– Hazel Bedingfield, 79, who now travels 24 miles for her Social Security payment at her new bank

You deposit your paycheck on Friday and can’t get money out on Saturday.

But don’t worry, the FDIC will cut you a check on Monday morning.

Your county commissioner tells the evening news: “The bank failure opens up an opportunity for another bank to set up here. Until then, customers will have to find another bank in a surrounding county.”

Your bank might have been built in 1905. It may have survived two world wars and a Great Depression. It was sold in 2000 and rebranded when the new owners moved headquarters to Atlanta…you can guess the rest.

This happened to citizens in Gibson, Georgia. And it could happen to you tomorrow.

The Feds raid your bank on Friday…They escort the CEO out. Then they empty the vault.

Right now, aren’t you wondering how much longer will this go on? The short answer: about $13 billion worth of FDIC intervention. I’m wondering if that’ll be enough.

Gargantuan, unfounded suburban growth ringing ’round the Peach State’s metropolis Hotlanta takes the brunt of the blame for bank collapses left and right. Especially those construction loans. A typical example of why these failed, according to FDIC investigation: Over 75% of the loan money was handed out before a single day of on-site construction began.

But here’s a big reason: Banks invest in other banks. Some banks never see nice depositors walk up to their ATMs or get lollipops at the counter. The wholesale bank’s only clients are other banks. If some of those big-ticket clients fold, well, there goes the bank. Silverton was just such a bank, with about 1,500 client banks in 44 of the 50 states. This earned Silverton the nickname “the Mini-Federal Reserve.”

The trouble came from the chunks of real estate loans Silverton sold to other banks in “low-growth” areas: deposit-rich regions that are “loan poor.” Guess that means places that aren’t Nevada, California or Georgia. It didn’t stop Florida Community Bank from adding a stake in the now-defunct Silverton bank to its $978 million dollar asset base. And the FCB ranks among the weakest financial institutions in Florida. We are not surprised.

Even Atlanta’s Federal Home Loan Bank, as 2009 dawned, was straddling the mere 3% capital ratio that would set a regulator’s teeth on edge. (The culprit there was the unwinding private-label mortgage-backed securities.)

Now get this. The Georgia banks facing FDIC conservatorship often depend on loan advances from the Federal Home Loan Bank of Atlanta to stay afloat, and the FHLB gets paid first, before depositors — costing the FDIC even more millions — even if the collateral isn’t there to do it.

Georgia regulators OK’d any fly-by-night bank startup. After all, who didn’t want a cut from making loans to real estate developers? At the start of the housing collapse, Georgia had 334 banks. That’s more than in California, which has four times Georgia’s population. Dan Amoss, the editor of Strategic Short Report, points a finger at this failed bank and offers some advice:

“A perfect example is Integrity Bank in Georgia, which should have been shut down long before it was allowed to attract new deposits with high CD rates.

“Also, note to Whiskey readers: If your CD rates seem too good to be true, your bank may not be healthy, and you may have to deal with the hassle of not accessing your money while the bank is resolved.”

All last week, Dan and I fired e-mails back and forth about the next U.S. bank to fail: The Great Southern behemoth: Colonial BancGroup. Then, on Friday Aug. 14, it finally happened…

BB&T to Swallow Colonial Whole: What Bones Will It Spit Out?

Colonial tapped the FDIC’s matchmaking skills to shack up with BB&T. Expect this marriage to look like the 20-something who marries the wealthy old man because she can’t wait to max out his credit cards. Dan bet me last Friday that dilutive stock offerings were on the way.

Sure enough, come Monday, BB&T offered 26.6 million brand-new shares to some willing dupes.

Like the other Southern banks we’ve been talking about, Alabama-based Colonial’s arms stretched into bad places like Georgia and Florida. And here’s what helped shake Colonial’s foundation. They call it warehouse lending. That’s short-term financing that independent mortgage bankers relied on to do business. Fannie, Freddie or Ginnie did not guarantee these loans.

Back in the 2007’s warehouse-lending heyday, the market was a $200 billion business. Lately, of course, the rich well dried up, to just $25 billion in lending. Colonial held the big 25% chunk of it. So now that it has dropped out of the race, who’s left?

The other warehouse-lending trendsetters already lie in the grave. The biggest tombstones: Countrywide and WaMu. And there’s a fresh hole dug for a new occupant: Guaranty Bank of Texas, which issued the FDIC red alert last month. Finally, we have National City (acquired by PNC).

What does this tell us? If all the big enablers for these loans are shutting up shop under duress, it makes you think there could be something wrong with the product. Instead of letting the free market eat the gross error of overexuberance, the industry is lobbying Washington to give government-backed Fannie Mae, Freddie Mac and Ginnie Mae a bigger role in warehouse lending.

