Friday Night Lights(out): Bank Failures in Slow Motion

0:00Just to get you in a good mood, it's Friday, I want to remind everyone that every Friday evening a few more banks are closed, yeah, seized by the various state banking regulators and handed over to the FDIC. And this all happens rather quietly, it barely makes the news, you probably never even hear about it, right? I mean, we're told that these bank failures are no big deal. There's no reason to panic, the name of the banks change over the weekend and many customers don't know the difference. I mean their bank used to be something state bank and then it's just called something else state bank the next Monday, so they don't even worry about these things.

0:45And we've only had 294 bank failures this cycle, 294, but it's a big deal and adjusted Adjusted for Current Dollars, the depression banking crisis that we hear so much about was $100 billion, adjusted for current dollars. The SNL crisis was $923 billion, adjusted for current dollars. The current crisis, nearly $8 trillion. So it is kind of a big deal. But Sheila Baer, you know her, the chair Baer, as I call her on CNBC, she's the chairwoman of the FDIC, and she said that the current crisis would, quote, be nothing compared with the previous cycles such as the savings and loans days.

1:33Well, as the numbers indicate, that's just not true. And the reason that it's a much bigger deal is that the financial sector of the economy had grown to be nearly half the economy by 2006, at least if you use the measure of the and the earnings of the S&P 500. So the banking sector was huge by 2006, and that's why these failures are such a big deal dollar-wise. But the question is, why haven't we had more failures? 2008 there were 25, last year there were 140, this year we've had 129, as of 130 more or less, central standard time. There'll probably be a few tonight.

2:20We've had the greatest real estate bubble in history. That bubble has popped, both for residential, now for commercial, and we've only had 294 failures. Now, it takes easy credit to create a real estate bubble. And it was America's commercial banks that provided most of that easy credit. And it's estimated that half the community banks in America remain over-leveraged to to Commercial Real Estate, and that there's another $1.5 trillion in losses that remain to be taken. And Moody's Commercial Property Index has fallen 43% since its peak in 2007. So real estate prices have fallen over 40%.

3:08Raw land has been cut in half. Residential lot values, same way. We've got 3,000 banks of the 7800 banks in the United States loaded with real estate loans. Their collateral values have fallen over 40% and yet less than 300 banks have failed. Now we all know what's happened with the residential property market, but to illustrate how bad The bad situation is commercial, over 8% of the commercial mortgages that have been packaged into bonds are delinquent. That's $51 billion worth of loans that are at least 60 days past due. And that's compared to $22 billion a year ago.

3:59I mean, everything in the commercial property market would seem to be getting worse. Loans that were packaged into commercial mortgage-backed securities, those losses totaled $501 million in August. That's more than double the $245 million in April. And it's over ten times more than the $41 million a year ago. Now as far as the nation's banks go, the past-due loans have increased 16% from a year ago. Restructured loans have increased 54%, 7% of all real estate loans are 90 days past due. Construction and development loans, 17% of those are past due at the nation's banks.

4:52Even the collective real estate portfolio at the 105 largest banks, 9% non-current. And the big bank's construction and development portfolio, 19% passed to. Now these delinquency numbers are bad, anyway look at it. So they must be reflected in banks' profit numbers, right? Well, no. Second quarter earnings at the nation's banks were the highest in three years, $22 billion. And based on these numbers, Sheila Baer says the banking sector is gaining strength. Earnings have grown. Most asset quality indicators are moving in the right direction, putting banks in a stronger position to lend.

5:41And bankers figure that, they figure the coast is clear. I mean, they're cutting their provisions for bad loans. You've got one in four Americans have a FICO score, a credit score less than 600. You have a quarter of all homeowners under water on their mortgages, you've got commercial real estate hitting the ditch, but you've got banks dipping into their loan loss reserves to report profits. So to illustrate this, bankers have cut their loan reserve coverage ratio almost in half. This is the amount of money reserved divided by non-current loans. In the first quarter of 2000, in 2008, in March of 2007 actually, that ratio was 120%.

