Wednesday, September 23, 2009

The FDIC Announces Intention To Rob The Rich To Give To the Poor

We assure you that it was never our intention to become a site dedicated to unmasking the shitshow that is the FDIC, but we play the hand we are dealt.

The most recent FDIC ridiculousness, which we will address below, should not surprise loyal TILB readers as we have been stating over and over again that, using the FDIC's own numbers, the FDIC is insolvent.

Last week, we proved mathematically that the FDIC DIF is now negative and chewing through its reserves. While its liabilities exceed its assets, a portion of those liabilities are reserves that will be used to offset actual losses and pay its creditors (depositors of failed banks). This conversion of reserves into realized losses will keep the DIF alive for a period of time, but the FDIC will soon hit a wall in which it still has "assets" but those assets just don't happen to be "cash". In fact, we also noted that a huge portion of its assets are illiquid assets that are amongst the toxic of the toxic. This of course would not be a problem if they could pay depositors with toxic mortgages, but alas...

After losing another $650 million of value to the Deposit Insurance Fund (DIF) last week (basically $850 million of insured losses offset by $200 million of accrued premium and guaranteed fees), the DIF's capitalization now stands at worse than negative one billion!

As we have said many times, if the FDIC were a bank under the regulation of the FDIC, it would have been seized a long time ago. As American citizens, we find this all very embarrassing.

So, that leads us to this week's FDIC announcement: the FDIC is considering asking sound banks to pay their regular deposit insurance premiums in advance of the normal timeframe (while not asking unsound banks to do the same [note: calling all sellside analysts, you now have a great question to ask the banks you track!!!])

This announcement tacitly equates to stating the following:
1) Oh, shit - we're out of money! ...but not really, but we do need cash, but don't worry, everything's great!
2) In order to remedy this problem, we are going to make all of our lend us their insurance premiums until the premiums come due (don't worry though, this isn't a backdoor special assessment - next quarter we'll credit you for it - wink, wink...)
2a) Oh, and we're not going to make relatively weak banks pay this advance just feels more fair that way
3) For the time being, our real problem is a "cash" problem rather than an asset problem - don't you see all our pretty reserves? We keep those reserves right there on our balance sheet offset by assets (e.g., toxic, unpurchasable mortgages)

What the deuce is going on here? Are we the only people on Earth that think taking capital out of the banking system to prop up the banking system makes no sense? Isn't Bernie Madoff in jail until he dies for f'ing fewer people behind their backs?

At least the mainstream press is catching on a little bit to the debacle that is the FDIC. That said, the press is confused in its rationale for why big banks "support" this. They obviously support it because they don't want yet another "special" assessment and if paying their normal assessment early helps them avoid said special assessment, they certainly will be in favor of that. However, the article goes on to state big banks don't want the FDIC to borrow from, the Treasury.

This we are skeptical of.

To say that this would be construed as a taxpayer bailout of banks, is ridiculous. It's a taxpayer bailout of the government. And by the way, the FDIC's entire purpose is to provide bailouts. That's what the FDIC inherently is: a taxpayer guaranteed bailer-outer...but the bailout is to depositors, so to bailout the FDIC is to bailout depositors. While banks, of course, benefit from this in the form of reduced risk of bank runs, that is a statement that is always true, not true just now.

This proposal does not begin to address the FDIC's core problem: THE FDIC IS INSOLVENT. IT HAS LIABILITIES THAT MASSIVELY EXCEED ITS ASSETS. Borrowing more money does not generally address solvency (actually, it often makes the problem worse). What this solution does is simply delay the inevitable; kick the can down the road. As we said on SeekingAlpha last week, the FDIC's core problem is that while it has "reserved" $30 billion for losses (before Q3), it does not actually have $30 billion in cash. In fact, depending on how you calculate "cash" the FDIC had $20 billion or so of cash on June 30th (which is down by about $12 billion so far this quarter). Its largest asset was actually $22 billion of the most toxic loans from the most toxic banks: assets that buyers of failed banks were not willing to purchase ($22 billion as of June 30th, much bigger now).

...and, as we noted, the problem is compounding because the FDIC has been underreserving and its assets are almost certainly overstated. Because the FDIC has been extremely reticent to sell siezed assets, these generally non-performing loans have been sitting on their books stagnant, largely unmanaged and thus suffering deteriorating value as the likelihood of ultimate recovery declines by the day

[Note: generally when a bank fails, the FDIC sells some portion but not 100% of the assets of the failed bank. It retains the balance for disposition at a later date, generally through auctions]

And so this frames the FDIC's problem. It can pull cash forward by a few months, but that just means that unless the new payment cycle becomes permanent, the problem is worse three months hence. The FDIC can borrow from the, the "U.S. Treasury", but that does not address solvency - it simply adds another liability to the FDIC's balance sheet. Unless the Treasury makes an "equity" injection into the FDIC, we are not talking about "if" the FDIC is insolvent, we are simply talking about "when" people realize it.

When the FDIC files its September 30th balance sheet for the DIF, unless they start gaming their reserving (which is why bankers go to jail, mind you!), Sheila will have to admit that the DIF is technically insolvent.

The FDIC will have some modicum of claims paying ability that lasts for another two quarters perhaps, but it hits a wall soon unless she starts converting toxic assets into cash. TILB has been following the whole loan mortgage market for the past few years in a variety of capacities - we strongly suspect that the FDIC will not be able to move those assets at anything close to carrying value. When Q3's new basket of bank failures is added, the FDIC's total will exceed $30 billion of super-toxic loans. This is an enormous volume of this type of asset. Extracting value from these kinds of loans requires lots of time and manpower - the likely buyers are niche oriented.

Of course, if these toxic assets start actually trading to new hands (so that the FDIC can raise cash), these sales will have a depressing impact on the realizable value of similar assets on what are theoretically solvent banks, leading to yet more bank failures.

And so here we sit, staring at a Federal government operated trainwreck that's playing out in slow motion. Nobody seems to be paying any attention, yet we find ourselves mesmerized and not able to turn out attention away. We deal with it by standing tall and sharing our views with the our readers.

This is our world and we suppose it's indicative of the role that we play. If the mainstream media will not talk about the Emperor's lack of clothes, we'll go ahead and let you know: Sheila Bair is naked. No, not that way. She's naked in that she is managing a debacle of a regulatory body that has failed at its mission, is insolvent and is introducing all sorts of despicable incentives into the system. She's naked because she is now undertaking in all the despicable acts that she so rightly criticizes and regulates. She's playing favorites, mismarking her assets and understating her liabilities. But time is running out. The paintrain is coming - our view is man-up and admit the situation.

Don't "borrow" from Timmy G; rather, ask for an infusion of new "equity". Frankly, the truly appropriate thing to do would be to seek private capital, recapitalize the FDIC, spin it out completely from the government and operate it as a for profit insurer.

But what is the FDIC's response?

Pretend it's not happening.

Head in the sand, just hoping taxpayers keep walking by pretending there isn't some crazy bastard suffocating under the weight of the beach around them.