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.

Toxic Mortgages and U.S. Social Security

We saw an article (first published 18th November 2009) featured on MSN which got us thinking; the title is "How long can Social Security last?" Reading the article, the answer seems to be "not long at all." It's very interesting that this article was apparently dredged up from the archives and floated once again on MSN, unless it's just that popular.

The article perpetuates the myth of an SS trust fund, stating that the fund will go in the red "in a few years," and be empty by 2037. Oh darn, that sounds unfortunate. But what actually caught our attention was when the article talked about how to fill the 'short-coming' in the 'fund.' The list was as follows:

-Benefit cuts
-Tax increases
-Riskier investments

The first two options are obvious: more money coming in, less money going out, just like our wallet and bank account. The irony of cutting benefits is that inflation is constantly decreasing the value of the SS payouts, but that is beside the matter. We want to dissect the third option: investing the 'trust fund' in riskier ventures.

Given the present, heady atmosphere in the United States Government, we can think of a few exciting places wherein the SS Administration can dump the excess cash it has just sitting around at the office. Now, we have to point out here, that the SS 'trust fund' is actually just money which flows in and out of the U.S. Government's General Fund. In spite of all the accounting shenanigans, in reality the SS cheques are drawn from the general operating budget, as simply any other expenditure.

If the SS 'trust fund' is authorised to be 'invested' in riskier ventures, it will allow the U.S. Government to treat those monies as, effectively, another slush fund. Or, to put it another way, the SS 'trust fund' becomes the SS 'bank, automaker, and whatever-else-Congress-feels-necessary bailout fund.' This can, of course, be dressed up as a good thing: banks and automakers are 'turning the corner,' and will make massive profits to investors; mortgage-backed securities will recoup their value, and then some; credit cards will become profitable again; car loans will be great as the economy turns around; et cetera, et cetera. All these would seem, on paper, to help the SS 'trust fund' close its fiscal gap.

"Surely they won't do that!" you exclaim, dear Reader; "the Government wouldn't put the retirement of millions of Americans on the line to bail out banks and other corporate interests?"

Well, what can we say to that? Frankly, the U.S. Government seems to be constantly doing exactly the worst thing possible during this Depression. From bailing out banks and automakers, to planning on raising taxes via health care 'reform' and other such nefarious plots, we can't see any good moves having been made at all! So, if the SS 'trust fund' were to be allowed to invest in riskier sectors of the economy, where would that investment go but to the arenas which the Government has already been furiously bailing out for two years? We'd be overjoyed to hear other likelihoods, but such corruption as we lay out herein seems inevitable to us. That is, of course, contingent on the SS 'trust fund' being loosened in its restraints.

If the SS 'trust fund' is successfully retooled as a slush fund for banks and automakers, we fully expect to see all other Federal 'trust funds' to be similarly revised. Since all such 'funds' are facing budget shortfalls, brought on by whatever cause(s), such changes can be presented as both necessary, and intelligent. Perhaps even shrewd. Those manoeuvres will be, of course, none of the kind, but rather hopelessly wasteful and economically destructive.

The Dubai Gambit

Although we just wrote about Dubai and its impressive level of debt - not to mention its impressive malinvestment of its resources - the Emirate has made a manoeuvre which we didn't even think of: declaring the debt of Dubai World not backed by government guarantee. From the BBC:

"[Creditors] think Dubai World is part of the government, which is not correct," said finance minister Abdulrahman al-Saleh. "Creditors need to take part of the responsibility for their decision to lend to the companies."

Clever, very clever; it seems to us that Dubai is looking to have its cake and eat it too, after a manner of speaking. They got their theme parks and little islands, and now the investors can go stick it wherever they'd prefer the pain. And if those investors attempt to foreclose on the assets of Dubai World, they just might run into the little problem that said parks and islands are property of the Dubai government, or perhaps the Abu Dhabi government; in other words, foreclosure is not happening, because we really don't think an UAE court would care to strip a sovereign government of its assets. Certainly not for foreigners, and the latest incident with the Swiss banning minarets will likely not help the situation.

A thought arises from the move, which we give the same title as this post: the Dubai Gambit. We'll put it in the general terms for starters. A nation's Government spawns this enterprise (we'll use the U.S. term of Government-Sponsored Enterprise, or GSE, with apologies for such Amero-centrism), and lets it just toddle along, doing its thing. As a GSE, it would seem to investors that the GSE enjoys an implicit Government guarantee; the Government made it, so why wouldn't it keep it going if times were tough? So, investors cheerfully pile into the debt of this GSE, because from their perspective it's just as good of debt as sovereign debt.

But surprise! It doesn't say anything anywhere in the GSE's charter (or what have you) about a Government guarantee. That means the Government, at its fickle discretion, can either help out the GSE in times of trouble, or not. The average investor, being apparently rather dim-witted when it came to reading fine print, was speculating much harder than he or she thought; the money he or she plopped down for the GSE's debt might never come home from the front lines of the Free Market. It's a messy place, we hear, and casualties can be heavy.

Bad times come along, and the GSE gets into some serious trouble. Investors start thinking "Boy, I be sure glad that thar GSE's got some sort of gum'ment guarantee or some such. I's real smaaart," and patiently sit on the deck of their double-wide trailer waiting for the cheque from the Government to make them whole. Grandma Kettle's rocking chair creaks as she loads up the shotgun to take aim at a stray dog; the hole in the roof gets a little bigger; no Government cheque comes in.

That's because the Dubai Gambit was brought into play; the Government decided the GSE was not, in fact, going to enjoy a bailout. In the real world, this would probably happen when such a GSE was in such horrible shape, that the Government would have risked its own credit rating to support the malinvestment of the investors, and the GSE's own malinvestments. GSE debt goes from being 'as good as Government' to 'someone has to do something about this!' overnight, as the bonds go belly-up. Investors are left footing the bill for someone else's good time, and the Government comes out, theoretically, smelling like a rose, at least to the credit markets.

As this meltdown of the GSE is underway, the Government finally steps in, but not in the way the investors were expected. Instead of providing a backstop for the full value of the GSE debt, the Government starts Agency X, with the explicit goal of winding down the GSE's debt. With a pre-packaged bankruptcy agreement - and a sufficiently... agreeable... court system - Agency X gets to cherry-pick the good assets of the GSE, and leave the GSE with all of its liabilities. Investors in the failed GSE would get Agency bonds worth pennies on the dollar of their original GSE debt, and the Government gets to have at least something for its efforts.

We fully expect Dubai to do this manoeuvre, or at least something like it. If it seems far-fetched to you, dear Reader, please consider the shenanigans surrounding the General Motors bankruptcy fiasco in the United States. The 'old' GM went into bankruptcy, gave its few good assets to the 'new' GM (owned by the U.S. Government, the Crown in Right of Canada, and a few other favoured parties), and then left its legacy of toxic waste dumps (or, 'factories,' as they are charmingly misnomered) and other such massive liabilities upone the shoulders of now wiped-out investors; the 'new' GM is in the clear. This, in civilised countries, is typically considered unlawful conveyance, but since the Federal Government was involved, such trivialities were easily brushed aside.

