The Banking Crisis Is Far From Over Revisited – FDIC Troubles and Bank Shenanigans

In August of 2009 I wrote an article The Banking Crisis is Far From Over where I concluded banks were still threatened by bad assets, forced to pay higher premiums to the FDIC, and market to market accounting was at the center of a heated debate.

When I wrote that article, 77 banks had failed and by the end of 2009, just 4 months later, the number of failed banks had almost doubled to 140.  22 banks have failed thus far in 2010.

Is the FDIC Solvent Enough To Keep Up This Bank Rescue Pace?

The FDIC solution to shore up their funds was to have the banks themselves pony up three years of dues in advance rather than the “pay as you go” funding.  This was to add $45 billion to the fund, yet by November of 2009, the FDIC fund was in the red for the first time since 1992.

Today, the fund sits at negative 20.9 billion with no help in sight.

With these kinds of numbers, does it really matter whether the FDIC insurance limit was raised from $100,000 to $250,000 when the Fund itself is insolvent?  I have an idea….why don’t they raise the FDIC insurance limit to $1 Million?  That will solve all the problems right?  Do you see how absurd this FDIC insurance limit number is?

The Problems for Banks Don’t End With the FDIC Insolvency

With the first bailout proposed by the Bush administration with the blessing by both Republicans and Democrats voting for it, the banks and Paulson were screaming that if we didn’t get this funding the whole system would collapse.  So the Toxic Asset Relief Program (TARP) was passed by Congress and the banks started to receive their funds and remove their “toxic” assets from their balance sheets.

Except that’s not what the banks did with the tax payer money they received.

Instead of removing the toxic assets, the banks shored up their own balance sheets.  Banks at that time were in a dire need for cash.  Without cash, they couldn’t fund their operations.

Banks Were In Dire Need of Cash

How do I know this?  I was in my branch of Washington Mutual when they had their problems and were in the process of being purchased by Chase Bank.  While there I overheard one of the bank tellers soliciting funds from clients.  They were offering a CD that was paying 6%.   I asked the bank teller in front of me, “how can you offer 6% to clients when short, medium and long term treasuries aren’t even paying more than 4.5%?  Naturally she didn’t have an answer for me.

The fact that Washington Mutual was offering to pay 6% to clients told me they were hard up for cash and would pay “out of market rates” to acquire more funds.  They were indeed cash strapped.

Banks Not Lending and Not Offering A Good Return To Investors

This offer of higher returns subsided but at the same times banks were still calling for more bailouts from government and talk of a second stimulus package surfaced.  But with the Republicans now finding their fiscally conservative roots since losing the 2008 election, they couldn’t be caught voting for any further bailouts of the banks and expect to win congress back, despite the fact that both sides of the Congressional isle have no problem continually voting an increase in the debt limit.  They have to keep their spending ways alive right?  That’s what Congress does for a living.  Spend…and pass a few laws to benefit lobbied special interests.

But what hurt the banks was the fact they now had to mark to market their toxic assets leaving them with a troubling situation, one that continues today and won’t end pretty.

Proof that Banks Are Still in Deep Trouble

Mark to Market of assets is simply taking an asset and valuing it at today’s selling price, the “market price that someone would buy the asset for today.”

If the house next door to yours sold for $500,000 in 2006, but this year sold for $300,000, then the value of most other homes in your neighborhood, barring short sales and foreclosures, would have fallen by $200,000.

This is what we have seen occur over and over throughout the nation and because of this steep decline in the price of real estate, many folks are underwater with their mortgage to the bank.  In other words, the loan or mortgage with the bank is higher than the value of their home.

Adding Fuel to the Fire

If we add on the fact that many people have lost their job, the problems for banks escalate as the main bread winner may no longer be able to afford the mortgage payment to the bank   (keep in mind approximately 10% of the nation is currently unemployed, but this number is actually much higher as the current unemployment reports no longer count those who have been out of work past a certain length of time).

While homeowners struggle with the reality they are paying on a loan worth more than their house and the family bread winner is no longer employed, they are forced with the fact they have to stop paying their mortgage.

The Wall Street Journal Would Have You Just Walk Away From Your House

This is where it gets interesting.

The Wall Street Journal recommends you just walk away from your home.

In the old days when banks no longer received their mortgage payments from the homeowner, after a contractual time-frame had passed, foreclosure occurred and the bank had the Sheriff put locks on the foreclosed home as the bank took it back.

But that’s not occurring today…

While we’re seeing foreclosures occurring today at a higher rate, banks are doing something today that doesn’t seem to be getting much attention.  People have stopped paying their mortgages and the banks aren’t foreclosing on many of them.

Why Aren’t Banks Foreclosing on People Who Aren’t Paying Their Mortgages?

Many folks are trying to do short sales in getting out of their property and the mortgage they took out which is now valued more than the real estate itself.  Of course, with a short sale, the buyer of the property has to come to some sort of agreement with the lender (bank).  The problem is, the lender is not agreeing to the lower prices offered by the buyer.  Why?  Because the bank would have to mark to market that asset at a lower price and this in turn would/could cause the bank to need more cash to make sure their balance sheets are in line with Federal minimum requirements.

If that 2006 $500,000 home is worth $300,000 today, a 40% decrease, the bank that has the house listed as an asset of $500,000 would all of a sudden have to be decreased by $200,000.  Their balance sheets can’t afford that steep of a decline in valuation, so they don’t foreclose.

What escalates the problem for banks is they work on a fractional reserve basis where they loan out 9 times the money they take in.  Multiply this $200,000 number by a few more mortgages and you can readily see the banks balance sheet would soon be in the red if they foreclosed on these homes and the FDIC would be knocking on their door soon after.

Banks Are Letting Non-Mortgage Paying Homeowners Live In Their House for Free

There are numerous people I know of that are living in the homes they bought and are underwater with their mortgage being worth more than their home.  They haven’t paid their mortgage in some cases for over a year.

Does anyone wonder how the homeowner can get away with this? Why aren’t they being kicked to the curb by the banks foreclosure unit?

The answer based on my research is simply that the bank cannot afford to mark that depreciated asset at current market prices for they risk falling under the threshold where the FDIC draws the line of solvency resulting in a take over of operations and the search for a more solvent bank to take them over.

This is a problem that is being played out over and over and its just going to get worse once the government stimulus for first time home buyers runs out April 30th.

Any government stimulus program is just a temporary fix and does nothing to resolve the underlying problem. Unfortunately, that’s all our government knows how to do.

Is the Banking Crisis Far From Over?

I asked in my last article the question that I’ll ask again; “Is the banking crisis far from over?”  Based on the above analysis, what do you think?

Is their an additional stimulus that can help the banks “toxic” assets?  Do banks deserve being bailed out?  How long can this government continue the charade that “all is well?”

All is not well….and this banking crisis is far from over, especially with the FDIC losing a grip on things.  But hey…maybe they’ll raise that FDIC coverage to $1 Million and we can go about life feeling more secure!  Business as usual!  Sure….and maybe the Cubs will win the World Series this year…

Unlike us always faithful Cubs fans, maybe Americans better wake up and plan for the troubles ahead and not put so much faith in the banking system or the FDIC.