Insolvency!

from paul.kedrosky.com


October 23, 2008
The Bank Capital Mirage
The following more or less supports what some have been saying for a while -– that major banks in the U.S. and the U.K. will end up being entirely nationalized before this crisis is over –- but it's still a striking way of looking at the data. The gist: Government recapitalization and other fund-raising has largely been in service of banks' prior subprime losses, while corporate and consumer loans are just starting to hit bank balance sheets. It won't take much to tip banks over into insolvency again.









[via Bloomberg]


Also from ftalphaville.ft.com


This is a singularly arresting chart (same as the one posted above):
It’s Bloomberg’s chart of the day and has been reproduced by Paul Kedrosky on his blog, Infectious Greed.







Kedrosky writes:
The following more or less supports what some have been saying for a while — that major banks in the U.S. and the U.K. will end up being entirely nationalized before this crisis is over — but it’s still a striking way of looking at the data. The gist: Government recapitalization and other fund-raising has largely been in service of banks’ prior subprime losses, while corporate and consumer loans are just starting to hit bank balance sheets. It won’t take much to tip banks over into insolvency again.


This is frightening stuff. Not least because the Fed’s own balance sheet is not looking healthy. Via Brad Setser at the CFR, here’s Paul Swartz’s latest graph:






The balance sheet is likely to grow further too. Jan Hatzius, Goldman’s chief economist has pointed out that during the Japanese credit crisis of the 1990s, the Bank of Japan ended up with a balance sheet equivalent to 30 per cent of GDP. The Fed’s is currently 12 per cent. And on Wednesday the Fed made this announcement:


The Federal Reserve Board on Wednesday announced that it will alter the formula used to determine the interest rate paid to depository institutions on excess balances.
Previously, the rate on excess balances had been set as the lowest federal funds rate target established by the Federal Open Market Committee (FOMC) in effect during the reserve maintenance period minus 75 basis points. Under the new formula, the rate on excess balances will be set equal to the lowest FOMC target rate in effect during the reserve maintenance period less 35 basis points. This change will become effective for the maintenance periods beginning Thursday, October 23.


Which is an admission, basically, that the Fed lost control of the Federal Funds Rate. And if that needed proving, take a look at the graph from the New York Fed:

Lastly a nice picture courtesy of http://www.ridingthedax.com/

http://www.ridingthedax.com/2008/10/23/bubble-banks-revisited/

I have been harping for a while about insolvency issues. Looks like many others are catching on. The is one of the first issues that needs to be tackled. Unfortunately President Bush has made it clear that Nationalization wont happen on his watch. Volcker mentioned that banks have been "effectively" nationalized either overtly or through other lines by the Fed. But this is lack of clarity as many of these banks have market capitalizations well in excess of their balance sheet worthiness. What we vitally need right now is clarity (read the end of the insolvency issues) and then an INTELLIGENT strategy to combat the simultaneous develeraging of both banking and consumer levels -(regulating derivatives, debt restructuring of consumers, creation more jobs in the creation of tangible goods in the US, simultaneous creation of incentives for savings and increasing money velocity) etc.

China Banks say NO! to US Banks

China banks told to halt lending to US banks-SCMP
Wed Sep 24, 2008 9:52pm EDT

BEIJING, Sept 25 (Reuters) - Chinese regulators have told domestic banks to stop interbank lending to U.S. financial institutions to prevent possible losses during the financial crisis, the South China Morning Post reported on Thursday.

The Hong Kong newspaper cited unidentified industry sources as saying the instruction from the China Banking Regulatory Commission (CBRC) applied to interbank lending of all currencies to U.S. banks but not to banks from other countries.

"The decree appears to be Beijing's first attempt to erect defences against the deepening U.S. financial meltdown after the mainland's major lenders reported billions of U.S. dollars in exposure to the credit crisis," the SCMP said.
A spokesman for the CBRC had no immediate comment. (Reporting by Alan Wheatley and Langi Chiang; editing by Ken Wills)

© Thomson Reuters 2008. All rights reserved. Users may download and print extracts of content from this website for their own personal and non-commercial use only. Republication or redistribution of Thomson Reuters content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Reuters. Thomson Reuters and its logo are registered trademarks or trademarks of the Thomson Reuters group of companies around the world.
Thomson Reuters journalists are subject to an Editorial Handbook which requires fair presentation and disclosure of relevant interests.

Failed Bank Specialist JC Flowers starts moving in

Flowers, LBO Investor, Approved to Buy Missouri Bank (Update1)
By Jonathan Keehner and Jason Kelly

Sept. 23 (Bloomberg) -- J. Christopher Flowers, founder of private-equity firm J.C. Flowers & Co., was approved by U.S. regulators to acquire the First National Bank of Cainesville in Missouri, a move that may allow him to buy other lenders.

The U.S. Office of the Comptroller of the Currency cleared the purchase by Flowers personally on Aug. 27, according to a public filing by the regulator. He may use the bank, which has assets of about $14 million, as a platform to buy failed institutions, according to a person close to Flowers, who asked not to be identified because the plans are private.