The Dubai Gambit is, at its core, entirely designed to have the Government - any Government - protect its credit rating at all costs. Dubai seems to be very much conscious of that factor, as why else would the Emirate have explicitly withdrew any implicit Government guarantee? Dubai World et al. is a mess financially, and it would probably bring down the Government if it tried to back the enterprise's debt for its full value. At pennies on the dollar, as it were, Dubai might be able to convince the UAE central bank, or Abu Dhabi, to bankroll a resolution of the fiasco; Dubai keeps its sovereign credit rating, the UAE and Abu Dhabi look like heroes, and investors in Dubai World don't feel quite as raped as they otherwise would have.

The question is, if Dubai makes this Gambit work, and to paraphrase Tom Lehrer, who's next?

House Prices, Property Taxes, and Rent

Today we present a case study of a sleepy little town on the Pacific Coast of North America somewhere between Powell River and Portland. We have changed the name to Prosperity Harbour to protect the innocent. This town is fairly average; its heyday being some decades in the past.

Being an older place, the houses tend to be on the small side with plenty of cottages, each having less than 1000 square feet of floor space. As of today, the asking price on these little, older cottages ranges from $90,000 to $180,000. Prices have only sagged a bit since the onset of the Depression thanks to generous mortgage programmes from the Government.

Property taxes here are modest, averaging about 1% annually of the market value of the houses. Rents in Prosperity Harbour are low for a place on the West Coast. A typical two bedroom house rents for $600 per month.

The gross rental yields tend to range from 5 to 6%. After allowing 1% for taxes, 2.5% for maintenance, and .5% for insurance the net yield works out to only 1 to 2%.

Until recently, landlords were banking on appreciation to make up for the lack of yield. The last two years have been disappointing in that department, to say the least. Furthermore, there is no hope of raising rents or even maintaining them anytime in the foreseeable future. A great wave of rental construction completions has been hitting the market: luxury duplexes; low-income projects; warehouse district renovations; and everything in between - all begun at the peak of the recent housing mania. The major property management companies have even entered a price war as their efforts to whittle down their swelling rental listing portfolios become desperate. Even with asking rents down 1/3 or more from their peak two years ago, vacancies go begging.

Prosperity Harbor is not losing population. What is shrinking is the number of households. Or put differently, the increase in household formation - a fact of life in North America since the European settlement began - has gone into reverse, here as elsewhere. Unemployed and underemployed persons are doubling up and making do with more cramped conditions.

What hope is there for Prosperity Harbor's landlords? None. As long as incomes continue to fall, there will be less and less money available for rent. Property taxes will not fall. As assessed property values decline, rates will rise in order to maintain public expenditures. Even if a frenzy of cutting the public sector hits Prosperity Harbor's voters, it will only serve to shrink the incomes of the local public servants - furthering the vicious cycle of declining incomes.

In a word, Prosperity Harbor's landlords are f****d. This goes for the landlords who rent to themselves as well, a.k.a. homeowners. Housing here is a terrible, terrible investment and will be remain so until prices come in line to a sane multiple of rents - meaning those old cottages need to be selling for something like $9,000 to $18,000 - a mere one tenth the current prices!

Housing Price Report for November

Our result for the first six months of our North American Housing Price Index is a drop of 10.45%. This is a very serious drop, and has implication for more than just the house owners who need the value of their houses to say up. It also means that, on average: the housing collateral on bank balance sheets is impaired by around 10%; any and all securities of bundled mortgages have seen their value reduced by 10%; any house owners relying on the value of their house to keep up appearances have seen their appearances reduced by 10%.

Prices are showing some sign of improvement in the USA, which is to be expected thanks to the Federal Government's herculean efforts to prop up the industry.The 10% US Federal income tax credit has been extended, and all things being equal, this will tend to keep prices in the USA 10% higher than they otherwise would be. We'll be watching for a sudden fall when the program ends, if ever.

Interestingly enough, though, we are seeing some weakness in the Canadian housing market. This strikes us as rather odd, as the credit available to Canadian Citizens is still growing at a respectable clip. Additionally, the Federal Government has a very direct hand in guaranteeing mortgages in Canada, whereas the U.S. Federal Government only proves a wishy-washy guarantee to bail out banks.

Frankly, it seems that the animal spirits are friskier in the United States than Canada, undoubtedly supported by the U.S. Federal Government's housing tax credit. It is also possible U.S. Citizenry is a bit more credulous of the 'recession is over' propaganda than are the Canadians; it's time for Americans to do their patriotic duty and spend, spend, spend!

The Big Bank Problem No One Talks About

Consumer credit in the USA is falling, falling, falling. Whatever numbers you pick, there's no massaging the data to make it look innocent. This all is well known, as is the concern that lack of consumer borrowing will be a drag on the consumer portion of the economy.

Something else about this situation seems to be slipping through the cracks of public awareness, however. Once upon a time, maybe twenty years ago, when lenders cared a lot more about credit quality, it was well known that subprime could never work as a profitable lending model. Too many companies had come and gone promising to be profitable lending to high-risk customers. Their seeming profitability was a trick of accounting legerdemain: a growing book makes loss ratios look lower than they actually are since ageing loans are more likely to sour than fresh ones.

In the huge, recent credit bubble when almost everyone (and sometimes their pets) were receiving credit offers, loan books were growing smartly and loss ratios were low. Now that credit is contracting, people who can pay back their loans tend to be doing so. And those who can't (but are not yet to the point of defaulting) are just trying to keep them rolling over. The net result is that the overall quality of bank's loan books is deteriorating rapidly.

Banks are becoming less solvent over time, not more so, in spite of their efforts to improve their condition. Banks efforts to reign in credit by jacking up interest rates and cutting credit lines will actually backfire because better borrowers will simply pay off their loans. Borrowers who accept the barrage of insults are in such poor condition financially they can only subject themselves to usury.

In conclusion, the end state of this process will likely be the Federal Government (having had to bail out the banks and then the FDIC over and over) holding consumer loan portfolios that have little to no value. Cost to taxpayer: something like two trillion dollars, and further debauchment of the Dollar. Banks will be kept in business to keep up appearances, and may even book a nominal profit.

A Clunker of an Economic Policy

Yesterday, the world was greeted by a much-trumpeted USA GDP report showing 'growth' has returned. Admittedly, the 'growth' was primarily the result of Federal Government stimulus, mainly in the form of the first time house-buyer credit, and the 'cash-for-clunkers' plan. These two giveaways really only pulled consumption forward as opposed to creating new demand. The collapse in auto sales after its programme ended proves the point.

