The good news is that the FDIC payments to those organizations and institutions buying failed banks during the present crisis are smaller than the regulatory officials anticipated. The FDIC has paid out $8.89 billion to “cover losses” at 165 banking institutions that have failed during the recent financial crisis. (See Wall Street Journal article: http://professional.wsj.com/article/SB10001424052748704396504576204752754667840.html?mod=ITP_moneyandinvesting_0&mg=reno-wsj.)
The reason for this good news, I believe, is the monetary policy followed by the Federal Reserve over the past three years, now captured in the quaint symbol QE2. Excess reserves pumped into the banking system by the Fed now total around $1.3 trillion.
I have argued for at least a year-and-a-half now, that the Federal Reserve is pumping all these reserves into the banking system to help the FDIC close banks in an orderly manner. The basic premise is that if the Fed can provide sufficient “liquidity” to the financial markets in order to maintain the value of financial assets it wil give the FDIC breathing room to close banks as rapidly as they can without causing major disruptions to the many other troubled banks in the system.
The Federal Reserve has argued that it has pumped all these reserves into the banking system to help stimulate the economy. The economic recovery has almost reached its two-year anniversary, although there is general dissatisfaction with the speed of the recovery, and looks likely to extend beyond this milestone.
However, the recovery seems to have taken place without the Fed’s help except for the argument that there have not been further disruptions to the recovery due to major cumulative banking failures. Certainly, one cannot argue that the Fed’s actions have provided banks with the incentives to increase their lending activity for they have not. Commercial banks are still sitting on the money.
This is exactly my point! The policy of the Federal Reserve has been to support the FDIC and allow the FDIC to close insolvent banks in an orderly manner.
Thus, the monetary policy followed by the Federal Reserve over the past three years has succeeded.
Added evidence that the policy of the Federal Reserve has been successful is that reported above: the FDIC payments to those acquiring banks have been “smaller than FDIC officials anticipated.” Without the market liquidity, results would have been much worse.
The Wall Street Journal even reports: “Some executives at U. S. banks that bought failed institutions using the FDIC lifeline agreed that losses on the troubled loans aren’t piling up as high or as fast as they previously anticipated.”
The bad news?
“FDIC officials expect to make an additional $21.5 billion in payments from 2011 to 2014. More than half of that total is predicted for this year, followed by an estimated $6 billion in loss-share reimbursements in 2012, according to the agency.”
According to my calculations, $21.5 billion is almost two-and-one-half times the $8.89 billion the FDIC has already paid out during this cycle of bank failures!
This would bring the total of FDIC payments up to more than $30 billion!
It also seems to mean that we have a lot of bank failures that still have to be resolved!
The banking system now has less than 8,000 banks in it. Over the past year or so, I have argued that this number will drop to less than 4,000 by 2015.
I see nothing inconsistent between my forecast about the number of banks that will be in the banking system and the estimates made by the FDIC, itself, concerning the amount of payments it will need to make to those that acquire banks to cover loan losses.
Bottom line: there are still a massive amount of bad loans that still reside on the balance sheets of commercial banks!
Consequently, there are still a lot of commercial banks that need to be closed!
And, what does this mean for the Fed and QE2? The Fed claimed on Tuesday that the economic recovery is picking up. However, QE2 will need to continue, as planned, through June. Also, the Fed will maintain its interest rate targets at current levels for “an extended period”. NO CHANGE IN MONETARY POLICY!
If I am correct the Fed will only change its monetary policy when it…and the FDIC…believe that problems connected with bank closings have receded sufficiently so that more normal operations can be resumed.
Since the Fed…and the FDIC…have never claimed that the excessively loose monetary policy over the past few years has been to assist the regulatory closing of commercial banks, any statements about changing policy will not be worded in a way that ties the policy with the closing of banks.
Maybe it has been just as well for us…that we have not really known how bad off the banking system has been. But, so much for openness and transparency.
Showing posts with label loan losses. Show all posts
Showing posts with label loan losses. Show all posts
Thursday, March 17, 2011
Wednesday, January 6, 2010
Housing and Banking
One of the most disturbing statistics around these days is the status of home owners. The New York Times reported yesterday that it is estimated that one-third of homeowners with a mortgage, or 16 million people, owe more than their homes are worth. Any further drop in home prices, of course, would just enlarge that figure and exacerbate the problem.
