Tuesday, February 23, 2010

Commercial Banks Continue to Struggle

The Federal Deposit Insurance Corp. presented us with the new list of problem banks. As of December 31, 2009, there were 702 commercial banks on the problem list of the FDIC. At the end of the third quarter of last year, the total stood at 552. If 3 to 4 banks failed every week, then roughly 39 to 52 banks failed last quarter. Thus, at least 200 new names were added to the list in the fourth quarter about 36% of the number on the list at the end of the third quarter.
The rule of thumb that I have heard used on bank failures is that approximately one-third of the banks on the problem list will fail over the next 12 to 18 months. If this holds true then about 234 banks will fail during this time period, roughly an average of 3 to 4.5 banks per week!

Right now the quarterly net loan charge-off rate and the number of loans at least 3 months past due were at the highest levels ever recorded during the 26 years that these data have been collected. As I have said many times, the important thing is that these charge offs are occurring in on orderly manner. The banks seem to be able to absorb these loses without substantial disruption to their operations. Also, the closing of so many banks by the FDIC seems to be taking place in an orderly manner without substantial disruption to the banking business.

The banking system, as a whole, continues to be risk-averse at this time as banks continue to reduce the amount of loans of their books. In this the FDIC data are consistent with the call report data released by the Federal Reserve in that the total loan balances on the books of the banking system continue to decline.

The economy may be recovering but the outlook for the banking industry remains dark. Other news released this morning point to a continued dismal future. The Gallup organization released information that suggested that 20% of all workers in the United States are underemployed.
This is a larger number than put out by the labor department and is attributed to the fact that the Gallup data are not seasonally adjusted.

However, this does not seem inconsistent to me with the information, also released this morning, that consumer confidence dropped precipitously in February from a revised 56.5 to 46.0. Furthermore, consumer expectations for economic activity over the next six months fell from a revised 77.3 to 63.8. In addition, the people that are expecting more jobs in the near future fell while the proportion of those expecting fewer jobs rose. More than 17% of the respondents expected their incomes to fall over the next six months, while 9.5% expected their incomes to increase.

This is not good information to the banks as foreclosures and bankruptcies continue to increase. Furthermore, there is more and more information about people walking away from properties after allowing their loans to go delinquent, even though they might be able to pay the loans. It seems as if more people are arguing that the decision to abandon a house is a “business decision” and not a decision about whether or not to leave a “home.” If the price of the “home” is less than the mortgage, then the “home” becomes a “house” and is abandonable.

But, banks, and others, still face several other serious shortfalls in the future. The commercial real estate situation is well known and Elizabeth Warren, head of Congressional oversight on the TARP funds has claimed that 3,000 commercial banks face a potential torrent of defaults on commercial properties.

State governments continue to teeter on the fiscal edge as state tax collections declined in the fourth quarter of 2009 for the fifth quarter in a row. State governors, meeting in Washington, D. C. this last weekend, warned Washington, as well as the nation, that the fiscal year beginning in July 2010 will be the most difficult of any met so far during this financial and economic crisis.

City and municipal governments also have their backs against the wall with many of them now considering the pursuit of Chapter 9 bankruptcy. This, too, is not a good sign for the banking community.

Both the cities and the states are soliciting Washington, D. C. for more and more stimulus money cover their needs. They obviously do not see their salvation coming from the private sector. But, what about the federal government? Is there any hope here?

One answer comes from the likes of Joe Stiglitz, Paul Krugman, and others with a similar leaning: the federal government has erred on the side of not spending enough. Washington just has to spend more and more and more until jobs stabilize, incomes begin to rise, and confidence turns upward once again.

The other side? The other side is represented by Bob Barro who has another op-ed piece in the Wall Street Journal this morning. (See http://online.wsj.com/article/SB10001424052748704751304575079260144504040.html.) Barro has contended all alone that the spending and taxing multipliers used by the Obama economics team far overstates the real effect that the government fiscal stimulus program has on the economy. To quote his results: “Viewed over five years, the fiscal stimulus package is a way to get an extra $600 billion in public spending at the cost of $900 billion in private expenditures. This is a bad deal.”

Add to this the fact that the deposit insurance fund fell by $12.6 billion in the fourth quarter of 2009 to $20.9 billion; and the only proposal on the table being to assess the banking system to replenish the fund. It looks inevitable that the federal government will have to provide some sort of assistance to help keep the fund solvent. Oh, and then there is the upcoming costs related to Fannie Mae and Freddie Mac (http://online.wsj.com/article/SB10001424052748704259304575043573979877134.html?mod=WSJ_Opinion_AboveLEFTTop). But, the addition to the deficit from these outflows relates to things that have happened in the past, there is no stimulus or job creation here but some fairly sizable price tags.

None of this is good news for the banking system. Is it possible for the list of problem banks to reach 1,000? Probably not at the end of the first quarter of 2010, but maybe in the second quarter. Remember that there are only slightly more than 8,000 commercial banks in this country. Can you imagine if one out of every eight banks were on the problem list?

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