Where to Begin?

Washington Mutual failed last night. It wasn't even a Friday. Given how much I look forward to checking the FDIC website every Friday evening, it's with a small tinge of disappointment that I note WaMu failed on Thursday September 25th. That said, it is with a great deal of self-congratulatory arrogance that in the same above linked post, I also noted that WaMu was "probably still six or eight weeks out" from failing. That post was dated August 2, 2008. That was just under eight weeks ago. I'm not sayin', I'm just sayin', that's all... I also have been predicting that the catalyst for WaMu's failure would not be a traditional run on the bank, but a slow motion run on the bank by large depositors who a) have more to lose; and b) on average are more market aware and thus would be the most likely people to withdraw their deposits. In the last two weeks or so, the media has reported that $17 billion in deposits walked from WaMu, driven largely by large depositors.

I first predicted WaMu's failure in this blog back in mid-July. I started talking about it privately a few months prior to that. In fact, you'll note that the WaMu failure post was actually my first blog posting of 2008. That overwhelming sense that WaMu/SnaFu was toast and that nobody was focusing on it is what actually opened the floodgates for my blogging. Since then, everything that I've expected to happen (and some) has occurred.

Now, onto news. Effectively, JPM paid $1.9 billion to the FDIC and took a $31 billion write down as the cost of the acquisition (basically, $34 billion). They expect the WaMu transaction to add $2.4 billion in earnings in 2009 and then grow in the out years. That implies that JPM was able to acquire WM at 14x run-rate earnings. I suspect that WM contributes much more than that to JPM's annual earnings over time.

In that first post of 2008, I said that the failure of WaMu would be more important than the failure of the GSEs. I believe that proved out today, though most people still don't realize it. When WaMu was seized by the FDIC then flipped to JP Morganington Mutual Chase Stearns & Co, it had at least one odd unintended consequence. It absolutely screwed senior creditors who certainly assumed that their loan was secured by the assets and liabilities of the bank operating companies as well as the HoldCo assets. Instead, the FDIC used its authority under a seizure to rip the assets from the bond holders and sell them to JPM. In fact, the FDIC turned a $1.9 billion profit on the flip!

If you happened to be a senior lender to the next-weakest large financial institution, like, say, Wachovia, it turns out that you may not have enjoyed witnessing your colleagues in the world of lending to banks getting publicly gutted by the Feds.

So, what happened today to Wachovia? Well, it wasn't good. Wachovia CDS spreads blew out. As noted in the link, a standard CDS contract is quoted as the cost over swaps of a five year senior obligation. Wachovia closed Thursday (just prior to the WaMu gutting) at about 695 bps over (no up front points). It closed Friday at 40 points up front and 500 bps running! Doh! So, if we assume swaps are about 3.5% today and we just evenly divide up the 40 up front points over five years (8%/year), we are looking at Wachovia's current senior funding costs at about 16.5% per annumn (3.5% + 5.0% + 8.0%). Ouch! Hopefully they don't need to tap the credit markets in the near future!

Also, this is a classic unintended consequence of the no new short selling rule: if you want to short WB, the SEC has pretty much forced you to use CDS. Idiot Cox.

Some how evil speculators and Wall Street derivatives traders will be blamed for "manipulating" Wachovia's CDS costs, but the reality is it simply reflects the new failure paradigm that the FDIC defined through its actions for large bank failures. Charging a higher cost to lend to financial institutions is absolutely the rational thing to do. As regulators continue to manipulate the natural order of things, the more frequently and painfully these unintended consequences will pop up.

Luckily for Wachovia, if they need to shore up their capital base, they can always just issue stock.

Or...maybe not. Wachovia's stock was down about 40% today to $9/share. Interestingly, if you look at the presentation JP Morganington Mutual Chase Stearns & Co. sent around last night on the WaMu acquisition, they break out bucket by bucket how they came up with the $31 billion write-off they took on WM's portfolio (page #15), they wrote off another $8.2 billion or about 13% of the remaining Option ARM portfolio. They also wrote-off another 17% of the HELOC & LOC portfolio in addition to other broad asset category write-offs. In total, JPM wrote down WaMu's asset portfolio by about 15%.