This, to me, raises additional concern about the banking industry. My guess is that banks, and other financial institutions, haven’t taken this potential write down onto their balance sheets. For one, they don’t know which individuals in the 16 million are going to default on their mortgage and they don’t know when that is going to happen.
This is, of course, a very important reason for banks not to lend at this time. They are uncertain as to the real condition of their own balance sheets.
The forecast is for a new flood of foreclosed homes to hit the market later this winter and spring.
It has been argued that the best way to assist troubled borrowers is not through reducing the interest rate that has to be paid on the mortgage but by reducing the balance of the mortgage. But, this would mean that in reducing the balance on the mortgages of troubled borrowers, the banks would have to take the loss immediately, something they may not have reserved for, given the fact that they don’t know exactly who is going to need assistance. Many of the plans require the borrower to come in for assistance.
This, however, would reduce the capital that the bank has and threaten the existence of the bank.
And, how many banks are already on the problem bank list of the FDIC? At the end of the third quarter of 2009 the number was 552.
What might be the strategy of the banks?
Well, if banks amend the mortgage agreement to include a lower interest rate they do not have to recognize any loss on the loan at the present time.
But, analysts have said, this just postpones the problem and, in all likelihood, the borrowers will still not be able to pay back their mortgage and so this just slows down the recognition of the failure of the loan.
Right! That is the point!
Banks gain something by adjusting loan rates. They lose by granting principal reductions. By adjusting loan rates, they don’t have to take a charge-off right now. If they grant principal reductions they do have to take the charge-off right now.
Bankers are always more willing to postpone taking charge-offs in the hopes of the environment improving. At least that was my experience in doing bank turnarounds.
Furthermore, the location of the problem we are discussing is in the small- and medium-sized banks in this country.
The big banks, they are running away with huge profits gained from the excessively low interest rates (thank you Fed!) and the large trading profits made in bond and foreign exchange markets. This is not their problem, now.
Also, these small- and medium-sized banks face additional problems down the road in commercial real estate, car loans, and other extensions of credit made during the credit inflation of the 2000s.
It seems to me that Main Street is still not “out-of-the-woods” and that 2010 may be the time when the Main Street “shake-out” really occurs. I hope not, but we need to be aware of this possibility.
The total of 552 troubled banks is really disconcerting. It only seems to me that this number will rise in 2010 before it begins to fall. Best guess is, however, that there will be a lot of bank failures this year.
BERNANKE BUBBLE
I would like to recommend the article in the New York Times this morning by David Leonhardt with the title “If Fed Missed This Bubble, Will It See a New One?” (http://www.nytimes.com/2010/01/06/business/economy/06leonhardt.html?hp)
I would also suggest reading this article along with reading my post from Monday, January 4, “The Bernanke Fed in 2010.” (http://seekingalpha.com/article/180764-the-bernanke-fed-in-2010)
Leonhardt quotes the recent Bernanke speech with regards to “lax regulation”: “The solution, he (Bernanke) said, was ‘better and smarter’ regulation. He never acknowledge that the Fed simply missed the bubble.”
Going further Mr. Leonhardt argues that “This lack of self-criticism is feeding Congressional hostility toward the Fed.” It is also fueling the criticism of other interested parties.
“He (Bernanke) and his colleagues fell victim to the same weakness that bedeviled the engineers of the Challenger space shuttle, the planners of the Vietnam and Iraq Wars, and the airline pilots who have made tragic cockpit errors. They didn’t adequately question their own assumptions.
It’s an entirely human mistake.”
From which Leonhardt concludes: “Which is why it is likely to happen again.”
Need I say more?
This, to me, raises additional concern about the banking industry. My guess is that banks, and other financial institutions, haven’t taken this potential write down onto their balance sheets. For one, they don’t know which individuals in the 16 million are going to default on their mortgage and they don’t know when that is going to happen.
This is, of course, a very important reason for banks not to lend at this time. They are uncertain as to the real condition of their own balance sheets.
The forecast is for a new flood of foreclosed homes to hit the market later this winter and spring.