More disturbingly, having the economy increasingly dependent on debt-funded, government stimulus is not a sound policy. Let us illustrate by analogy. Suppose Mr. Miller was down on his luck. Mr. Baker next door has a brilliant idea: "I have an unused credit line down at the Bank. Suppose I max it out and use the funds to buy flour from Mr. Miller. I need to buy flour anyhow. I'll just stock up and then gradually use it up." Mr. Miller is, naturally, delighted when the order for a tonne of flour comes in. He even needs to hire an assistant, Jack, and now Mr. Miller can order that new mill stone he'd been hankering after. GDP is now growing again!

Only here's the fly in the ointment: as Mr. Baker starts buying less flour as he draws down his stock, Mr. Miller's sales are lower than ever! Jack gets laid off and ends up moving into his parents' basement. Jack's former landlord is unable to find a new tenant and starts baking his own bread to economise. Mr Miller also reluctantly cancels the order for the new mill stone. Mr. Mason, faced with no prospects of further business, sells his home and joins a monastery. Mr. Baker is faced with falling sales, and now a hefty interest payment on that line of credit. GDP is falling again, and even worse than before!

A debt-binge set up the world economy for the 2007 Depression. The attempt to keep the debt party going will end in tears. Mark our words! [cue spooky music]

FDIC Bank Failure Report - Impossibly Late Edition

Apologies to all, but it's been a busy week. We're wrapping up our summer efforts, and save a few last projects we will soon have more time to devote to this blog.

***

This week, the Federal Deposit Insurance Corporation closed seven banks: Partners Bank, of Naples, FL; American United Bank, of Lawrenceville, GA; Hillcrest Bank Florida, of Naples, FL; Flagship National Bank, of Bradenton, FL; Bank of Elmwood, of Racine, WI; Riverview Community Bank, of Otsego, MN; and First Dupage Bank, of Westmont, IL. The total assets of the closed banks were $1,163,900,000, and total deposits were approximately $1,032,100,000. The cost to the FDIC is estimated at $356,700,000.

According to our methodology, the recoverable value of the bank was $675,400,000, or only 58.03% of the declared asset value. This makes this week's closure slightly above the cumulative recoverability since December, which stands at 57.46% (essentially unchanged from last week's 57.45%).

Cumulative cost-to-FDIC was brought to $46,457,800,000. This closure brings the total declared assets of FDIC-failed banks (since December of 2007) to $480,962,480,000, and total FDIC-insured deposits to $322,801,020,000. The recoverable value of all failed banks was only $276,343,220,000 (57.46% of the declared value).

***

First off, we welcome Wisconsin to the 2007 Depression; the Land of Cheese has enjoyed the scent of its first - of many - bank failures. Additionally, we pat ourselves on the back, because at long last Florida is receiving the attention we predicted it would (see the commentary at the end of our piece). We called it almost a month ago, so please pardon us while we feel terribly smart. At any rate, Florida is in for a very, very painful time, have no doubt; the whole State's banking system is a morass of ultimate financial doom. We don't know if this is the beginning of that pain, or just a blip, but we're quite confident that Florida is going to see vast numbers of banks falling dead in their tracks from toxic mortgages, et cetera.

We noticed a surprising trend with this week's closures: a large percentage (95.27%) of the assets of all closed banks were successfully sold off, either outright or under a loss-share agreement between the FDIC and the acquiring institution. We don't have much back data (we'll work on that), so this might be a fluke of the week... but we wonder if the Federal Government's calling the recession over is actually working. Call us crazy, but we're just not feeling the love on this one. If the 'great recession' were actually over, we would expect to see that in improving quality of bank's assets. They have definitely not improved.

However, is seems that acquiring institutions feel the economy will be improving in the future, so they're happy to snap up most of the assets of the failed banks, no matter how toxic. The frisky animal spirits have possessed them at last, so they put on their war paint, do a victory dance, and march off to position themselves for the 'great recovery.' Apparently these acquiring institutions have forgotten they are akin to wolves; wolves can only consume fresh meat, and it seems these predators haven't noticed their prey is rotten. We don't know when the nasty effects of bad assets will start to bother the predator banks, but when the effects start it will be exciting. If acquiring institutions start to be closed by the FDIC, expect the U.S. to take the mother of all nosedives.

***

On the basis of the ratio of bank closures to population (i.e. simply the number of failures in the State, with no account of assets or deposits), the ten most afflicted States are listed here. Only those States which have two or more closures are considered.

1. Georgia
2. Nevada
3. Illinois
4. Minnesota (up from #6)
5. Utah (down from #4)
6. Kansas (down from #5)
7. Oregon
8. Missouri
9. Colorado
10. Florida (new to list)

The recoverable value represents how much of declared assets are actually worth on the open market. The following are the ten States with the lowest recoverable value; only those States which have had two or more closures are considered in this analysis.

1. Florida (32.44%)
2. California (40.11%)
3. Colorado (42.76%)
4. Michigan (43.07%)
5. Nevada (50.13%)
6. Georgia (53.74%, down from 53.76%)
7. Utah (55.39%)
8. Arizona (56.08%)
9. Washington (56.18%)
10. North Carolina (56.7%)

***

Well, shucks, more back-patting for us: Florida is now officially on both lists. We fully expect the State to ratchet up to the #1 spot on closures-to-population, and stay firmly in the lead on the recoverable value scale. The collapse of Florida's finances will likely be coupled with the final catastrophic implosion of the vast majority of well-off senior citizens' own finances. Why? We suspect that most of the elderly retirees in Florida have a big portion of their wealth in over-valued real estate, and when the State's real estate bubble pops and that value goes down, down, down, those seniors are not going to have much to fall back on. Social Security will not be enough to support them in the style to which they've become accustomed, and they will be forced out of their homes and into the homes of their children.

That's, of course, making the rash assumption that their children still have homes of their own. If the Baby Boomers have taken the hit at around the same time, the United States is going to see a large indigent population of elderly and Baby Boomers, whinging about how it isn't fair. No one in power will be listening, we suspect; the ear of the Federal Government is firmly owned by banks. Indeed, at that point the Government might not have any money at all to throw around - at least, no money that can actually buy anything.

The question rattling around in our mind is this: is Florida the first domino in a really big economic catastrophe? Or will it be another California, and simply be a bigger sag in the overarching, slow-motion collapse of the U.S. economy? We really don't know, but we could certainly see it either way. We'll be pondering that thought for a later blog post.

Q&A on the FDIC's Prepayment Plan

We just noticed a piece the FDIC released, giving what it considered answers to frequently asked questions about the proposed prepayment of three years' worth of insurance premiums by banks. This prepayment would bring in an estimated - and probably desperately needed - $45 billion, so that the FDIC can keep its dog and pony show going a little while longer.

