Friday, July 11, 2008
And IndyMac Folds
The bottom line: The bank failed and was taken over by the FDIC. It is now in conservatorship and will be run by the FDIC. Here's the first test of the newly-beefed-up bank closing teams! So IndyMac is now IndyMac Federal Bank.
Uninsured deposits are going to currently get 50% of their balance, and they should get that within 30 days. After that, it depends on how much money can be squeezed out of the remaining assets.
Bloomberg article. This failure places two other institutions in the limelight because what took IndyMac down (fundamentally) was really their Alt-A portfolio. I've tried to explain before why Alt-As are worse than subprimes, and the two basic reasons are that in subprime lending a lot of risks were recognized (not enough, but you do have far more room to modify!) and subprimes were spread more evenly geopgraphically.
I do have one comment about the current atmosphere of fear and panic. The difference between FNMA and an institution like IndyMac is that FNMA's risk spread is about the reverse, i.e. FNMA's loan portfolio had low bubble market penetration and low Alt-A concentrations.
However this bank failure and the ones to follow are a significant risk to FNMA in that they will probably not be able to put back some fraudulent loans, but instead must absorb those losses. With every move across this minefield, counterparty losses grow.
Still, FNMA can keep going, can write profitable business, and has a way out. If it experiences a capital shortage, that shortage will be redressed by public funds and thus will not stop it from operating. There are other institutions that can't.
I hope today's action will make Congress get serious about the additional risks it is asking Fannie, Freddie and FHA to assume. No sane entity would be lending jumbo on 5% downpayments in CA & FL right now. If Congress wants to shove those losses onto the GSEs, Congress needs to realize that it will be paying them our money later to make up for it.
Finally, Chuck Schumer needs to have his ass paddled in public. His behavior was a gross violation of ethics and this cannot happen again. The regulators need to be able to disclose honest information about the risks in the banking system to those in Congress who have responsibility. Without that information Congress will continue to aggravate the situation with short-sighted but well-paid legislation. Schumer violated that confidentiality.
An analogy: police need to have information about robbery risks and so forth. Suppose homeowners inform their local police that they will be away for a time, and suppose a policeman then identified one of those empty homes and discussed its vulnerabilities and liabilities to a local newspaper. Does anyone doubt that this would be more likely to generate a robbery? In this case, IndyMac would have failed anyway, but Schumer had no business doing what he did and he probably did precipitate its collapse. It is somewhat possible that the regulators could have worked out a deal for assumption of assets or even a quick sale of a portion of the bank in advance of failure, so Chuckie's little day in the sun may have cost taxpayers a pretty penny in the end. It also may have directly cost some depositors some money.
Here's Schumer's website email. Tell him what you think, and please pass this link along.
I always knew he was an arrogant jerk, but now he's shown that he's also very stooopid.
The general public must necessarily bear the losses at this point. Whether as depositors or counterparties to depositors, they will bear the losses. We have met the bagholder, and he is us. The only question is in what manner will the losses be allocated. There is something to be said for simply taking them on the chin right away. It might be some percentage more expensive than a careful runoff, and concentrate the losses a little more, but it prevents the financial engineers from fixing the problem with a cosmetic "solution" that just postpones the day of reckoning: TSLF, Level III assets, etc.
Bank runs are not the biggest danger we face. The lurking risk is that the financial engineers will by increments become increasingly bold in "protecting" failing institutions, leading to a zombie banking system and an American lost decade. You know they will unless stopped. The FDIC and its alphabet soup friends must be stopped from playing chicken with depositors, and Schumer's approach works and has the benefit of simplicity. If we get through this without a lost decade, history will remember Schumer as giving strong medicine to a sick nation.
That could be but another scenario is Schumer called out the state of the ship to the folks in steerage while the first class passengers where quietly being ushered out...
The central question is whether you can afford to deleverage the system all at once. Do you want to follow Mellon, and liquidate everything; or do you want to follow the Japanese, and have a zombie banking system? The 1930's, or the 1990's?
A lost decade is not the worst thing that can happen.
The powers of the regulators are limited, and banks fail all the time. When capital ratios fall to a certain point, or management refuses to do what is necessary, the regulator can take over the bank. Not before.
The reason you don't know about it is that regulators come by, assess the situation, mandate corrections, etc. Many institutions recover, but those that don't are usually sold. Even when banks fail and have to be taken over like this, the effort is to minimize losses by making deals with other institutions.