Flowers's deal comes as private-equity investors press the Federal Reserve to loosen regulations that limit their ability to invest in and influence management of banks. The Fed yesterday released revised guidelines for minority investments in banks, and New York-based J.C. Flowers & Co. is among the firms seeking controlling stakes to profit from the U.S. financial crisis.

``Their competitive advantage is to team up with experts in the industry and really make changes in the business,'' said Robert Kennedy, a partner with the law firm Jones Day in New York. ``That's the piece of financial-institution investing that's been unavailable.''

While buyout firms want the flexibility to buy controlling investments in banks, they are wary of becoming a bank holding company. That status would trigger restrictions on non-banking activities and the amount of debt they can take on. To avoid that classification, some individuals from private-equity firms have considered acquiring banks.

Small Bank
Such was the case with Flowers's Missouri deal, which may be a template for other transactions. First National Bank of Cainesville was the 17th smallest bank in Missouri, by deposits, of the 397 listed on the Web site of the Federal Deposit Insurance Corp. as of June 2007.

``An individual cannot be a bank holding company,'' said Mark Tenhundfeld, director of regulatory policy at the American Bankers Association, a Washington-based trade association, who was unaware of any other major private-equity firm head having bought a bank. ``If the OCC approves a change in bank control proposal by an individual, then that person may avoid bank holding-company regulations.''

An individual may also be able to co-invest with private- equity funds and still avoid bank holding-company classification if those funds take a noncontrolling stake in the bank, according to Tenhundfeld.

Model Deal
The revised Fed guidelines raised the threshold for such stakes to 33 percent from 25 percent.
Flowers, a former Goldman Sachs Group Inc. investment banker, may expand the First National Bank of Cainesville ``by means of internal growth or through the acquisition of troubled or failed depository institutions,'' according to the OCC's filing. Other businesses in Cainsville, a community of 400 in northern Missouri near the Iowa border, include A Thyme to Sow Herb Farm and the Wing Tip Hunting Preserve, according to the town's Web site.

``I don't see why this move by Flowers couldn't be repeated,'' said the ABA's Tenhundfeld. ``This could be a model for private-equity firms looking to acquire banks.''

J.C. Flowers & Co. spokesman Edward Grebow declined to comment. The private-equity firm has led minority investments in banks including buying a 23 percent stake in Japan's Shinsei Bank Ltd. and a 24 percent stake in Hypo Real Estate Holding AG, Germany's second-biggest commercial property lender.

Silo Approach
J.C. Flowers & Co. has also invested in non-banking companies, such as derivatives broker MF Global Ltd.

Making controlling investments plays more directly into private-equity firms' main business model -- using cash and borrowed money to buy troubled companies, fix them and sell them for a profit. Minority investments by buyout firms in Washington Mutual Inc. and National City Corp. have plummeted in value amid the ongoing U.S. financial crisis.

The Fed has explored ways for private-equity to take control of struggling U.S. banks, in addition to yesterday's guidance that loosens some restrictions on non-controlling stakes.
Such minority stakes don't ``allow them to do the things they like to do, which is to take over improve operations,'' said Jones Day's Kennedy. ``They're not typically passive investors.''

With the turbulent state of the banking industry, private- equity firms are more likely interested in controlling banks, such as through a ``silo'' structure that would be walled off from other investments in an attempt to keep Federal oversight of banking companies from their other holdings.

In the silo concept, a fund is specifically designated to own a bank and nothing else. That isolates the investment from other funds, and other companies, under the private-equity firm's control.
To contact the reporter on this story: Jonathan Keehner in New York jkeehner@bloomberg.net; Jason Kelly in New York at jkelly14@bloomberg.net. Last Updated: September 23, 2008 18:03 EDT

Calculated Risk on the Bailout

from calculatedrisk.blogspot.com

Friday, September 19, 2008
The Price of the Bailout
by CalculatedRisk

Secretary Paulson said: "We're talking hundreds of billions."The NY Times DealBook has other estimates: Putting a Price Tag on a Government Bailout

“It’s probably $500 [billion] to a trillion dollars, and that’s going to visit the taxpayers sooner or later,” [Sen. Richard Shelby] said. “It’s either going to be a debt charged to all of us or to all our children.”...Bloomberg News ... reported that the government is considering establishing an $800 billion fund to purchase so-called failed assets and a separate $400 billion pool at the Federal Deposit Insurance Corporation to insure investors in money-market funds.

However buying the assets isn't enough. These asset sales will lead to substantial write-downs, and that will reduce the regulatory capital at the banks. So how do the banks recapitalize?The hope is that by making the assets transparent, and selling off the toxic waste, that will rebuild confidence with investors. Maybe.

But the U.S. Government might also have to help recapitalize the banks to keep them lending (like the Reconstruction Finance Corporation (RFC) did during the Depression). Either way, it appears the current shareholders face massive dilution.

Also - as an aside - when the banks make their assets transparent (should be a requirement for participation), we will discover if any executives misrepresented their assets and filed false reports with the SEC. That could be prosecuted under Sarbanes-Oxley, and perhaps a few executives spending time in jail might help with the moral hazard issues.