6:38That means they had $1.20 for every bad loan they had on their books, March of 2007. Now it's 65% as of June 30th of this year. So they've got 65 cents reserved for every dollar of bad loans they have. Now banks added 40 billion in provisions to their loan loss allowances in the second quarter. This is the second smallest total since the first quarter of 2008. That's 27 billion less than the industry's provisions in the second quarter of 2009. So the banking industry made 22 billion dollars in the second quarter by not putting as much and by the way, of the $22 billion in second quarter profits, $20 billion was earned by the 105 largest banks.

7:30The other $2 billion was spread between the other 7,725 banks. So the big banks are backing off, putting money in reserve, booking big profits only months after being rescued by government TARP money. And by the way, we've been hearing a lot lately how the government's going to somehow make money on TARP or that they're going to get their money back or whoever they is, right? Ninety-one banks are behind on making their TARP payments, let alone not paying it back. There's 91 that are in arrears. But most importantly for the big banks, what they were the beneficiary of was two accounting rule changes in April of 2009 and that was amendments to FASB 157, 115 and 124.

8:22This allows the banks greater discretion in determining what price to carry certain types of securities on their balance sheets and the recognition of other than temporary impairments. That means that banks can value their portfolios any way they want to. Now these new rules were sought by the American Bankers Association and not surprisingly they will allow banks to increase their reported profits, strengthen their balance sheets by allowing them to increase reported values of their toxic assets. This was according to James Quack who co-authored a book called Thirteen Bankers, the Wall Street takeover and the next financial meltdown. So the banks get some accounting breaks and they're aggressively reporting earnings at the expense of putting money in loan loss reserves, but still, why haven't we seen more failures?

9:19I mean, earlier this year, Elizabeth Warren and her Congressional Oversight Panel, they did a report that indicated that 2,988 banks were in trouble because real estate concentration in their loan portfolios. Ms. Warren noted that office of vacancies had increased 25%, apartment vacancies had had increased 35%, industrial vacancies 45%, retail vacancies had increased 70% since 2006-2007. And the reports, her report said the recovery rates for defaulted real estate loans was 63% last year. Land loan recoveries were only 50%, development loans were even worse, 46%.

10:05Another banking expert who sounded a warning signal was Chris Whelan who said a year ago the estimated number of trouble banks was 1,900. And the FDIC itself in June said there was 829 problem institutions on their top secret radar that they don't tell anybody about. And that's almost double the 416 announced by the FDIC at the middle of last year. So by all indications, the pace of closures should be speeding up. But instead, third quarter 2009, there were 50 closures. In the fourth quarter of 2009, 44 closures. First quarter of this year, 41 closures.

10:51Second quarter of this year, 45 closures. And in just completed third quarter, there were 41 closures. Now Sheila Baer said many times that the peak in bank failures was going to be the third quarter of 2010. So what's the holdup? Why aren't more banks being closed? Well, maybe there's nobody there to do a deal. After all, the FDIC's main deal maker, a guy named Joe Gianpietro, left suddenly in August. Gianpietro came to work at the FDIC, I really don't know I don't know why, after working at J.P. Morgan Chase and UBS, but he and his partner, Jim Wiggin, sold more than $508 billion worth of assets, including the Wall-Mu Transaction and the Corus Bank Transaction.

11:43The New York Times reported that Jim Pietro and Wiggin did good work for the government, quote, by acting like bankers, not bureaucrats. not sure there's much of a difference there but New York Times would make that distinction Now Wigand's worked for the FDIC for a couple of decades so the fresh blood in this partnership was Jean Pietro and he was the eyes and ears in the market, he advised on the biggest and most complex deals, met with bank executives, hedge fund managers, other big investors, got their feedback on deal terms and Other Agency Policies. And these two started hatching deals with companies like Rialto, which is a division of homebuilder Lennar.