Don’t Let the GSEs Take Over

Let’s flash back to a nice piece of advice that still holds true for Fannie, Freddie and fast-growing Ginnie. Back in March 2002, the prescient Chris Mayer (before he joined the Agora family) wrote a missive for Mises.org called “Mortgage Market Socialization.” Take a look at this bit of prophecy:

Forgotten is the truism that periods of prosperity necessarily precede periods of crisis. Thus, caution becomes heresy and optimism becomes the new religion.

The only way to correct this problem is the same way all socialistic practices are corrected — the government’s involvement must be severed completely. Just because the GSEs have led a charmed life so far is no reason to infer that their future will always be so bright. Socialism is not dead; it is alive in institutions like the GSEs.

The longer the GSEs are able to expand as they have, the more certain it becomes that someday taxpayers will have to bear the cost of such excess. Like Russian roulette, the longer you play, the more certain it becomes that you will bear the risk for playing.

I don’t know about Congress, but I think you Shooters would be eager to put down this particular gun. We’ve already paid about $86 billion in bailouts and what’s it gotten us? But since Fannie and Freddie backs or owns more than half of the single-family mortgages — probably yours — how about we just don’t load any more bullets?

Here’s the directionless drivel from Tim Geithner, recently before the Senate Banking Committee, as reported by Bloomberg:

“Fannie Mae and Freddie Mac will remain in limbo, as the U.S. Treasury secretary said the government doesn’t have time now to deal with the future of the two mortgage-finance companies it seized in September.

“We did not believe that we could at this time — in this time frame — lay out a sensible set of reforms to guide, to determine what their future role should be. We’re going to begin a process of looking at broader options for what their future should be…

“We just didn’t think it’s an essential thing to do just now, but it is an essential thing to do.”

Doesn’t this fill you with confidence? You see, Shooters, this whole mess began at an exclusive resort island off the coast of Georgia…The ol’ Jekyll Island Club set the foundation for sopping up and propping up incompetence in 1913.

Regards,
Samantha Buker

August 21, 2009

Who Killed 21 Georgia Banks? was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Right now, the market has priced bank stocks for perfection, but the earnings outlook remains bleak. Investors are excited about the wide yield curve that’s enabling banks to borrow at ultra low rates and lend at much higher rates. But starting a few years ago — and going forward a few more years — losses on loans made during the bubble will matter more than the wide yield curve. More bank failures, capital shortfalls, dividend cuts and shareholder dilution are in the cards for most bank stock fans.

Because bank stocks usually act as a canary in the coal mine, a continued bear market in banks translates into a continued bear market in most other stocks. The evidence tells me we’re experiencing a bear market rally, not a new bull market. The promoters of the idea that this is a new bull market are ignoring one of the worst enemies of stocks: uncertainty. Right now, especially considering aggressive government policies, uncertainty about the future business environment is very high.

As regular readers of Whiskey & Gunpowder know, the government’s land grab is going to make things worse. It seems that there’s no end to the threats facing corporate profits, which will make corporate loans that much harder to pay back. This is not a garden-variety recession. It’s more like a depression, so the so-called economists parroting the “recession is over” message will have a rude awakening soon enough.

Let’s briefly consider the sentiment toward overall market. Aside from the investor sentiment polls, you can tell how bullish investors are by the multiples they are willing to pay for stocks. And right now, after the sharpest 5-month rally since the 1930s, the market is trading at valuations that require a strong economic recovery, and a return to credit bubble conditions. The rally was powered entirely by P/E multiple expansion, not earnings growth. That sort of rally would be justifiable if corporate revenues and earnings were about to soar, but they’re not. Most earnings surprises were due to cost cutting, rather than top-line growth, which is like burning your furniture to stay warm.

The market is not even that cheap when you consider how artificially inflated earnings were at the 2007 peak. Financial earnings made up 18% of the S&P 500’s earnings in 2007 — much more if you add the “earnings” from the finance divisions of industrial conglomerates like GE and GM. Any claims that the S&P 500 is cheap because 2007 somehow represents “normalized earnings power” are bogus. The corporate profit margins and earnings won’t return to that level for many years.

The talking heads are getting more creative in their rationale for owning stocks right now. Most money managers seem to be thinking: “I don’t believe in this rally, but I’ll ride it until it looks like it’s over, and then I’ll sell.” This is the type of dangerous crowd psychology that consumes most people during bubbles. When enough investors share this Ponzi sentiment, and nobody’s investing on the basis of sober, rational fundamental analysis, the result is sometimes a crash.

Bank Accounting: Educated Guesses about the Future

This brings us to the poor quality of earnings, particularly at commercial banks. Accounting — especially the accounting that produces income statements at banks — is more art than science. It’s as much opinion as it is fact. Bank executives have a lot of leeway in how and when they recognize credit losses. As you’d imagine, some of them have more creative imaginations than others. Some are actively engaging in “extend and pretend,” a practice in which banks refinance deadbeat borrowers to avoid reporting loan losses.