Please read the FDIC's prepayment FAQ first, as in the rest of this post we will provide actual answers to the listed questions. We will be writing the replies in the manner of an awkward FDIC employee injected with truth serum. Pretend, if you will, we stand with you in a darkened room. It is stuffy and hot. A sweating accountant is 'cuffed to a chair, blinded by an extremely bright light; his eyes are squinted nervously. A squeaking fan is over in a corner, next to some doughnuts; throw in a couple beefy guys with names like Moose or Rocco for good measure. You get the idea.

***

Question #0: Has things gotten this bad because the FDIC is incompetent, or because its leadership is corrupt?

The answer is, obviously, yes.

Question #1: Why is it preferable to prepay assessments rather than borrow from the Treasury?

Well, as revealed by a former FDIC chairman, the FDIC really doesn't have any money at all in the Deposit Insurance Fund; in fact, it can be argued that the DIF doesn't exist at all. The monies which the FDIC takes in for the DIF actually go onto account at the U.S. Treasury, whereupon the money automatically becomes part of the Federal Government's General Fund, and the FDIC gets a lovely I.O.U. But, if you want to pretend the DIF exists, no skin off my nose.

Anyway, prepayments are probably preferable because it is a back-door way of getting real, cash money out of the private sector and into the greedy hands of the U.S. Congress. God knows the need as much money as they can get, and this is a pretty quick way of getting it. Plus it has the perfect cover story: the FDIC needed to 'repair' the DIF, and it needed the prepayments to do so. The money goes into the Treasury where the FDIC can pretend it is on its balance sheet, and the Congress can pretend it hasn't already spent the money a gajillion times over. Sure, the prepayments are only about $45 billion, but it's real money, which is hard to come by these days.

Question #2: Isn’t this a short term solution predicated on a swift banking recovery?

Oh, you noticed?

Ow! Okay, okay!

Yes, this does assume a swift recovery, because banks are going to need all the cash they can get in order to stay afloat when their balance sheets take another nose-dive. That'll be especially true when the Alt-A mortgages start rolling over, because you know those house owners will default right and left. At that point banks will find themselves the proud owners of really overvalued property, as opposed to the merely overvalued stuff already on their books from the sub-prime fiasco. Even if they don't foreclose, the non-performing loans will be bad enough. They'll need cash to try and stop-up the leaks.

Another tidal wave that banks face is the commercial property catastrophe. You had better believe that strip-malls and mega-shopping-centres are on the ropes, and there is no way that consumption will ever recover enough, and quick enough, to rescue those outfits. So, they'll naturally go under, default, and presto the banks have more useless property or non-performing loans on their balance sheet. More leaks, which will need more cash.

Question #3: Would smaller banks be affected disproportionately by this action?

Tough call... probably not all at once, but in the medium term, it will definitely be bad for smaller banks. In theory, it will be worse for the big banks, like Wells Fargo or Bank of America, but those guys have a government guarantee to never run out of money. So, even if this prepayment hurts banks, the smaller banks will feel the pain more, because they don't have a hotline to [Treasury Secretary Tim] Geithner.

Sure, the FDIC could give some exemptions, let a few stressed banks of the hook, but between you and me that probably won't happen much. We need that money, perhaps Congress needs that money to fund something or other that shouldn't be happening, but is anyway. Even if the prepayments help kill a few weak banks, they were probably going to go sometime soon anyway, so it's no big deal

Question #4: Didn’t Congress raise the FDIC’s borrowing limit for just this scenario?

Sure they did, but the FDIC doesn't want to touch that line with a ten-foot pole. Why? Well, the big buzz is that the line is being saved for some 'emergency.' That emergency should be obvious: a sudden and unexpected implosion of, say, Wells Fargo, or Bank of America, or JP Morgan . Hell, maybe this $500 billion has Goldman [Sachs'] name on it, just in case they have some trouble refueling their yachts, or something.

At the same time, if the FDIC were to tap its Treasury credit line, it would have to start paying interest at the Treasury rate. That would mean the FDIC would have to start earmarking money coming in from regular [deposit insurance] premiums, which would be bad because the FDIC is cash-starved. We need every penny coming in to keep up operations, at least at some level, and to have to set aside money for Treasury interest would be dangerous... who knows what that interest rate could do? If it went up sharply, for whatever reason, the interest payments would take a bigger and bigger chunk out of incoming FDIC fund. Hell, interest could end up being more than incoming premiums!

Question #5: Wouldn’t this take much needed capital out of the system and constrict lending?

Hahahaha, lending? Who's lending? Nobody important is lending, you dumkopf! All the big banks are taking their free government money and using it to buy T-bills and other government debt, because that's viewed as an utterly safe investment. I suppose it is, in a way, because they're guaranteed to get paid the face value of their bonds and such. The question is, of course, how much will that buy at the end of the game?

As for capital, well, like I said that really doesn't matter to the big banks, at least not right now. Those banks can simply get a dump-truck of new money dumped into their vaults overnight, problem solved. It's the real banks out there, the smaller ones which tried to be responsible and maintain standards, those are the banks to get socked in the mouth by capital shortages. They probably won't get a bailout from the Treasury or the Fed[eral Reserve]. Instead, if they go insolvent, the FDIC will just close them down and sell them off to bigger, more irresponsible banks which have a Treasury or Fed credit line.

Question #6: How would the banks account for the prepayment?

Ah, here's where it becomes genius. Let's say that Wells Fargo has to cough up $1 billion in cold, hard cash and mail it off to Aunt Sheila [Bair, FDIC Chairwoman]. In the real world, that should show up as a large, one-time draw on liquid assets, like when you write a cheque for cheese doodles and beer at the Seven Eleven.

But hey, this isn't the real world. Instead, accounting law allows Wells Fargo to count that $1 billion as an asset. Cool, yeah? Wells Fargo would thus end up with a three-year 'asset,' which would 'depreciate' by the value of the bank's monthly premium payment. This is how we can claim that banks can handle this prepayment, because they can spread out the pain over three-plus years, when in reality most banks probably couldn't handle such a large outlay of cash.

Question #7: How would the FDIC account for the prepayment?

Well, suddenly we'll be about $45 billion richer, so of course we'll get extra cream-filled doughnuts that day. Beyond that, and at the same time, we'll pretend we only got that quarter's premiums, without the subsequent quarters' prepayment being acknowledged. As the quarters roll by, we'll then pretend that we just received that quarter's premiums, and so on, until three years go by and everything is back to normal.

Hahahaha, normal...

Anyway, it's like having our cake and eating it, too: we've got the money from the next three years, but we'll still count it as regular income over that period, instead of in one lump sum. Don't let that fool you, though, because the FDIC will count the entire $45 billion as being available for spending during the whole period, if the money actually lasts that long.

Question #8: Isn’t this the same as borrowing from the industry without charging interest?

