Could Your Bank Fail?

by Bill Sardi by Bill Sardi

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My wife and I took my 4-year-old son to a children’s theater this weekend to watch a live presentation of Robin Hood (rob from the rich, give to the poor). The mother of one of my young son’s playmates said she is ready to go on a long-planned vacation. I asked where she does her banking. Her answer: Downey Savings and Washington Mutual (WAMU).

Good God, Downey savings is at the top of the list of banks predicted to fold and Washington Mutual is burdened with the prospect that many of its customers with adjustable rate mortgages, which will be re-set in the coming months, won’t be able to make their monthly mortgage payments. Most of my friends and acquaintances are oblivious to what is going on in America.

Re-setting of adjustable rate mortgages triggers the collapse

What IS going on is approximately 600 billion dollars’ worth of subprime adjustable rate mortgages (ARMs) will go through rate-resetting between now and the end of 2008. About 15% of these ARMs are predicted to default, representing $75 billion of mortgages that banks will have as non-performing loans on their books, which will be reflected in their quarterly earnings reports. The stock price of these banks will then tumble and depositors will run to withdraw their funds from checking and savings accounts. Since most banks have no more than 10% of their depositors’ funds in cash (the rest has been loaned out), even a small run on the bank could leave a bank with no cash.

When the FDIC becomes insolvent, now what?

So what happens if nearly every bank in America is calling on the Federal Deposit Insurance Company (FDIC) to bail them out at the same time?

The FDIC, which insures your bank deposits, sees the handwriting on the wall. It doesn’t have enough funds ($52.8 billion) in reserve to cover trillions of dollars in bank deposits. According to Wikipedia, as of June 2008 the FDIC insures 8471 banking institutions with total deposits of $8.575 trillion (March 31, 2008 deposit figures).

The IndyMac bank failure will swallow up $4—8 billion of the FDIC’s treasure chest and there are 300 other banks at risk of failure that represent another $26.8 billion of deposits the FDIC has to ensure. The failure of a large bank, like WAMU ($160 billion in deposits, with only $15 billion in cash reserves), would totally deplete the FDIC insurance fund by itself.

Sheila Bair, FDIC chairwoman, trying to head off an unprecedented banking disaster, is calling for banks to take all homes covered in ARMS right now and freeze the rates/and or convert them to a fixed rate product.

Bank implosion not impossible

Martin Hutchinson, writing in the Asia Times, says "It is thus not impossible for the entire US banking system to implode." (The Bear’s Lair, July 16, 2008)

Hutchinson also points out that Fannie Mae and Freddie Mac, the two institutions that are supposed to guarantee home mortgages, require a bailout that prompted the Federal Reserve chairman to offer them a temporary lifeline — access to the discount window at the Fed, which supplies the nation with money.

Freddie Mac seeks $5.5 billion of outside capital, but who would put money into this sinking ship? The American public is being asked to provide $100 billion to bail out Freddie and Fannie, which means you as a citizen are now bailing out other people’s bad loans!

The life ring thrown to Freddie and Fannie by the Federal Reserve is only temporary. Congress must now vote on proposed legislation that would throw the burden of this whole mess upon the taxpayers. Recognize Freddie and Fannie own or guarantee nearly half of the nation’s $12 trillion in mortgages. A bigger crisis lies ahead, say the experts. Freddie and Fannie will be back in the headlines later this year. This means a giant implosion is only being delayed.

Why should taxpayers bail out Freddie and Fannie?

Hutchinson says "There can be no economic justification for the government guaranteeing the great majority of the nation’s home mortgages, and the spurious u2018government-sponsored enterprise’ structure of Fannie and Freddie merely hides the likely consequences of their default."

Hutchinson goes on to say: "Fannie and Freddie do not represent the entire US finance sector, far from it. Nevertheless their insolvency would further erode confidence in the rest of the sector, very likely leading to a cascade of death spirals among other institutions. After all, the best-run large non-global US bank, Wachovia, has itself got in trouble by its insanely foolish acquisition of the California mortgage lender Golden West Financial at the peak of the market in 2006, while Bank of America, the largest retail-oriented US bank, voluntarily took on more of the mess by its purchase of the diseased and probably criminal Countrywide Financial as recently as last January."

Says Hutchinson: "Thus a total collapse of the US financial system, while not inevitable, is a contingency which should now be planned for."

Liar’s loans to be banned, but not soon

The Federal Reserve has a belated answer for all this. It has put its foot down and will invoke a rule banning subprime "liar’s loans" — those loans where loan institutions overlooked the ability of borrowers to repay, and borrowers simply wrote down unconfirmed income numbers on their loan applications (sometimes the lender’s just scratched these number in themselves). Well, that’s a long-needed fix, but for unexplained reasons the Fed won’t put it into effect till October 1, 2009. (Fed Prohibits subprime u2018liar’s loans’, Holden Lewis, Bankrate.com)

News media and bank insolvency

Harry Koza, senior Canadian markets analyst at Thomson Financial, says the IndyMac bank failure has "barely got any news coverage outside of California papers." (IndyMac bank run: a sign of things to come? Globe and Mail, July 18, 2008) Is the news media intentionally blacking out the IndyMac bank failure to areas outside of California?