It has been argued that the best way to assist troubled borrowers is not through reducing the interest rate that has to be paid on the mortgage but by reducing the balance of the mortgage. But, this would mean that in reducing the balance on the mortgages of troubled borrowers, the banks would have to take the loss immediately, something they may not have reserved for, given the fact that they don’t know exactly who is going to need assistance. Many of the plans require the borrower to come in for assistance.
This, however, would reduce the capital that the bank has and threaten the existence of the bank.
And, how many banks are already on the problem bank list of the FDIC? At the end of the third quarter of 2009 the number was 552.
What might be the strategy of the banks?
Well, if banks amend the mortgage agreement to include a lower interest rate they do not have to recognize any loss on the loan at the present time.
But, analysts have said, this just postpones the problem and, in all likelihood, the borrowers will still not be able to pay back their mortgage and so this just slows down the recognition of the failure of the loan.
Right! That is the point!
Banks gain something by adjusting loan rates. They lose by granting principal reductions. By adjusting loan rates, they don’t have to take a charge-off right now. If they grant principal reductions they do have to take the charge-off right now.
Bankers are always more willing to postpone taking charge-offs in the hopes of the environment improving. At least that was my experience in doing bank turnarounds.
Furthermore, the location of the problem we are discussing is in the small- and medium-sized banks in this country.
The big banks, they are running away with huge profits gained from the excessively low interest rates (thank you Fed!) and the large trading profits made in bond and foreign exchange markets. This is not their problem, now.
Also, these small- and medium-sized banks face additional problems down the road in commercial real estate, car loans, and other extensions of credit made during the credit inflation of the 2000s.
It seems to me that Main Street is still not “out-of-the-woods” and that 2010 may be the time when the Main Street “shake-out” really occurs. I hope not, but we need to be aware of this possibility.
The total of 552 troubled banks is really disconcerting. It only seems to me that this number will rise in 2010 before it begins to fall. Best guess is, however, that there will be a lot of bank failures this year.
BERNANKE BUBBLE
I would like to recommend the article in the New York Times this morning by David Leonhardt with the title “If Fed Missed This Bubble, Will It See a New One?” (http://www.nytimes.com/2010/01/06/business/economy/06leonhardt.html?hp)
I would also suggest reading this article along with reading my post from Monday, January 4, “The Bernanke Fed in 2010.” (http://seekingalpha.com/article/180764-the-bernanke-fed-in-2010)
Leonhardt quotes the recent Bernanke speech with regards to “lax regulation”: “The solution, he (Bernanke) said, was ‘better and smarter’ regulation. He never acknowledge that the Fed simply missed the bubble.”
Going further Mr. Leonhardt argues that “This lack of self-criticism is feeding Congressional hostility toward the Fed.” It is also fueling the criticism of other interested parties.
“He (Bernanke) and his colleagues fell victim to the same weakness that bedeviled the engineers of the Challenger space shuttle, the planners of the Vietnam and Iraq Wars, and the airline pilots who have made tragic cockpit errors. They didn’t adequately question their own assumptions.
It’s an entirely human mistake.”
From which Leonhardt concludes: “Which is why it is likely to happen again.”
Need I say more?
Thursday, May 28, 2009
"Problem" Banks and the Economic Recovery
Sheila Bair, chairwoman of the Federal Deposit Insurance Corporation, released the latest information on “problem” banks on Wednesday. The list now includes 305 institutions, up from 252 at the end of 2008. We have had 36 bank failures this year and if no more than a quarter of the “problem” institutions fail, we will be over 110 bank failures for the year. This is nowhere near a record and the cumulative number of failures since the beginning of the recession in December 2007 is minimal compared with what happened in the 1988 to 1991 period.
This raises a question about how many more financial institutions are going to merge or close in the next two to three years. If the historical record is any indication, one could argue that a minimum of 100 banks or thrift institutions will close each year for the next two years. Bank closures are not a leading indicator of economic health and can continue for some time even after the economy begins to recover.
The basic scenario that we are looking at for the next two to three years or so is a stagnant economy for much of the time. Economic growth is supposed to be tepid for an extended period of time. Mohamed El-Erian of the bond fund PIMCO stated the other day that PIMCO was expecting the United States economy to grow by no more than 2% or less in the near term. Given that potential real GDP will only be growing at a crawl during this time, unemployment will stay around 8% or above, something similar to the period from January 1975 through to February 1977 where the unemployment rate was at 7.5% or above and the period from October 1981 through to January 1984 where the unemployment rate was above 8.0%. Thus, from January 1975 through to January 1984, unemployment averaged more than 8%.