I am not sure I would want to be a long term shareholder of some Financial firms with large Tier 3 assets.

Bigger Banks might fail

from www.reuters.com

Bigger U.S. bank failures may be coming - FDIC
Thu Jun 5, 2008 11:08am EDT
(Adds comments on FDIC planning to issue guidance, Basel II)
By John Poirier
WASHINGTON, June 5 (Reuters) - Future U.S. bank failures linked to the downturn in the real estate market may include "institutions of greater size" than in the recent past, Federal Deposit Insurance Corp Chairman Sheila Bair said on Thursday.
An increasing number of banks face high exposure to deteriorating conditions in commercial real estate and construction lending, Bair told a Senate Banking Committee hearing on the state of the banking industry.
"There is also the possibility that future failures could include institutions of greater size than we have seen in the recent past," Bair said. "Uncertainties in today's economic environment continue to pose significant challenges for the banking industry, households, and bank regulators."
So far this year, four small U.S. banks with deposits insured by the FDIC have failed, up from three in 2007. The agency last week boosted its list of troubled banks to 90, which have a combined $26 billion in assets.
The FDIC, which has about $52.8 billion in its deposit insurance fund in the event of bank failures, has launched a review of its risk-assessment rates for larger banks to determine if they reflect current conditions, Bair said.
"The agency plans to examine, among other issues, whether changes in how long-term debt issuer ratings are used to determine premium rates can improve the assessment system's effectiveness in capturing risks posed by large institutions," she said.
The FDIC is also focusing on banks' liquidity risk management and investments in structured credit products.
"The FDIC expects to issue guidance to the institutions we supervise on liquidity risk and issues related to investments in structured credit products," Bair said. "Market stress over the past year made shortcomings evident in some institutions' risk management of these areas, and our guidance will address specific areas where risk management efforts should be improved."
Additionally, the FDIC is preparing guidance for banks that rely on third parties such as loan originators and mortgage brokers. The guidance will include due diligence in selecting a third party, contract structuring, and compensation arrangements to avoid encouraging third parties into steering customers to higher cost products, she said.
The FDIC chief also indicated regulators were open to the idea of allowing the biggest U.S. banks to use a simpler set of capital adequacy rules designed for smaller banks under the so-called Basel II international banking framework. The proposed rules for smaller U.S. banks, known as the "standardized approach," were submitted to the White House in April for review.
"The standardized approach introduces a more risk sensitive approach for residential mortgages that bases the capital charges on first and second liens on loan to value measures, and also better captures the risks on negative amortization loans," Bair said.
Previously, the biggest U.S. banks had been expected to use an "advanced approach" requiring complex computer models to understand their credit, operational and market risks.
The Swiss-based Basel committee for international bank supervision, which has been monitoring the deteriorating conditions at big global banks, is also "very close" to updating its practices for liqudity risk management and releasing them for public comment, she said. (Reporting by John Poirier; Editing by Chizu Nomiyama)
© Thomson Reuters 2008. All rights reserved. Users may download and print extracts of content from this website for their own personal and non-commercial use only. Republication or redistribution of Thomson Reuters content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Reuters. Thomson Reuters and its logo are registered trademarks or trademarks of the Thomson Reuters group of companies around the world. Thomson Reuters journalists are subject to an Editorial Handbook which requires fair presentation and disclosure of relevant interests.
Reuters journalists are subject to the Reuters Editorial Handbook which requires fair presentation and disclosure of relevant interests.

This is the first official indication that Large Banks might fail. The question then is how large is large?

Jamie Dimon on the Consumer Recession

Long slump may follow crunch: JPMorgan CEO
Mon May 12, 2008 2:37pm EDT

By Joseph A. Giannone
NEW YORK (Reuters) - JPMorgan Chase & Co (JPM.N: Quote, Profile, Research) Chairman and Chief Executive Jamie Dimon on Monday told bank investors that while the current credit market crunch may soon be over, the U.S. economy could still face a deep and extended recession.
The slump in mortgage and corporate loan markets could bottom out this year, said Dimon, whose bank largely side-stepped the losses and mark-downs that have hobbled rivals during the past year.
Yet the economy may face a longer-term challenge even as financial markets begin to function again, the "slower burn" of a recession that may rival the severity of the 1982 contraction, he said.
These challenging conditions, marked by tighter bank credit, new rounds of mark-downs, further capital infusions and asset sales by banks, could last through next year and into 2010, he said.
If that happens, Dimon warned that New York-based JPMorgan and its national consumer lending businesses would suffer some significant losses, such as home equity losses doubling to $900 million by year-end.
Dimon further warned that the bank would have to continue boosting loan-loss reserves if economic conditions deteriorate, further eating into profit.
In the current quarter, Dimon said subprime mortgage losses could rise to between $200 million and $250 million, with prime mortgages generating about $100 million in losses.
Loss rates in JPMorgan Chase's massive credit card business are expected to reach 5 percent in the second quarter and rise to as high as 6 percent next year, while at the same time interest and fee revenue decline.
The third-largest U.S. bank also expects to write down "several-hundred-million" dollars of auction rate securities, he said.
(Editing by Braden Reddall)