Well, if my pulling a gun on you and demanding all your money is considered borrowing without interest, then yes, this is like borrowing without interest. But really, no, this isn't borrowing. The FDIC doesn't believe in 'borrowing.' Borrowing means the other party has the right to refuse, and Shelia [Bair] doesn't like hearing negatives. The FDIC says jump, and all the insured banks say how high.

Question #9: How many banks would be exempt from paying the assessment up front?

Who knows, probably only a handful. Those banks will be very weak indeed, and they probably should have been closed anyway. If anyone could get their hands on the list of exempted banks, they would've just found the list of the next banks to be failed in the future.

Question #10: If a bank’s total deposits or actual assessment rate decreases during the next three years, would the FDIC refund a portion of their prepaid assessment?

What, does this look like the March of Dimes?

Ack! That hurts, man! C'mon!

Honestly, no, okay? It's part of the deal of getting the insured banks to swallow a prepayment plan. Even if their assessment rate increases, they won't have to pay extra for the next three years. It's actually a pretty sweet deal for banks which are planning on expanding deposits: they pay out, then enjoy insurance on their new deposits for a lower cumulative cost. It's bad for shrinking banks, though, because they'll theoretically be paying extra even if their real assessment has gone down.

Of course, if by some miracle there are any leftover funds in three-years' time, the FDIC will return that to the bank or banks in question. Nice idea, right? Too bad there probably won't be any money left!

Question #11: When is the DIF expected to go negative?

Go negative, as in the future tense? Haha, try July of last year [2008]! Indy Mac was a kick in the pants, far more than we can admit publicly. Simply put, we bit off more than we could chew, and boy did that hurt us bad. Our original estimated cost was over $2 billion short of the actual cost [which was $10.7 billion]. We've been scraping bottom since then, trying to manage closures to keep costs to the DIF down.

Of course a couple times we were forced into action, like with Colonial Bank or Corus Bank. We were hoping that those banks could pull themselves together, but in the end the Comptroller [of the Currency] and Alabama's Banking Department pushed those pieces of crap on us. It was pretty lucky that we could scrape up the money needed [$4.5 billion for the two] in order to get them out the door. Wasn't pretty.

Question #12: When was the last time the insurance fund had a negative balance, and why?

During the [Savings and Loan] fiasco, before I was working at the FDIC. From what I've heard from people, though, the FSLIC [Federal Savings and Loan Insurance Corporation] was trying to pull the exact same thing we are now: hold off on closures as long as possible, keep their costs down, and pray hard that financials could pull themselves together on their own.

That didn't turn out so well, and the FSLIC ended up blowing out so bad that the FDIC had to step in and take over. It was a real mess, as I understand it, and damned expensive. Kinda funny that the FDIC is doing the same mistake the FSLIC made, isn't it?

Question #13: If the DIF goes negative, does this mean that the FDIC will no longer be able to protect insured depositors?

In theory, yes. If the DIF comes up dry, then there's no more money to cover deposits if the sale of banks' assets doesn't cover the full amount of their insured deposits. However, the FDIC has some money squirrelled away which it could tap in a pinch, as well as that infamous $500 billion credit line which it could tap.

However, if the FDIC gets the prepayment to go through, it could be shooting itself in the foot. See, if we do blow through that $45 billion, that's it for three years on premiums. We could levy special assessments, but that would get unpopular really fast. We'd have to tap the Treasury for money, but it we don't have income, how can we pay the interest? It's a no-win scenario. Deposit insurance goes up in smoke, because the NCUA [National Credit Union Administration] doesn't have the resources to take up the slack. Depositors will be at the mercy of their bank's bad investing.

Realistically, though, I suspect that if the FDIC becomes undeniably, inescapably insolvent it will probably be absorbed by the Federal Reserve. It's the only institution big enough to handle the mandate of the FDIC, and it has the ability to simply print up money to pay out insured deposits, even if a bank's assets are completely worthless. That will probably create some serious moral hazard, because with the printing press guaranteeing all deposits banks will have no real reason to seriously invest in real assets.

Question #14: Has the FDIC ever required prepaid assessments or borrowed from the Treasury before?

Yes. There was a prepayment once for... I think it was just an extra quarter, nothing more. So this three-year prepayment is completely unprecedented. We've never done anything like it, and frankly it's because we're desperate for money, and lots of it. We're taking a big chance with the prepayment too, because it removes income flexibility for a very long time. Who knows what can happen in three years? I really don't know what Sheila [Bair] is thinking...

As for borrowing from the Treasury, no. The only borrowing the FDIC has done in the past was from, I think it was the Federal Financing Bank in the S&L crisis. Wasn't much money either, only about $15 billion, so the $500 billion max credit line is a really big deal, especially if it gets tapped. When - not if, when - the FDIC calls on its Treasury credit line, things are very bad and will be getting much worse. Just you wait.

Question #15: How much does the FDIC expect to spend on bank failures, and how much money would the proposed prepaid assessment raise?

Well, the prepayment will take in about $45 billion, like I said. As for the cost of bank failures, the number I've seen kicking around is $100 billion from this year till 2013, but that's just bull. There's no way that the cost will be so low. Heck, this year alone has been about $26 billion, so if that rate keeps up it'll be $130 billion by 2013. But I'll be willing to bet that things are going downhill soon, and fast. Why else would we want that prepayment, and such a big prepayment at that?

Look, we've already set aside over $50 billion in the DIF's Contingent Loss Reserve, and with the $45 billion theoretically incoming, we should have our $100 billion, right? Well, what happens if the next several years ends up being like Indy Mac writ large? What if, instead of $100 billion, it's more like $130 billion? That means $30 billion has to come from somewhere, perhaps the Treasury credit line. But what happens if that comes next year? What happens if the cost is actually $200 billion by 2013? The margins are razor thin right now, and with this prepayment thing in the works it's basically guaranteeing the FDIC is going down smoking.

I hope I can get a job when that happens... Hey! What are you doing with that needle? What is that stuff? Hey, answer me!

Economic Stress Report for August 2009

Once again we've gathered sufficient data to provide an update on the Economic Stress Report. According to our analysis method, the following are the top ten States on our list of economically stressed states. We present them here in order of highest to lowest severity:

South Dakota
Vermont
Ohio
Arizona
Kansas
Montana
Washington
West Virginia
New York
Indiana

Of those States on our watch list, the following have suffered bank closures - another sign of economic stress - since December 2007:

South Dakota (1 closure)
Ohio (1 closure)
Arizona (2 closures)
Kansas (3 closures)
Washington (2 closures)
West Virginia (1 closure)
New York (1 closure)

The past month or so saw two big surprises for us: first was the very rapid fall of Maryland from stressed to 'troubled.' We're not completely convinced that Maryland's situation has suddenly improved for some reason, The State is still on our watch list, but it is no longer stressed, according to our analysis. Even so, we suspect that things will be getting quite a bit worse in Maryland, especially when the Federal Government is forced to commence personnel cutbacks (whenever than might occur), or when large numbers of bank failures finally take place.