Within such an environment, foreclosures and bankruptcies will continue to increase and more and more personal loans and mortgages will have to be charged off bank balance sheets. Furthermore, this environment will not be a good one for non-financial business and many more businesses will close their doors. The restructuring of industry will continue as businesses attempt to align themselves with the markets and technologies of the future. This will impact commercial and industrial loans and more of these will have to be charged off going forward.
There is great concern in the F. D. I. C. and beyond about the adequacy of current loan loss reserves in financial institutions. The underlying fear is that a lot of banks have not sufficiently reserved for the loan losses they will be facing in the near future. Bankers have a tendency to be slow in accepting the fact that so much of their loan portfolio is severely challenged. It is a historical fact that reserving for loan losses tends to lag behind the need to build up bank coffers for future charge offs. The present time is not an exception.
This is not a scenario that contains a lot of enthusiasm for producing loan growth. For one, the focus of the bankers should be upon cleaning up their balance sheets. Therefore, they should not be looking for new loans or new sources of loans. These bankers should be focused internally on what they already have on their books. They need to be focused on the performance of existing loans, on working out existing loans, and on charging off loans that are no longer performing.
As many analysts have stated, we still are anticipating increasing charge offs connected with credit cards, consumer loans and commercial real estate. Furthermore, we still have not reached the end of the problems connected with residential mortgages. And then there are the business loans to keep small and medium sized businesses going. The point of all this is that “we are not out of the words yet” in the banking sector.
Secondly, there is not going to be a lot of acceptable loan demand coming into the banks. Credit standards are higher now than they have been for a long time. Bankers are getting back to the idea that you don’t deserve a loan from them unless you are so well off that you don’t really need a loan from them. This has recently been referred to as “boring” banking. Boring, yes, but also prudent.
Some analysts are arguing that the trouble in the smaller banks is not as big a problem as that for the larger banks. Stuart Plesser, a banking analyst at Standard & Poor’s in New York has been quoted as saying that smaller banks were more vulnerable to a souring economy than larger institutions because they were more specialized or focused on a particular region. “But,” he continued, “the repercussions of the failures among the smaller institutions were not as severe for the overall economy as they would be if a larger bank stumbled because the big banks are more important to the economy. It’s not as big a hit if the small fail.”
This may be true in terms of the “systemic” risk in the banking system, but it is not true in terms of the impact of bank failures on “Main Street.” Because the small and medium sized banks are “more specialized or focused on a particular region,” their failure can contribute to the weakness in the local or regional areas they serve and, hence, can slow down any turnaround or recovery that might take place there.
For the past year or so, we have been focusing on big banks and the problem of systemic risk. Now we need to turn our attention to the rest of the banking sector for there is still much work to be done there. Bank failures are going to rise and remain at a relatively high level for an extended period of time. This is an adjustment process that the economic and financial system must go through. It will be a painful process, but there is little that the government could or should do to accelerate the restructuring.
One comment on recent discussions of the government’s P-PIP. Enthusiasm for this program is waning. As I have written, the problem with the toxic bank assets the government has been worrying about is not a “liquidity” problem. The problem is not that certain “legacy” loans or securities cannot be sold within a reasonable period of time. The problem has been that the value of the loans and securities has been in question because of the quality of the assets. The government has been trying to “force” a sale of these assets. But, this is not the problem. The problem is one of working out the value of the assets and the solvency of the banks themselves. An effort to “force” the sale of bank assets is only a program to “socialize” bank losses so that the government can transfer the losses from the banks to the tax payer and does not resolve the ultimate problem. As the banks are attempting to re-capitalize the solvency issue becomes less pressing and so the interest in the program drops off. Except in the case where the government allows the banking system to make a risk-free re-purchase of their own assets at a profit!
This raises a question about how many more financial institutions are going to merge or close in the next two to three years. If the historical record is any indication, one could argue that a minimum of 100 banks or thrift institutions will close each year for the next two years. Bank closures are not a leading indicator of economic health and can continue for some time even after the economy begins to recover.