12:29See big homebuilders aren't making any money now because nobody needs to buy a house. So they are now in the business of teaming up with the FDIC to buy distressed assets or loans. And in this case, Rialto bought a 40% share of $1.2 billion in loans from various failed institutions. And they bought these loans at $0.40 on the dollar. Now with the FDIC carrying the paper on $1 billion of the transaction. So it's not a bad deal, buy $1.2 billion in loans for $0.40 on the dollar and the seller The dollar of the loan carries most of the paper at 0% interest for seven years.

13:25That's a hard deal to turn down. These two also came up with an idea called the FDIC Securitization Pilot Program. Now Barron's reported that the FDIC has 37 billion of bad bank assets to sell, but the The loans could only fetch a dime to 50 cents on the dollar. But the US-guaranteed FDIC senior certificates enables the FDIC to push much of the losses off their books thanks to the US government guarantee of principal and interest. Now, these notes, if you're concerned because you're a taxpayer, don't worry. These notes are backed by loans. Those same loans that were worth a dime are 50 cents, so ultimately the losses will be absorbed by Uncle Sam, but we all know who Uncle Sam is.

14:21Now ex-FSLIC regulator William Black says the FDIC is actually selling the equivalent of Treasury bonds without congressional approval, and that the deposit insurer should be selling these bad assets, not making essentially junk bonds. and others. He says it hides the economic substance of what's really happening, an unlimited taxpayer bailout. The FDIC was called for comment and they disagree. Now next, maybe more banks aren't being closed because it's an election year. Bill Bartman, who publishes the Bartman Bank Monitor, says the FDIC isn't closing banks And what about banks any faster? Because they are waiting until after November is over.

15:14And then the other shoe is going to drop. And he says that next year there will be 500 banks closed after these midterm elections have been completed. Well, are bank failures political? Well, consider Shore Bank in Chicago. It was kept alive for months. This was a bank. Senior Obama advisor, Valerie Jarrett, served on Chicago's civic organization with one of the directors of the bank and President Obama himself had singled out the bank for praise, for lending to low-income communities. I'm not sure he said anything about whether those communities could pay the loans back, but be that as it may, ultimately the bank was seized on August 20th.

16:02Both, and it was only seized when the FDIC found a single buyer to buy this failed bank and assume the deposits. The single buyer was the Urban Partnership, includes American Express, Bank of America, Citicorp, Goldman Sachs, Wells Fargo, you get the idea, the usual cast of characters lined up to buy the politically connected shore bank. So, it is possible, oh and by the way, the management that was operating Shore Bank when it failed, will operate the new bank going forward. So it's possible that bank failures are political. Number three, maybe the number of bidders for bad banks have dried up.

16:49Maybe that's why we haven't seen more deals. The juicy deals that Jean-Pietro and Wiggin were making last year, they're all over according According to the Wall Street Journal and according to Keith Bretton Woods, acquiring banks were booking 4.5% capital gains on deals done in 2009. Now that's down to 2.5%. So frankly, it's just not as good a deal now to buy these bad banks. Investors are halting efforts to bid on these banks, saying that the economics no longer make sense. In fact, William Isaac, who used to be an FDIC chair, he recently ended his push to raise a billion dollars for bidding on failed banks in the southwest, in part because of the lower returns.

17:40Another group, a former group of Wachovia Corp executives, they had hoped to launch the Charlotte, North Carolina-based Union National Bank and it recently pulled its charter application because bank failure bargains are being tougher to find, according to a spokesman. In the current environment, our view is the FDIC existed transactions are not really attractive entry points, according to union national spokesmen. But while some are still paying up for failed banks deals, others that were able to grab bargain deals earlier, they say they're done for now.

18:25There was a tiny bank called Sun West Bank in Tustin, California, that grabbed assets of failed banks, three banks, with discounts as high as 44%. And by doing these deals, they were able to double the size of their bank, and they increased the number of employees from 68 to 140, But the chief executive says that he doesn't expect to be a bidder anytime soon, acknowledging how the pricing has changed. So the deals just aren't out there anymore for these busted banks. So maybe that's the reason that more banks aren't being seized. But finally, we come to the fourth and my final reason, or maybe the FDIC just doesn't have the money to close the banks.