Banks make loans expecting to receive interest and principal payments in a timely fashion. Banks book revenues, expected credit and operating costs, and profits associated with every loan upfront. But as we’ve discovered, the credit costs, or losses, often wind up being much larger than originally expected. When this happens, banks must dramatically ramp up their “loan loss provision” expense, which cuts into earnings, often pushing earnings into the red.

So the ultimate credit costs associated with bank revenues often take a year or more to be reflected in earnings and capital cushions. That’s why regulators require banks to maintain an “allowance for loan losses.” This allowance is a contra account on the asset side of a bank’s balance sheet, and its purpose is to absorb credit losses from loans as they run through the default and recovery phases. Loan losses, net of recoveries, deplete the allowance. Banks can rebuild their loan loss allowance by booking larger provision expenses, but this process cuts directly into earnings.

The chart below shows how under-reserved banks are right now, so they still have a ways to go in accounting for the losses on loans made during the bubble. These numbers are the combined figures for over 7,000 U.S. commercial banks insured by the FDIC. In blue, you see the combined loan loss allowance climbed to $156 billion by the end of 2008. In red, you see that noncurrent loans — the raw material for credit losses — had soared even faster to $200 billion by the end of 2008, and are still climbing sharply. As a rule of thumb, to remain well capitalized, and to prevent their allowance from shrinking to dangerously low levels, banks should book provision expenses in line with the increase in noncurrent loans.

But since the credit crisis began, this has not been happening. As the green line shows, the ratio of loss allowance to noncurrent loans for the entire banking system has fallen below 100%. To rebuild the industry wide loss allowance back up to an adequate level, provision expenses will have to rise faster than delinquencies. Some banks can only catch up by raising new capital from investors. Those banks that are too far behind, and cannot raise capital, will be taken over by the FDIC. All of this translates into a strong headwind for bank earnings over the next few years.

Recall that bank executives have lots of control over the timing of loss recognition. Evidence that banks are delaying loss recognition is springing up all over the place. For instance, some banks that provided unsecured revolving lines of credit to highly indebted REITs have waived some restrictive loan covenants. In residential mortgages, we’ve seen lots of instances where banks are stringing along underwater homeowners with modifications that do little more than kick the can down the road.

It would make more sense to restructure mortgages on underwater properties where the bank receives a property appreciation right in exchange for a large reduction in mortgage principle. This makes more sense from a societal perspective, and would help accelerate the return to a healthier, less “zombified” banking system. But this idea is not popular among bankers, because doing so would force the bank to immediately recognize lots of losses, which could cut heavily into the bank’s capital.

This state of bank accounting is not limited to the U.S. In fact, in some instances, the accounting at some foreign banks is even more detached from reality than it is in the U.S. For readers of Strategic Short Report, I recently uncovered a non-U.S. bank that’s been especially tardy in disclosing its credit losses. It’s a very attractive short sale right now, especially because the market loves this bank, and is totally ignoring the wave of credit losses to come in the near future.

Regards,
Dan Amoss

August 13, 2009

Bank Accounting Fudges Loan Losses was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

THOMAS McANEA was a drunk, an ex-con freed on a technicality, and a failed businessman with barely two pennies to rub together, according to the Scottish police.

He was also an expert forger, a specialist in faking holograms for official documents. And in January, “Hologram Tam” — as his underworld clients knew him — was caught with nearly $1.7 million worth of counterfeit banknotes.

The fake cash had been printed alongside the takeaway menus that McAnea made for local Chinese restaurants, the cover he used to look legit. By the time of his arrest, the police estimate, Hologram Tam and his gang had put almost £700,000 of fake banknotes — more than $1.3 million — into Britain’s financial system. (They don’t know how many Glaswegians are still waiting for a delivery of Chinese food ordered off the fake menus.)

All told, according to the report in The Times, McAnea’s printing works had the capacity to produce $4 million worth of counterfeit notes per day, “enough, potentially, to destabilize the British economy.”

But that $4 million per day would have been small beer compared with the money created by the U.K.’s private banking sector each day. It’s been helping to grow the money supply by more than $1 billion — every 24 hours — for the last year and more.

Might this flood of legitimate money “destabilize” the economy? It outweighs Thomas McAnea’s threat 250 times over, after all.

And if forgery were a question of quantity as well as quality, the entire banking system might be queuing up to empty its slop bucket tomorrow morning…right alongside Hologram Tam.

“Modern economists have difficulty in deciding whether they should define money as M1, currency plus demand deposits,” writes Charles Kindleberger in his classic text, Manias, Panics, and Crashes, “or as M2 — equal to M1 plus time deposits — or M3, consisting of M2 plus highly liquid government securities.”