The second surprise was Vermont's meteoric rise to runner-up basket case of the Union. We can only assume that Vermonters were somehow heavily over-extended, which quickly came back to haunt the economy in general, but that's just hand-waving. Frankly, we're not exactly sure why Vermont is apparently in such bad shape, so if any of you, Dear Readers, have thoughts, please share.

At this point we're hopping onto our old horse and ranting about South Dakota, still the worst-off State in the Union, according to our analysis. Simply put, we suspect that some political shenanigans are going down to prevent South Dakota from suffering the effects of its zomboid banking system. We have some thoughts on that, which we'll touch on in a future post, but suffice it to say that South Dakota should have had so many bank closures by now, it's not even funny.

Moving on, Ohio continues to hold third place for another month, so we take this as a sign that the State is in bad shape. Presumably the collapse of the American car industry continues to hit the State hard, and we expect that this condition will continue to worsen (perhaps by the eventual failure of Ford, or the re-failure of Chrysler or General Motors). Whatever the case, though, we feel it is a sign that Ohio is experiencing a relatively stable rate of economic contraction, as evidenced by its stable place as #3.

As a final note, we're very pleased to see that an increasing number of those States on our top ten list have suffered bank failures. This we take to be a good sign, perhaps indicating that our stress analysis will have a strong correlation with future bank failures. Time will tell, at any rate; the next report can likely be expected around the end of September.

U.S. Monetary Policy Does Not Make a Strong Dollar

U.S. Secretary of Treasury Timothy Geithner recently stated that: "Given the dollar’s role in the international financial system and the significant impact of the U.S. economy on global economic conditions, we fully recognize that the United States has a special responsibility to play... The policies of the United States are designed to lay the conditions for a strong dollar and more stability in the international monetary system."

Say what, Mr. Secretary?

There is a serious disconnect in Mr. Geithner's reasoning in this statement. Although it is true that the U.S. Dollar has been comparatively strong in recent days, we hazard to say that this is probably a temporary state of affairs. As ShadowStats.com shows, the Dollar has experienced a relative peak, but is is, as of July 6th, in a steep decline. Additionally, deflationary trends to the tune of about 2% has apparently developed, rendering every dollar in circulation slightly more powerful as time goes on.

However, we posit the exchange strength of the Dollar is liminal; the currency markets are probably changing their minds about the relative value of the Dollar. More telling, though, is the continuing growth of the M1 Money Supply - physical cash and currency in chequeing accounts. That section of the Money Supply is increasing at a whopping 18% annualised... and shows no sign of slowing.

It is that growth which will, eventually, kill the U.S. Dollar, and destroy the wealth of any holders of Dollar-denominated financial instruments (be they savings bonds or Treasury Bills). The Federal Reserve is desperate to prevent any deflation whatsoever, as deflation makes debts all the more painful to the indebited - think the U.S. Government. So, the Fed is pumping up M1 as fast as the printers can press new currency, in the attempt to stoke inflation and thus lessen the pain for the indebited.

We have faith in the Federal Reserve. They may be bumbling and rather silly, but we believe they'll get this stoking-inflation thing down pat. The question, in our minds, is not if, but when. When will the inflation rate rise to once again destroy purchasing power at a rate the Fed finds agreeable?

When that finally happens, and happen we think it shall, Mr. Geithner's "strong dollar" talk will at last be seen as the hot air it really is. We suspect that many investors in U.S. Government debt will see the handwriting on the wall at some point, but there will be many, many investors who will be horribly damaged by the looming inflation. We also suspect those investors will be none too happy with the United States, nor with Mr. Geithner. Hopefully he has his ranch in Argentina already bought and paid for...

A Modest Proposal to Save California

With the State of California presently pumping out $3 billion in unconstitutional IOUs, we suspect that a more impressive meltdown of the State's government is not too far off. It seems unlikely that any mixture of creative accounting and tax schenanigans will be able to stave off the collapse of the State's tax revenue, nor its downgrading debt rating. Unless Governor Arnold Schwarzenegger manages to both get the California legislature to accept his drastic cuts to the State's outlays - as well as pushing for even deeper and sweeping cuts - California will likely perform a sovereign default, and experience a collapse of the Government's services.

But, as with most things, it really doesn't have to go down like that, and to that end we have an idea: de-State-ify California, and convert it into the District of California. We think the move could go, as Bob Newhart says, something like this:

The Federal Government forces bond holders to swap California's debt for fresh Treasury debt at face-value, or perhaps a token premium. With that move complete, the Federal Government would then dissolve the State Government, and place the political administration of California directly under the authority of Congress. As we understand it, this would convert California into a Territory (which is how the District of Colombia is classified). In order to get the residents of California to feel happy about this move, the Congress could pass a Constitutional amendment allowing territories - like the District of Colombia, and possibly the District of California - to vote in elections of Representatives and the President.

This move would not be without benefits to both parties (i.e. California and the Federal Government): Californians could conceivably see lower taxation, as there would be no parallel State/Federal services, such as welfare... but we would count on that one too much. The Federal Government would be the bigger winner, because California would lose its Senators. That may not seem like such a big deal, but if turning a State into a District is successful, or at least not a total catastrophe, the Federal Government would likely perform the act on several other failing States. With fewer and fewer Senators, an argument could be made for the dissolution of the Senate, and the transfer of the Senate's powers to the Executive or the House of Representatives. Such a move could be dressed up as a 'drastic change to increase efficiency in Government, and reduce public expenditures.'

Be that as it may, if the Federal Government were to take over California directly, it would at least stave off the embarrassment, and potential fallout, from having a State default on its debt. It would also be a shrewd move for the Federal Government, for a somewhat complicated reason. As, in theory, the Federal Government is the representative of its constituent nations (as in a Republic), the credit rating of the Federal Government probably would be affected negatively by a Californian default. Such an effect would have a concurrent negative affect on the Federal Government's spendthrift ways. Ergo, prevent a Californian default at all costs, to protect the Federal budget.

Or... the Federal Government could just fork over a tonne of money to California, since Michigan has already gotten its own, private bailout. We can only remark on how well it seems to have worked.

Introducing the Economic Stress Report

We've developed a method of measuring economic stress by State within in the United States. We believe it is fairly accurate, but it is, at the very least, not doctored or focus-group tested for maximum warm-fuzzy-feeling-ness. Our method is a secret, but it is tied to each State's percentage share of the total U.S. population.

Related to that, our depth of data is presently not sufficient for us to analyse the economic condition of some of the States in the Union. In the coming weeks we expect our data quality to improve, and concurrently our ability to analyse these States.