19:20The FDIC Deposit Insurance Fund has spent over $19 billion this year, which is well above the $15 billion in prepaid assessments that it collected from banks for all of this year. If you remember a year ago, one way to bail out the FDIC was for them to charge their member banks assessments for deposit insurance for three years going forward. And so they did that to keep themselves afloat. Well, they've already spent $4 billion more than what they had collected for this entire year. Situations likely to get even worse than the FDIC portrays, again, according to X regulator Professor Bill Black, he says the FDIC is sitting there knowing that it has both the residential disaster and the commercial property disaster, and it knows it doesn't remotely have enough funds to pay for it.

20:19He's not surprised there aren't more failures, but he said we all should be upset by it. The industry has used its political muscle to get Congress to extort the accounting rules Board to gimmick the rules so that banks do not have to recognize their losses. Black claims that the prompt corrective action law that used to be in place when the SNL crisis occurred, that mandated closure of insolvent institutions is being ignored. And those FASB rule changes that I mentioned earlier have allowed banks to value their Your assets inflated bubble values. They have nothing to do with the real value. We've already heard that the real value of these assets is a dime or 50 cents on the dollar. So if you can value your assets at the old bubble values rather than new values, the reported bank capital is greatly inflated and even insolvent banks are reporting not only big earnings, but lots of capital.

21:28Now William Black, he wrote a book called The Best Way to Rob a Bank is to Own One, which is a very clever title, and it's about the S&L crisis. It's very expensive, by the way, on Amazon, so there couldn't be too many floating around, but it contends that the FDIC is intentionally keeping foreclosures down because it knows Because it does not have enough money to pay off depositors that are insured by the FDIC. Maybe that's why suddenly the expected losses on some of the failures in the third quarter were considerably below historic norms. The FDIC estimated that the expected loss as a percentage of assets for three banks that were seized on August 20th, and three banks were Sonoma Valley Bank, Los Padres Bank and Butte Community Bank.

22:23The FDIC assumed the losses were going to be, for these three banks, 3%, 1%, 3.5%. Now that's just a fraction of the average expected percentage loss when you compare it to other closures in 2009, which were 22%, and the closures in 2010, which were 23%. Black told Aaron Task at Yahoo Finance, this delaying in liquidating and solving banks will just, it'll make the ultimate losses grow, it's this Japanese type of strategy of hiding the losses that will result in a lost decade, somewhere in Japan, or two lost decades like they've had in Japan.

23:12So while banks are being propped up, capital is diverted from businesses and entrepreneurs. Back said, well, I said it from the beginning, Geithner and Summers were selected and promoted and the same is true for Bernanke because they are willing to be wrong and have a consistent track record of being wrong. That's useful for senior politicians but disastrous for the country. Now, the FDIC is required to maintain a deposit insurance fund, a DIF, and what that means The FDIC means to you is that you have money in the bank and they're maintaining some reserves to cover you in case the bank fails. And they're required to hold 1.25% of insured deposits.

24:02That means for every 100 bucks you have in the bank, the FDIC has to have $1.25. That should be comforting. At June 30th this year, their DIF stood at a negative $15.2 billion, standing behind $5.4 trillion in insured deposits. So not only is the DIF not 1.25%, it is a negative 0.28%. But the second quarter banking profile that the FDIC put out did put out the cheery news is that that was actually an improvement from the previous quarter where the DIF was a negative 38.38 percent.

24:56Now, Value Engines Rich Sutmeier, who is a bank analyst, he calculates that the DIF is actually currently at a negative 0.62 percent and that the FDIC is in the hole, almost $34 billion. But I don't want you to be afraid because it's early in the conference and it's Friday and I want you to be in a good mood. And so it's good that Chris Dodd and Barney Frank have taken care of everything. The Dodd-Frank Wall Street Reform and Consumer Protection Act not only made the increase in deposit insurance to $250,000 to be permanent, but it requires the FDIC to, quote, take steps necessary to attain a 1.35% reserve ratio by September 30th of 2020.