Does the way we define money matter? The U.S. Federal Reserve says not. It famously ceased publication of its M3 data in March 2006, claiming that the measure “had not played a role in the monetary policy process for many years.”

But lack of use didn’t negate M3′s value, however. Private economists have since pegged its growth rate above 10% per year. At the end of August this year, M3 growth hit 14%, according to analysis by John Williams at ShadowStats.

“At least we should all be able to rest assured that a global deflation [a shrinking money supply] is not in the cards,” as Rob Kirby notes for Financial Sense.

But across the Atlantic and here in London, inflation of the money supply remains on view to the public — and M4 remains the key money supply data. The broadest measure of money supply tracked by any central bank outside Chile (those silly Chileans go up to M6), it covers all notes and coins in the British economy, plus bank deposits — both time and demand — and sterling bank bills, as well as all commercial paper, bonds and floating-rate notes issued for five years or less.

In short, M4 measures what a 1959 commission called those “highly liquid assets which are close substitutes for money, as good to hold, and only inferior when the actual moment of payment arrives.” And M4 has more than doubled in the last decade. It’s risen by 65% since the “Deflation Scare” starting in 2002.

But forget for a moment about the supply of what passes for money — even if it did grow by 13.5% in August from 12 months before.

Gasp instead at the surge in private sector lending!

After lagging the outstanding total of M4 money throughout the 1960s and ’70s, the volume of private sector debt first ticked higher during Margaret Thatcher’s deregulation of the financial services industry in the early ’80s.

Then the real jump came back when the current government took power in May 1997. The U.K.’s money supply has very nearly tripled since then.

By the end of summer 2007…and just as the global “credit crunch” began to bite after the British economy had enjoyed 15 years of expansion, its longest boom ever in history…total private sector lending in the United Kingdom outstripped the sum total of broad money by almost half of one year’s entire economic output.

Put another way, private households and businesses in Britain now owe the banks 39% more in debt than actually exists in cash, bank savings and near-cash equivalents added together (August data).

Down there with the devil and his number-crunching detail, “Most banks have advanced more loans to borrowers than they hold in savers’ deposits,” as The Telegraph noted recently. Little does the newspaper know, however, that the situation applies right across the entire British economy. But the point is well-made, regardless.

Halifax Bank of Scotland (HBOS) has lent out £1.74, says The Telegraph, for every £1 it’s taken in from its savers. Standard Life Bank has lent £2.40…Northern Rock lent £3.21…and Bristol & West, another aggressive mortgage bank, has turned every £1 kept on deposit into £6.60 in loans!

The scam is simple enough to spot, if not to stop. Lending £6.60 against every £1 on deposit makes for a tidy “arbitrage” between the cost of paying bank savers and the income earned from debtors. And what The Telegraph’s horrified expose misses, of course, is that — on the banks’ balance sheets — creating credit in this fashion looks simply beautiful.

Loans are called “assets,” but cash on deposit is a “liability.” So the more money the banks lend, the greater their assets. The less cash they accept from savers, the smaller their liabilities!

“The very fact of imitation,” writes Glyn Davies of the Roman denarius in his magisterial A History of Money, “indicated that the demand for money locally exceeded the official supply, a gap which the counterfeiter exploited directly for his own interest.”

Fast-forward 2,000 years, and Hologram Tam was merely improving liquidity for his local economy, too — in this case, the economy of drug dealers, junkies, and pimps in Glasgow.

Britain’s biggest mortgage banks have merely been doing the same, this time helping out would-be homeowners with a flood of liquidity. It pushed the average house prices up threefold in the 10 years to July 2007. The proportion of income going to service and repay the resulting mortgage debt doubled over that period, to a record 32% per month.

Might this surge in “seignorage” — the profits earned first by medieval kings for issuing money, and now by the private banks for issuing debt — come to overwhelm the poor serfs plowing the fields and trying to decorate their newly built starter homes (carpets and curtains included)?

It’s not just Britain, of course, where money has been piling up without the bother of taking physical form as notes, coins, or even a line in your banking deposit book. Prior to its untimely demise, the Federal Reserve’s M3 data showed marked growth compared with the smaller, less inclusive M2 measure.

You’ll note the upturn in the gap between M2 and its bigger cousin, the now dead M3 money supply figure, right at the same time that Britain discovered the joys of private money creation in the mid-to-late ’90s.

A global stock-market boom followed, and a housing bubble followed that when the frenzy in equities wore out. But in the Fed’s own words, M3 included all of M2, plus large time deposits of $100,000 or more, as well as “term repurchase agreements in amounts of $100,000 or more, certain term eurodollars, and balances in money market mutual funds restricted to institutional investors.”

Put another way, a big chunk of the private banking sector’s money is not included in M2. Now why would the Fed not want to track what was happening there?

Watch this space…

Regards,
Adrian Ash

October 16, 2007

Hologram Tam & the Great Global Banking Swindle was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.