It is obvious that any censorship is an attempt to calm the public from running to pull their money out of their accounts.

Oh, the news media has broken ranks to publish what is called "The Texas ratio," which is a measure that fairly accurately predicts whether a bank will fail. The "Texas ratio," coined from a tool used to predict bank failures in Texas banks in the 1980s, is calculated by dividing the value of a lender’s non-performing leans by the sum of its tangible equity capital and loan loss reserves.

A few smaller banks made it on this list in what appears to be an effort to wipe out the small banks while the larger banks grab market share. What’s the Texas ratio for large banks like Wachovia, WAMU, etc?

IndyMac Bancorp Inc argued its "Texas ratio" had been unfairly calculated (it was around 140%, anything over 100 is a predictable collapse of the bank). So the Texas Ratio accurately predicted the IndyMac collapse.

Using data gleaned from Wachovia’s Quarterly SEC 10-Q filing, ending March 2008, shows a Texas Ratio of 78%, which is down from 84% last quarter, but these are dated figures now, and their loan loss reserves declined, and most of their ARM loans are now being readjusted upwards, so anticipate many non-performing mortgage loans at Wachovia.

Nobody has uttered a word about this, but if the prospect of insolvency is pointed at smaller banks, and leaks of such information prompts the public to run and demand withdrawal of their funds from these institutions, the depositors will likely take their money and open accounts at bigger and seemingly safer banks. The FDIC has sufficient funds (~$53 billion) to cover the deposits at these small banks should they become insolvent, and this would infuse billions into the banking giants.

This appears to be what is happening by the leak of a list of smaller local and regional banks at the top of the "Texas Ratio" list and the indiscretion by Senator Charles Schumer (NY), member of the Senate Banking Committee, who publicly disclosed to the news press a letter he wrote to regulators about the financial status of IndyMac Bancorp, which resulted in a run on that bank’s deposits.

Restricting bank withdrawals

The banking industry is walking on pins and needles, hoping the bad news doesn’t become a self-fulfilling prophecy that drives bank depositors to demand withdrawal of funds en masse. Try to withdraw $10,000 from your bank today and you are likely to be told you can only withdraw $5000 at a time.

The banks know. The news media knows. The FDIC knows. The Federal Reserve knows. But DO YOU know? There is a high likelihood the American banking system will fail, and you will likely be the last to know. The more panicked you get, and withdraw funds, the worse the implosion. In an effort to avert runs on the banks, will the news media delay informing the public of the current dire situation, which appears to be an inevitable system-wide banking collapse?

What to do?

So, while your bank still has money and can process your checks, it may be time to pay down debts, pay quarterly taxes and mortgage payments in advance, and think of having money outside of banks (gold, foreign currencies), etc., before your money is inaccessible or even evaporates!

Don’t think all your investments outside of banks are immune from all this turmoil. For example, money market mutual funds, where Americans have invested $3 trillion, are not covered by FDIC insurance (however, money market accounts offered by banks are covered). Recent losses in some of these money market mutual funds have caused some companies to rush to plug the losses. For example, Legg Mason Inc. and SunTrust Banks Inc., recently pumped $1.4 billion each into its money market funds. Bank of America Corp. has injected $600 million.

As for your checking and savings accounts, recognize you may have five different accounts in the same bank, but the FDIC only insures individuals, not each account, up to $100,000. Putting your money in different accounts in the same bank does not necessarily provide better insurance for your deposits.

Kathy M. Kristof of the Los Angeles Times offers a simplified explanation of what the FDIC does cover: "Knowing your insurance limits on bank accounts is key," Los Angeles Times, July 20, 2008.

Finding a bank

There are bankers today who know their institutions are doomed to fail soon. They will issue misleading press releases and put a positive spin on their financial status in a futile attempt to stave off a run on the bank by depositors for a time. Which financial institutions will fail first? “The only way to find out is for investors to push every institution toward failure and see which ones keep operating,” says Joseph R. Mason, a financial economist at Louisiana State University in Baton Rouge. (Investors are pushing institutions to the limits to assess risk. Peter G. Gosselin, Los Angeles Times, July 20, 2008)

Ideally, find a bank that does not have any adjustable rate mortgages on its books, like Union Bank of California (in the top 25 U.S. banks, has over 334 branches in California, Oregon and Washington).

Recognize, when you deposit money in a bank you agree to allow the bank to use most of it to loan to others and only keep 10% of your money on hand for withdrawal. Banks operate on the supposition depositors won’t all need their accounts turned into cash withdrawals at the same time.

Will we ever address the underlying cause?

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