Commentary on the FDIC Bank Failure Report (12 March 2010)

New York City was the scene of much action this week, with the closures of LibertyPoint and Park Avenue Banks. It was also a very strange circumstance, as well, because LibertyPointe was closed on a Thursday, which is very much not how the FDIC likes to do business. The why is not exactly clear, since - as far as we can tell - LibertyPointe was actually not all that badly off. The worst bank this week was Old Southern Bank ($315 million in assets, $319 million in deposits. Oops.), and that bank managed to politely sit pretty (and insolvently) until Friday evening.

Additionally, LibertyPointe's recoverability was not all that bad: 87.93 cents on the dollar. That's actually the best recoverable value in our records! So go figure; there must have been something especially exciting going on at LibertyPointe for a mid-week closure, but unfortunately it is invisible to our financial analysis. Whatever was going on, though, we have the strong suspicion that the FDIC knew all about it, and had taken the traditional regulator stance toward fraud: do nothing.

Speaking of fraud, we notice a trend of recent weeks, regarding the recoverable value of the banks which the FDIC closes. Except for the closures on 6 January 2010, all have been sharply over the overall trendline of ~57%. This week alone was 86.78%, one of the best weeks we've seen, if not the best ever. This makes us wonder: is the FDIC targeting their end costs ever more closely? If so, that means the FDIC is not necessarily closing the worst of the banks, but rather the banks they can afford to close. Remember, Dear Reader, the FDIC will not be receiving any quarterly insurance payments for a little under two years now; they have no source of regular income. Whatever is in the coffers is pretty much what they have to work with, barring either A) tapping the Treasury credit line, and B) a special insurance assessment.

However, the first has been vicoferously written off as an "extreme emergency measure" by Chairwoman Sheila Bair (translation: Goldman Sachs needs pin-money), and the second is likely not politically palatable, considering that banks would prefer to hunker down and park their money in Treasury Bills. Even if the FDIC should decide to tap their Treasury credit line, they will still have to pay the interest on the funds thus extended. As many people are discovering in this Depression, it's pretty hard to pay off debt when one does not have any income.

Sure, the FDIC could levy special insurance assessments to pay the interest, but that is a one or two trick pony; if the FDIC should try to levy multiple special assessments, the banking system would likely rebel. Congress would apply pressure to the FDIC, and force it to back down; at the very extreme, Congress would attempt to force out Sheila Bair for someone more light-handed. The banks, after all, are tolerant of the FDIC, so long as it does not interfer excessively in their operations.

Bringing this back to our original comment, a constricted income is likely the driving force behind the targeted closure programme which we posit the FDIC is undertaking. Capital is presently scarse, and it will be two years until new, dependable income will resume; therefore, the FDIC has every impetus to conserve their resources as carefully as possible.

This, Dear Reader, brings us to fraud: if the FDIC is closing, not the worst banks in the United States, but rather those banks they think the can close with minimal outlays of precious capital, they are shirking their fundamental mission. They are not protecting depositors by closing the cheapest banks to close, but rather attempting to instill a false sense of health and solvency in depositors, to protect the truly horrible banks. By supporting the perception of solvency and deposit protection, the FDIC serves to shield insolvent banks (Citibank, anyone?) from sudden, disasterous outflows of capital.

Such a disastre can be seen in the capital flight from Greece, which - as of 23 February - amounted to 8 billion out of the 30 billion under management in private Greek banks (originial article here, subscription needed). 25% loss of a country's private capital base spells D-O-O-M for the banking system.

The FDIC-as-shield-for-banks, let us repeat, is fraud, if it is indeed the case. Innocent depositors are being duped into believing that their banks are in sound financial shape, since 'only a few banks are getting closed,' and 'the recovery is underway!', et cetera. We do not believe there is a recovery, nor do we see one in the future; the next leg down of the ongoing Depression, whenever it arrives, will likely take be a gut-punch to the FDIC. It's then that we expect bank runs to begin, and when the so-called insurance offered by the FDIC will be seen as the farse it really is.

Commentary on the FDIC Bank Failure Report (19/02/10)

La Jolla Bank was quite a nasty one, with the assets only apparently worth around 53.27 cents on the dollar. Quite a painful affair, as that is after the bondholders and shareholders have already been wiped out financially. Considering that the FDIC had to kick in another $1.9 billion or so to make the failed bank whole is very telling as well: the U.S. banking system is not in pretty shape.

In fact, it's in horrible shape. Over the two-plus years since the beginning of the ongoing Depression, the recoverability of banks is only 57 cents on the dollar. This means that, if the entire banking system were to be immediately liquidated, in some Keynesian nightmare come alive, the market value of all assets would see a 40% haircut or so - and that is a best-case. Of course, such a liquidation is not going to happen all at one, but it is certainly happening piecemeal, as the FDIC steadily dismantles the small-to-medium sized banks in the U.S. Such as the other three banks which the FDIC closed this week, representing only a bit over $586 million all together. We will bet dollars to doughnuts (we'll even make the doughnuts, mind you) that there are quite a few more La Jolla Banks out there, than the FDIC's closure patterns might suggest.

