing. They might not be performing exactly as expected, but they are certainly performing. The huge deleveraging of the financial markets caused many securitizers and other intermediaries to lack proper funding to ensure the normal flow of these assets to their final ware houses. This created a need to fire sale them, which is being used as the “mark” on the assets. Those who still have them are not likely to sell them until markets return to normal, so why should they be forced to write down their value? Were normal market conditions present, these reserves and write downs would not be necessary. This was the initial reason for buying troubled assets- to give everyone a sense of where the bottom would be. Since the government has elected not to buy the assets, it should return to its original intent to suspend mark-to-market.
The problem is not just a big bank problem. While these larger institutions have huge exposures to complex financial instruments for which there are no liquid markets, community and regional banks have large exposures to real estate and other similar assets that are similarly not being accurately priced in the current market. This was all caused by the problems at larger banks, despite these smaller institutions lack of direct exposure to the complex instruments that initially caused the market to crash. One of the extensions of FAS 157 is in reserve analysis methodologies and specifically those related to FAS 114 (FASB 1993). This extension has caused a great number of banks, particularly at the community bank level, to revalue their real-estate assets to an “as-is” or “mark-to-market” value when there is no intention by those bankers to sell these assets until a more viable market returns. Because of illiquidity in these markets and ongoing efforts by regulators to enforce “mark-to-market,” “as-is,” and “fire sale” valuations, the community banking industry is seeing its capital base erode just as quickly as its larger counterparts while seeing very little of the government help that was promised. Without spending a single dollar, governments and regulatory bodies around the world could at least provide a temporary relief to the huge amounts of pressure on capital levels at all financial institutions. Not doing so has been a major issue.
Another problem that will need to be addressed before the banking industry can be made truly safe and sound again is addressing the massive problems with the current regulatory structure. Secretary Paulsen has offered a large number of suggestions on this subject, but so far those efforts have been a waste. Just prior to the massive meltdown in the global economy the Treasury Department published the following:
The U.S. regulatory structure does not serve American as well as it could, and modernization is inevitable. It has been largely knit together over the last 75 years, put into place for particular reasons at different times and in response to circumstances that may no longer exist. The current U.S. regulatory framework for financial services providers includes:
Five federal depository institution regulators in addition to state-based supervision.
One federal securities regulator, additional state based supervision of securities firms, and self-regulatory organizations with broad regulatory powers.
One federal futures regulator
Insurance regulation that is almost wholly state-based, with 50+ regulators. This structure also has an international dimension that can be inefficient, costly and harmful to U.S. competitiveness. (Paulsen 2008)
Clearly, this is a highly ineffective regulatory structure, particularly given the evolution of the financial world over the last sixty to seventy-five years. Now, many are crying out for more regulation because of the obvious fraud and intense leveraging that went on for the last eight years. However, prominent bankers like Ken Lewis of Bank of America argue that any new regulation shouldn’t “impose heavy new burdens that harm the competitiveness of American companies” (Fitzpatrick 2008).
The current regulatory framework has become overly burdensome and highly redundant. Many banks, specifically, have at least three primary regulators: the FDIC, Federal Reserve Bank, and either their State Banking regulator or the Office of the Comptroller of the Currency. All of these currently serve very similar functions and perform very similar audits. This is absolutely unnecessary. Beyond the redundancy, this framework creates a highly combative environment between the regulators. On numerous occasions, and particularly recently, the agencies appear to have different opinions on methodology, procedures, and policy. This has caused undo stress, confusion, and has exacerbated an already strained relationship between banks and those regulating them. Governments must be sure to regulate properly and avoid the “witch hunt” mentality that they normally display during knee-jerk reactions to crisis. After all, their last knee jerk was Sarbanes-Oxley, which is widely believed to be incredibly ineffective as evidenced by the constant pushing back of compliance timelines.
In order to ensure that smaller institutions are not the fodder of those larger institutions being propped up by TARP, there needs to be a requirement of some of the funds from the TARP capital injection to the larger and regional banks to be used to extend lines of credit to smaller banks and bank holding companies (BHC’s). These lines would be senior debt and, in the case of BHC’s, secured by the stock in the bank. This would allow capital markets to get flowing again for smaller institutions, which would in turn allow for a more a fundamentally sound economy both on a very broad and localized scale.
The capital injections into financial institutions have failed to get lending going again because these banks are not only shoring up their own balance sheets, but also simply waiting for mounting liquidity and capital pressures at smaller institutions to finally force those banks to shut down and be placed into receivership at the FDIC. In a recent letter to Secretary Paulsen, Lynn Westmoreland charges that unless these banks are effectively forced grant lines of credit to smaller institutions, they will simply lay in wait for smaller banks, who are the obvious intended losers in this bailout, to fail (Westmoreland 2008). They’ll then buy deposits and assets at severely depressed prices, wiping out shareholder interest, and allowing them to rapidly expand their businesses without effectively stimulating local economies and small businesses. This will only add to the mounting pressure on the FDIC fund, to continue the ongoing, systemic flight of depositors from small to large banks, and to lead to a destruction of the community bank model. It seems as though the government allows that shareholders of the largest institutions who engaged in the most risky behavior (Citigroup, Freddie, Fannie, AIG, Wachovia, Washington Mutual, National City, etc) are going to be propped up by government funding, while those of community banks and small businesses, in large part, are left as fodder for those in the Treasury Department’s inner circle.
Further complicating problems at small bank is the fact that cheap funding sources and credit lines at government enterprises such as the Federal Home Loan Bank and the Federal Reserve Discount Window are drying up. Banks are either being cut off from anymore borrowings or forced to put up greater amounts of collateral, which heavily impacts liquidity positions in a negative manner. The question has to be raised whether or not this is part of a larger effort by the government to effectively leave the banking industry in the hands of a few major players. The Federal Reserve pumps trillions of dollars into markets that money center banks access, but does very little for smaller institutions without paying a heavy penalty. Larger banks and former investment houses routinely borrow huge sums of money to fund their daily operations, but when smaller institutions attempt to do the same, they are penalized heavily. There seems to be an obvious line in the sand drawn between these “too-big-to-fail” institutions and their smaller counterparts. This line is being turned into a giant crevice thanks to an inability of smaller institutions to receive funding when they need it most.
While it is true that the government programs, both in the U.S. and abroad, have had some impact in at least temporarily stabilizing markets, it is unclear how effective the response has been. There are seemingly obvious fixes that were never addressed, such as the suspension of mark-to-market. The government has chosen to start from the top and work its way down in addressing the needs of financial institutions. Whether or not this approach is in the financial system’s best interest remains to be seen. It seems to go against everything that capitalism stands for when companies are simply too big to fail, yet our government is, intentionally or not, encouraging this type of size. Funding sources for the vast majority of business and financial institutions are still dry, and the TARP program has failed to address this key issue thus far. Capital injections so far have appeared to only allow institutions to shore up their own balance sheets or snap up liquidity from failed competitors. This, too, seems to lack a sort of fairness. Finally, and perhaps most importantly after the world economy gets back on its feet, the regulatory framework has become an afterthought. Each day, however, the Federal Reserve, FDIC, State Regulators, etc all are vying for who will come out on top when the battle is over. They are all doing very nearly the same thing, but are increasingly having to be less willing to work with institutions in an effort not to be seen as the regulator that failed to regulate properly. The government appears to have done a decent job in avoiding a depression, but it is clear that they have not done everything possible.
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