The basic scenario that we are looking at for the next two to three years or so is a stagnant economy for much of the time. Economic growth is supposed to be tepid for an extended period of time. Mohamed El-Erian of the bond fund PIMCO stated the other day that PIMCO was expecting the United States economy to grow by no more than 2% or less in the near term. Given that potential real GDP will only be growing at a crawl during this time, unemployment will stay around 8% or above, something similar to the period from January 1975 through to February 1977 where the unemployment rate was at 7.5% or above and the period from October 1981 through to January 1984 where the unemployment rate was above 8.0%. Thus, from January 1975 through to January 1984, unemployment averaged more than 8%.
Within such an environment, foreclosures and bankruptcies will continue to increase and more and more personal loans and mortgages will have to be charged off bank balance sheets. Furthermore, this environment will not be a good one for non-financial business and many more businesses will close their doors. The restructuring of industry will continue as businesses attempt to align themselves with the markets and technologies of the future. This will impact commercial and industrial loans and more of these will have to be charged off going forward.
There is great concern in the F. D. I. C. and beyond about the adequacy of current loan loss reserves in financial institutions. The underlying fear is that a lot of banks have not sufficiently reserved for the loan losses they will be facing in the near future. Bankers have a tendency to be slow in accepting the fact that so much of their loan portfolio is severely challenged. It is a historical fact that reserving for loan losses tends to lag behind the need to build up bank coffers for future charge offs. The present time is not an exception.
This is not a scenario that contains a lot of enthusiasm for producing loan growth. For one, the focus of the bankers should be upon cleaning up their balance sheets. Therefore, they should not be looking for new loans or new sources of loans. These bankers should be focused internally on what they already have on their books. They need to be focused on the performance of existing loans, on working out existing loans, and on charging off loans that are no longer performing.
As many analysts have stated, we still are anticipating increasing charge offs connected with credit cards, consumer loans and commercial real estate. Furthermore, we still have not reached the end of the problems connected with residential mortgages. And then there are the business loans to keep small and medium sized businesses going. The point of all this is that “we are not out of the words yet” in the banking sector.
Secondly, there is not going to be a lot of acceptable loan demand coming into the banks. Credit standards are higher now than they have been for a long time. Bankers are getting back to the idea that you don’t deserve a loan from them unless you are so well off that you don’t really need a loan from them. This has recently been referred to as “boring” banking. Boring, yes, but also prudent.
Some analysts are arguing that the trouble in the smaller banks is not as big a problem as that for the larger banks. Stuart Plesser, a banking analyst at Standard & Poor’s in New York has been quoted as saying that smaller banks were more vulnerable to a souring economy than larger institutions because they were more specialized or focused on a particular region. “But,” he continued, “the repercussions of the failures among the smaller institutions were not as severe for the overall economy as they would be if a larger bank stumbled because the big banks are more important to the economy. It’s not as big a hit if the small fail.”
This may be true in terms of the “systemic” risk in the banking system, but it is not true in terms of the impact of bank failures on “Main Street.” Because the small and medium sized banks are “more specialized or focused on a particular region,” their failure can contribute to the weakness in the local or regional areas they serve and, hence, can slow down any turnaround or recovery that might take place there.
For the past year or so, we have been focusing on big banks and the problem of systemic risk. Now we need to turn our attention to the rest of the banking sector for there is still much work to be done there. Bank failures are going to rise and remain at a relatively high level for an extended period of time. This is an adjustment process that the economic and financial system must go through. It will be a painful process, but there is little that the government could or should do to accelerate the restructuring.
One comment on recent discussions of the government’s P-PIP. Enthusiasm for this program is waning. As I have written, the problem with the toxic bank assets the government has been worrying about is not a “liquidity” problem. The problem is not that certain “legacy” loans or securities cannot be sold within a reasonable period of time. The problem has been that the value of the loans and securities has been in question because of the quality of the assets. The government has been trying to “force” a sale of these assets. But, this is not the problem. The problem is one of working out the value of the assets and the solvency of the banks themselves. An effort to “force” the sale of bank assets is only a program to “socialize” bank losses so that the government can transfer the losses from the banks to the tax payer and does not resolve the ultimate problem. As the banks are attempting to re-capitalize the solvency issue becomes less pressing and so the interest in the program drops off. Except in the case where the government allows the banking system to make a risk-free re-purchase of their own assets at a profit!
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