Be that as it may, the stress information given by our analysis of the States' shares of the total cost to the FDIC for bank closures is quite enlightening. Overall, those States which have suffered bank closures are actually not all that badly off, relative to population. The six States listed in the report (Alabama, Georgia, Nevada, California, Florida, Illinois) are really the only States which are even remotely out of line with statistical expectations - i.e. how close their share of the total cost is, to their share of the total U.S. population.

The rest, interestingly enough, are lower - at times, much lower - than the State's population would suggest. Now, that of course could be because some State banking systems are healthier than others, such as North Dakota's. However, that would suggest the United States is not in, overall, terrible shape. We would object very strongly to such an intimation, because all economic indicators we'd care to consult are showing exactly the opposite.

Unemployment has increased year-over-year in all 50 States and the District of Columbia, for example. According to the Federal Reserve, assets of nonfarm nonfinancial corporations have shrunk year-over-year by 7% in the third quarter of 2009; household and nonprofit assets fell by 5.3%; if we pretend that private entrepreneurs are meaningful anymore, nonfarm noncorporate business assets collapsed by 13.8%. Is the picture grim enough, yet, dear Reader? We don't feel we need to continue to make the point: banks are reliant upon the health of the rest of the so-called economy. That economy is taking a face-plant, ergo banks are not in good straits.

Bank closures, to summarise, should not only be accelerating, but they will be getting worse. Since that factor is not apparent in the short-term of our present data set, we suspect that the FDIC has a modus operandi which has nothing to do with safe-guarding the health of the banking system, nor protecting depositors.

Rather, it seems more plausible that the FDIC is carrying on some sort of psychological management of the U.S. public. This assertion arises from our observation that the closures which the FDIC perform appear to be planned around some calculation of weekly assets, and perhaps total estimated cost to the FDIC. We can't necessarily prove this, of course, but it is our opinion on the matter.

The end of such a psychological management, at least from the perspective of both the banking system, and the Federal Government, is to keep the Citizenry from panicking. The last thing which both the Government and banks want right now is a full-scale bank run, as that would be a very difficult thing to have in concert with the 'ongoing recovery' incantations of the press.

* * *

This week's project for us will be to integrate pre-Depression (i.e. before December of 2007) bank closure data into our analysis. Our intention is to see the changes in recoverability over the early 2000's, leading up to the Depression.

The Risk Bubble

As one may have noticed, many of the strange financial instruments blowing up world-wide deal with risk. The sheer complexity of these instruments makes understanding them completely almost impossible, but a few generalisations can be made. Typically, these exotics disassociate the risk usually connected with a certain investment, packaging them into a 'security' and selling them off as an investment in their own right.

The how and why these instruments are blowing up is not particularly important, merely that the nuclear mushroom clouds are appearing across the world. It is our opinion that these exploding instruments are indicative of a major shift in the world's economy. Namely, a shift in how investment risk is managed.

For (a somewhat oversimplified) example, to ship cheap plastic crap from China, a manufacturing company will hire a freighter from a shipping company, since the manufacturing company does not own any shipping. The shipping company, at the same time, doesn't own the ships it rents out! It leases the ships from yet another company, which only owns commercial freighters and doesn't actually operate them.

This circuitous system is, at its simplest, merely a way the manufacturing company can avoid the risks associated with owning freighters. The risk of ship ownership is held by one company, the operating risk another. This particular intermediation is already breaking down: shipping companies are losing access to credit to finance their cargoes, and having difficulty making their lease payments to the actual owners of the ships proper. At the same time, the ship owners are having trouble making their financing payments...

It is our observation that one of the effects of the 2008 Depression is the collapsing of risk. This can be seen in the shipping example, as well as exotic investment vehicles. We posit a bubble of risk intermediation is popping. The symptoms of this bubble should become more apparent in the coming months, as the companies which depend on sloughing off their risk feel the squeeze; and in the coming years, as organisations who took on the risk of others cannot meet their obligations.

On the positive side, we feel there will be opportunity in the disintermediation of risk. Having intermediated risk is similar to credit leverage, and if one can avoid it at all costs, one likely has a higher chance of economic survival in the 2008 Depression.

In an extreme example, this is why holding one's money in one's mattress may be far better than leaving it on deposit in a bank. If a true bank run develops (i.e. every bank has its own run), cash and deposits will be rationed-by-queue. One only needs to look at Zimbabwe today to see how bad that sort of thing can get. People in Zimbabwe right now are queuing up at banks every day to withdraw the equivalent of 25 cents U.S., the maximum withdraw allowed by law. One shouldn't think it will never happen in the United States, or in other developed countries.