With that, we officially launch our Economic Stress Report. On our stress watch list are the following States, in order of most to least distressed:

South Dakota, Maryland, Arizona, Hawai'i, North Carolina, Ohio, Connecticut, Oregon, New York, Florida, and Georgia.

Our of those States, the following have suffered bank closures - another measure of stress - since December 2007: Maryland (1), North Carolina (2), Florida (5), and Georgia (11). Based on this information, we have several predictions to make:

One: unemployment in Maryland is going to "unexpectedly" spike in the coming months. Although the State is touted as having strong support from the Federal Government, and currently is experiencing unemployment below the national average, it has ranked second place in our analysis, so we suspect the Government-supported economy will begin to fail catastrophically. Additionally, more bank closures in the State should be forthcoming.

Two: numerous bank closures should be imminent in South Dakota, as it is the most distressed State in our analysis. Considering Georgia has suffered eleven closures, proportionally South Dakota should have seen over one hundred closures this far into the Depression. Why there have been no closures in South Dakota is a mystery as it is an important banking centre - especially for credit cards, but we posit that the longer there are no closures, the worse the eventual collapse of the State's banking system will be.

Three: Arizona, Hawai'i, Ohio, Connecticut, Oregon, and New York should all be seeing bank closures in the near future. Florida and North Carolina should also see additional bank failures, if Georgia is to be taken as a benchmark.

We are uncertain how rapidly we will be able to provide updates on the Stress Report. However, at present we suspect not less frequentlly than monthly. Rest assured we will keep you updated.

The Changing Face of Economic Power

It is our ongoing opinion that the financial hegemony of the United States Government is firmly on the wane. Between two costly and unwinable wars, massive bailouts, and grossly distended off-balance-sheet liabilities, we don't see anything other than a collapse of the U.S. Dollar at some point in the future. We can't say when, though... we are only certain that such a collapse will happen.

An interesting sign of the change in monetary power is the news that Brazil, Russia, India, and China (known as the BRIC) are holding their first-ever economic summit together. According to this article, the BRIC group together represents around 15% of the world's economy, and hold approximately 40% of the world's currency reserves. Such numbers make the BRIC group, if the member nations can act in concert, an economic force to be reckoned with.

Considering that the BRIC group is apparently weathering the Depression better than most nations - at least so far - that suggests the group will become a larger force in deciding the landscape of the world's economy. Specifically, we suspect the group will be taking a long, hard look at the U.S. Dollar's hegemony, and whether or not those little pieces of paper will have any value as a reserve currency for the future.

Frankly, we suspect not. The United States is going down a fiscal and monetary path blazed by Japan and Zimbabwe, among others. However, the meltdown of Zimbabwe and the constant doldrums of Japan weren't such a big problem, as those nations did not enjoy having the world's major reserve currency. The United States, on the other hand, does. Whether it goes the way of Japan or of Zimbabwe, will make it extremely painful for any nation to hold Dollars as a currency reserve.

It may take awhile for the collapse of the U.S. Dollar to sink into the collective minds of the BRIC group, as well as the European nations. But we expect that, sooner or later, it will; that will signal the end of the United States' credit line from the BRIC group, as well as the eventual collapse of the Federal Government's ability to grossly deficit-spend like mad.

When Governments fail, the currency need not. However, when a currency fails, the Government which issues said currency does fail. In the short term, we really can't say what will happen to the Dollar, nor of its status as reserve currency. Perhaps the world economy likes the abuse, and will therefore keep the Dollar around for awhile longer... or perhaps not. Whatever the case, though, we suspect the U.S. Dollar has a long-standing date with repudiation. The only question, in our mind, is when.

U.S. Government's Latest Conflict of Interest

With the U.S. Federal Government firmly in the automobile manufacturing business, we make the fearless prediction that they will be staying into the business until the Government itself collapses into ruin. When that day may come is anyone's guess, but in the meanwhile the United States is stuck with a Government-owned car company. Prepare for even more waste, even more unreliability, and even more ugly to be found in your next new GM car, dear Reader - if you are fool enough to buy one.

But that is neither here nor there; what we'd like to point out is that the Government is positioning itself for a conflict-of-interest situation. A "cash for clunkers" bill is presently making its way through Congress, and it seems to have a good chance at becoming law. The programme would give up to a $4,500 credit to buyers who trade in their older vehicle (25 years old and newer) for a brand-new vehicle. This will come with the price-tag of $4 billion... just a drop in the bucket, really.

The problem is, the Federal Government owns a couple car companies... and here it goes, putting out a bill to pay people to buy new cars! Instant conflict of interest: the Government would naturally prefer you, dear Reader, buys their cars, not the vastly superior Japanese or European models which might catch your eye. When the "clunkers" programme becomes law, we posit it's only a hop, skip, and a jump to legislation punishing those who purchase cars from the non-Government-owned manufacturers. Such a thing would fall loosely under the "Buy American" nonsense.

As an aside, and despite the concerns raised in this article about the possible bad effects the "clunkers" programme will have on auto repair shops, we suspect the new GM (and probably Chrysler) cars will suck so bad that they'll break some expensive - and functionless - part before the first oil change. Repair shops will have booming business for awhile, swapping out broken parts with faulty replacements.

***

At this point, we're officially putting Ford on the death-watch. Sure, the company may be able to limp along for awhile, but at some point Ford too will fail. The Government will be waiting with money in hand to add to its burgeoning car manufacturing empire.

The World's Biggest Board of Directors

Now that GM and Chrysler are de facto (and soon to be de jure) owned by the U.S. Government, the government in the person of the U.S. Senate is taking an interest in the operations of its automobile manufacturing operations. The Senate held hearings on Wednesday 'reviewing' the decision of the two companies to disenfranchise a number of dealerships.

This brings into plain view the inherent problem of government ownership of businesses competing in a private sphere. The government has no mechanism to guide business decisions. Politics is reactive, and that is no way to run a business.

Sound arguments may be put forward for the government operating commercial operations such as a postal service, but then it is set up as a part of the machinery of the state. It may be subject to some political pressures (the placement of post offices, distributions of contracts, and so forth) but this is merely the sort of cronyism one expects from any part of government bureaucracy.

The government could proactively set up a Motor Vehicle Manufacturing Authority and assemble a bureaucracy to run it. We don't advocate such a move but it would be preferable to the current situation: taking over corporations, telling the management that the government isn't going to be involved in the day-to-day affairs of the companies, and then proceeding to second-guess and meddle with management's decisions!

Follow-Up on Loan Delinquency

The FDIC is reporting delinquent bank loans are 7.75% of all loans. While this is not yet as bad as mortgage delinquency which we discussed in yesterday's post, it is still capital-annihilating (since most of these deadbeat loans will have to be written off).

With their capital evaporating, banks must shrink lending. It is no wonder that so many businesses and individuals are seeing their credit lines cut or cancelled. As those who have the means to pay off said lines of credit race to do so, they will not be investing or spending money. This will have a dampening effect on economic activity, to say the least.