26:00So that's right, in a decade, and nothing can happen in a decade, I mean a decade will just fly by, you're going to have a dollar thirty-five standing behind every hundred bucks you have in the bank. Promise, you've got Chris and Barney's word on it. So can deposit insurance really be considered insurance? I mean, can insolvent banks hide their losses with the help of their friends in the government and at the same time have another arm of the government that is itself insolvent cover their losses and call it insurance? I mean insurable risks such as death, accidents, or health, emergencies, they're homogeneous, they're replicable, random events that can therefore be grouped into these homogeneous classes which can be predicted in large numbers, you can't predict which particular situation will happen but you can predict that there will be a certain number in a certain group over a certain period of time.

27:11But market events are inherently unique. They're heterogeneous. They're not random. They influence each other. So they're not insurable and they're not subject to the grouping into these homogeneous classes that you can measure in advance. It's for the entrepreneur to assume these uninsurable If no business firm can be insured, Murray Rothbard wrote, then an industry consisting of hundreds of insolvent firms is surely the last institution about which anyone can mention insurance with a straight face. Deposit insurance is simply a fraudulent racket, and a cruel one at that, since it may plunder are the life savings and the money stock of the entire public.

28:07Now as far as this lack of bank failures, a dearth of bank failures should be treated with suspicion, according to Murray. He wrote that, as a witness, the drop of the bank failures in the United States since the advent of the FDIC, it may indeed mean that the banks are doing better, he wrote, but at the expense of society and the economy faring much worse. So you might ask, well, so are banks lending out this money that the FDIC is insuring? Well, no, loan balances continue to fall, down $96 billion in the second quarter. But banks are loading up in one area, derivatives.

28:57If you remember those things, they're essentially side bets between two parties on the value of a particular asset or direction of interest rates or something like that. You remember that Warren Buffett called them financial weapons of mass destruction. Society Generals Jerome Kerville orchestrated the largest bank fraud in world history using derivatives, amounted to a £3.6 billion loss. Arthur Leavitt said that derivatives are something like electricity, dangerous if mishandled, but bearing the potential to do good. Well, banks have increased their collective derivative exposure from $209 trillion a year ago to $224 trillion as of June 30th.

29:50Ten years ago, banks had less than $40 trillion in derivative exposure. But I'm sure these guys know how to handle these things because they're experts. Well, 20 years ago, for the 20 years prior to 2008 were, as we all know, a boom for banks. They morphed in size to gargantuan proportions on the rickettiest capital structure the world had ever seen. The needed correction is equally huge, and the FDIC can't stop it. The government agency may be able to delay the cleansing for years, keeping themselves and their zombie banks that they regulate in business, but ultimately the deposit insurer will fail along with the banks it regulates, going the way of the FSLIC that insured savings and loan deposits.

30:47That entity was recognized as insolvent in 1986. So now we have someone, our next speaker is going to put you in a better mood, make you feel better about things, because he's going to talk about the guy in charge. And the guy in charge knows he knows everything.

31:33But our next speaker is senior fellow at the Ludwig von Mises Institute. He's the book review editor for the quarterly journal of Austrian economics. He's taught over here at Auburn University. He taught at Trinity University in Texas. For whatever reason, for whatever reason, for two years He worked in the government, I don't know what happened. He was the assistant superintendent of banking and an economic advisor to Bob James. So here's a guy who knows government, he knows economics. He's written about economics, the economics of prohibition, tariffs blockades and inflation economics of the Civil War, done some great work for the Mises Institute in terms of putting together, our Bastiat collection and the quotable Mises, graduate of St. Bonaventure University, Ph.D., right next door at Auburn University. He's also a Mises Fellow, so he grew up right here on the property. Speaking about Bernanke, please help me welcome Mark Thornton.