All banks are leveraged. A dedicated run will take down virtually any bank or thrift, which IndyMac was.
This is a link to the piece of IndyMac's call report of March 31 that deals with capital ratios. The minimum would be 4 & 8. IndyMac's capital was being eroded, but it was not on the brink. This link is to the section of the call report that deals with deposits.
As a result of Schumer's action, IndyMac would immediately have lost all power to place assets for securitization or sell loans (because everyone would be afraid of counterparty risk) to anyone but the GSEs. Plus Schumer started a run on the bank, which took out deposits. Note that they were already not in the hot money game.
Not to be nasty, but at any one time in the US there are probably over 100 institutions that could be taken down in a couple of weeks if some idiotic senator decided to do it. It would be a very profitable side business line, too. Just lodge your short and call your senator. Banking is a confidence game. All this information is published; the regulators didn't hide anything; the regulators weren't covering anything up; the regulators couldn't.
Schumer didn't protect the FHL or the taxpayer. Schumer smacked them in the face for his own personal gain.
IndyMac was in the middle of a massive restructuring process, as can be seen from its 10-Q.
I have seen way worse-off institutions survive. I didn't think IndyMac could because of their area risk and markets, but I did expect them to go on for considerably longer and greatly reduce the backlog of bad loans, then get taken over or merged with another institution. That would have inflicted a loss on stockholders, but no loss at all for taxpayers. Schumer really did cost you money. Not only that, his action almost certainly inflicted a loss on the GSEs.
In another few months, quite a few of the loans being carried on IndyMac's balance sheet in the non-accrual category would have rolled out and then IndyMac could have sold some of them.
(Oh, heck, those call report links aren't working. Type in IndyMac, and search. Then wait to be redirected. The sections you want are PD, DI and CCR.)
Few people understand how removing capital from production works. The endpoint of a GD-type cycle is that production costs have risen sharply because of capital removed from production. By the mid 1930s, for example, food costs were sharply higher.
We unequivocally have worldwide overcapacity in some industries versus buying power. We are also globally removing some capital from production by some of the government moves, such as Argentina's war with farmers or Venezuela's baffled efforts at oilfield nationalization.
Right now the Fed has been extremely successful at controlling the credit contraction for productive assets in the States. However it remains to be seen how this is going to play out in the ROW.
Also, the oil speculation is causing a heck of a wave of correlation. The tide is now rolling out.
Banks are a legalized con game that the regulators must proactively prevent from turning into a swindle. Two and more years ago their random investigations ought to have found the exploding mortgages and put the industry on DEFCON 2. Alas, instead they were playing straight man for the swindlers. They might as well have been the well-dressed gentleman that wanders in and "discovers" a Stradivarius while the mark looks on.
"We are in the middle of a global cycle in which we can emerge out the other end in a GD-type era marked by overcapacity and deflation, ..."
Which describes the current condition of the finance industry. The lending business has artificial overcapacity today. Keeping the cheaters around does nothing more than steal customers from honest lenders, artificially driving down their profits. It also prolongs the price declines, putting off thawing, and thereby wasting the time value of the honest lenders' money. Those are real, non-zero-sum losses, unlike the zero-sum decision of where to write down the mortgage defaults.
Deflation is here today. US dollars are created when money is lent. When investors and depositors cannot, even with detailed investigation, tell the difference between exploding paper and money-good paper, then they will not lend. Until confidence is restored, the exponential term in our fractional reserve money multiplier will continue to decline. This is already getting out of hand by driving money into commodities.
I figure taking down some crooks is a good way to start restoring confidence. I don't care whether they were the biggest or nastiest crooks, just whether they were enthusiastic cheats, which IndyMac seems to have been.
Those with multiple accounts under $100,000 but totaling more than $100,000 are probably screwed. During the S & L mess I had a friend with three accounts each under $100,000 that totaled $230,000. She was reimbursed a total of $100,000. Those at the S & L assured her all the money was insured. There was another S & L across the street. She lobbied Congress to no avail.
Regardless of what happened, the appearance at least is dreadful. Furthermore, he should have known that he was completely off the reservation.
Dan, I will try to explain more about how FI regulation works.
The thing is, in a fractional reserve system, the quality of loans is as strategically important as the strength of the Navy. If your Navy has rusted out, it is better to learn about it by a politician forcing a field exercise with disastrous results, than to wait for enemy action to bring the whole system down on one awful day of chaos.
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