If the nationalised, yet insolvent Freddie Mac and Fannie Mae being ordered to expand their books to keep mortgage loans flowing were a precedent, we would anticipate an imminent, very large bank nationalisation instigated in order to have banks under political control and follow the directive to grow loans, no matter the ultimate cost. (The hurried, and ill-conceived TARP investments do little to give the Federal Government adequate policy leverage over the banks).

We think it wiser to let banks gradually expire. In the post peak-oil, resource-constricted world, there will likely be no further economic growth. In the aggregate, borrowing and lending will become much riskier propositions since loans will tend to impoverish, rather than enrich borrowers. There will always be room for lending to promising enterprises, but this will be a small niche.

It will be very shocking to witness much of the 20% or so of the US economy that is the banking and financial sector just go away. But there is no way around it. Like house building and automobile manufacturing, it is a sector whose preeminence has come and gone.

Correcting a Misconception about Home Equity

Note: We had hoped to deliver a FDIC Bank Closure Report today, but no banks were closed since last Friday.

We have been hammering on the shocking lack of home equity that most owners with mortgages in the USA actually have. This short article explains the situation mostly very well (and has a nifty chart to boot), but overlooks one critical point: about one-third of homeowners own their homes free-and-clear, that is, having no mortgage. We will explain why this is so important.

First, a brief quote from the article (bold added):

"When value falls and debt stays the same, equity gets crushed (See The Problem With Debt). If house prices end up falling more than 40% peak to trough, which seems likely, U.S. homeowner equity will drop more than 70% and as many as half of American mortgage holders will be underwater."

This is not correct. If homeowner equity drops more than 70%, virtually every mortgage holder will be underwater. Using figures from the article, at present the value of all houses is about $18 trillion and the amount of mortgages is $11 trillion, which leaves $7 trillion of equity. If you take into account that about one-third of homeowners do not have a mortgage, this means that about $6 trillion of houses is owned free and clear, and $11 trillion of mortgages is on $12 trillion of houses.

All that it would take to put the group of homeowners with a mortgage under water is just another drop of $1 trillion, or a little over 5% of the current value. Of course some would be very underwater, and some not at all, but the overall situation is quite precarious. This is very bad for the homeowners who can't sell if they want to, and can't refinance because there isn't enough equity.

It is even worse for the banks, and the Federal Government. Once that 5% additional drop happens, even prime mortgage portfolios are truly junk investments since the collateral no longer covers the principal amounts. A peak to trough 40% devaluation as suggested by the quoted article will bring many trillions in losses to the Federal Government, and ultimately the taxpayer. Underwater homeowners - either unable to make mortgage payments, or having little incentive to do so even if they can afford them - will 'walk away' en masse.

Building the AmeriCar Market

As we wrote previously, we have a pet theory that the U.S. Federal Government is in the process - deliberate or accidental - of forming a national car manufacturer, owned and operated by the Government. With Chrysler in bankruptcy, never to repay the over $7 billion in loans from the Government, we suspect that the process of forming "AmeriCar" is accelerating (if you'll pardon the expression).

However, as anyone who has actually paid attention knows, most American automobiles suck. It's all well and good that the Federal Government might be running its own car company in the future, but who's going to buy the crap that will - almost certainly - be produced? If the Soviet Union is any indication, the national cars will be impressively crappy... except for the members of the Government, of course.

We suspect that the preliminary methods for corralling people looking to buy new cars will be similar to the "cash for clunkers" programme; older autos can be traded in for a rebate on a new vehicle. It wouldn't be difficult to extend that programme to apply only to vehicles purchased from "AmeriCar." Indeed, an even more draconian move - and in keeping with the "Buy American" mantra of the Obama Administration and Congress - would be to restrict the programme to only American-made cars, on both the trade-in and the new auto. Additionally, we wouldn't be surprised to see hefty tariffs on imported vehicles, to further coerce buyers to get "AmeriCar" vehicles.

Problems of Comparing the U.S. with the U.S.S.R.

We have made several arguments in the past that the United States is following the Soviet Union's path to oblivion. Although we do feel that the basic trajectory is a reasonable one for analysing the U.S.'s descent, we have been giving the matter some thought recently. Some results from this pondering have been critiques of the U.S.S.R./U.S.A. collapse comparison.

First, though, is a proposal we have to offer the Obama Administration, although we expect it would be very unpopular. The first step would be to have President Obama admit the banking system is completely fracked up. He would then nationalise the entire banking system, thus wiping out the stockholders, the bondholders, and all uninsured depositors. From there, two new sectors would be formed: a national system of "good" banks, which would hold all insured deposits; and a trust to hold all the toxic 'assets' in an attempt to wind down the contracts and garner a profit therefrom.

After this schism is complete, the Federal Government would then issue vouchers to every American citizen. These vouchers would be good for stock or bonds in either the 'good' banking system, or in the trust of bad 'assets.' Through this system, the profit from both the renewed banking system, as well as the winding-down of toxic assets, will accrue to the Citizenry, and not to some banking elite or corrupt political toadies.

This voucher concept is not original; it was something that arose from the Soviet Union, in an attempt by the post-Soviet Government to unwind failed economic models and structures. The effort failed, because the Soviet system failed so utterly, but the concept behind the vouchers is brilliant: it distributes the potential benefit amongst the largest number of people, something that the United States desperately needs in dealing with its failed banking system (and automobile manufacturers).

However, we honestly would be shocked if a system of vouchers was ever implemented in the United States. The 'why' is simple: to do so would be a proactive admission of failure, which is anathema to the American ethic. Very few citizens in the U.S. would be able to admit that the entire U.S. banking system is in failure-mode, and needs to be liquidated as rapidly and efficiently as possible. The post-Soviet voucher system would be better a 'cure' than simply tossing vast sums of money indirectly into the over-seas retirement funds of the CEOs.

Americans are not able to understand that something so pervasive as banking could collapse utterly... and they really would not understand that, if the Federal Government were to lose its effectiveness in keeping the zombie super-huge banks limping along, the banking industry would utterly implode overnight. Failure of Government is totally alien to the American Citizenry, whereas it was very familiar to the Soviet populace. Soviets could clearly see that their economic system was non-functional, and cavorting with utter failure. Americans cannot understand that the "American Way" is just as hopelessly flawed as the Soviet's system, and just as doomed to failure.

It is in this great difference between the collapse of the Soviet Union and the decay of the United States that comparisons break down. The Citizenry of those two systems are so incredibly different in skills and outlook it boggles the mind; Soviets were lean, mean, frugal machines... while Americans go ape when they can't park their SUV right at the entrance to the strip mall. Comparative analysis between the U.S.S.R. and the U.S. are still valid, we feel, but it must be done with a caveat: the average American is likely going to suffer far worse than an average Soviet.