Those are enormous write-offs and, if apples to apples, would imply devestation for Wachovia. Even if Wachovia's asset base (page #4), which also has huge Option ARM ($125 billion) and HELOC/LOC ($58 billion) portfolios out of a total $477 billion asset base is of better quality than WaMu, it's only going to be modestly better and WaMu had been more aggressive in its write-offs than WB even before the JPM takeover. I first discussed WB's balance sheet issues vis a vie WM back on August 6th. Given a nearly half a trillion dollar asset portfolio, Wachovia's market cap is just over $20 billion, so the margin for error is unusually small.

Another unintended consequence of the JPM/WM deal is that if you are a potential acquiror of WB equity (in whole or part), what's the rush? The longer you wait, the more the situation develops, the lower the price seems to go, and the more desperate the Feds become for private sector help. The government's perspective surely is that a bank Wachovia's size cannot be allowed to "fail". Another issue is that Wachovia is so big, the government really cannot allow it to be swallowed by another large bank. So, that means it would be split up. By delivering WaMu on a silver platter to JPM, the FDIC has shown that it is more than happy to kill a bank prematurely if it facilitates an orderly transition. Of course, that "order" is real only if viewed in a vacuum. Each one of these government manipulations seems to spawn now uncertainties and unintended consequences.

Given the small market cap vs. the magnitude of the potential problem taken in conjunction with the cost of debt financing, Wachovia's clock is ticking. They will do one of the following, and soon: 1) prove everyone wrong and show their asset quality is such that it does not need to be marked down much more (btw, auditors will definitely look at the WM/JPM transaction for valuation comps); 2) sell itself; or 3) fail and be sold by the FDIC. Frankly, I don't think there are any other alternatives given the impracticality of raising the necessary financing.

A final unintended consequence of WaMu's failure being such an orderly failure (no depositors were hurt) is that the media, which had been fairly restrained in an attempt to help avoid causing a self-fulfilling fear-based run on a bank, now has some cover to start reporting negative bank news before it becomes overwhelmingly obvious. In fact, the media seems to have taken off the gloves and decided no holds are barred. This NY Times article on Wachovia is a case in point. This sort of article did not used to get published by the mainstream media.

So, as I said, WaMu's failure is s scary thing. Creditors and owners of weak banks everywhere are rightfully nervous

I hope your boots were strapped on, because we are knee deep in it now.

-TTB

Down Goes WaMu! Down Goes Wamu!

As I predicted, WaMu goes down. The FDIC technically seized it (creating a donut for WM shareholders) then immediately flipped the assets and liabilities of the bank to JP Morganington Stearns & Co. for $1.9 billion (paid to the FDIC). Very clean from the FDIC's standpoint. Very, very, very bad for creditors of WaMu HoldCo. Very bad.

Anyway, more on this and the fact that the bailout is BUSTED over the weekend. What a day, what a week!

The Overs Take it! (and how!)

For each of the last two weeks, the overs have taken it running away. I guess technically the failure of Fannie and Freddie two weeks ago (it seems like a lifetime ago!) don't qualify as depository institutions, but I'll make an exception. And while Lehman and AIG aren't perfect fits either, their epic failure combined with the failure of tiny Ameribank, Inc. in West Virginia certainly meets the intent of the rule.

I have an enormous number of thoughts about the Keystone Cops', I mean Hammerin' Hank and Helicopter Ben's, announcement about the reliquification of the global financial sector using We The People's money.

I can sum it up my views very briefly with the following statement: as long as they continue to expect any losses from this bailout, we know for a fact that the government intends to overpay for the mortgage assets! I can assure you the Street will hit that bid and hammer the Treasury over and over again with the worst assets at the wrong prices until the Treasury lowers its bid. Then the Street will pound the bid some more.

In theory, the taxpayers ought to be making a profit on this if we buy at reasonable prices (ignoring all of the unintended consequences) and it is an f'ing travesty that the implicit subsidy of the banking system which I've been railing on for years is becoming explicit.

We damned well better extract a pound of flesh.

The Hammer keeps saying that the root causes of this once "contained subprime problem" are falling housing prices and the resultant illiquid, depressed asset values that banks are carrying. That is fundamentally misleading. The root problem is too much allowable leverage by banks due to their falsely precise regulatory oversight and Fed backstop combined with bad to horrific underwriting practices. This reliquidifcation does absolutely nothing to address either of those issues.

Prediction: more pain to come, even it we shift who receives it.

Further prediction: before Treasie Mae and Feddie Mac can get this horrific foray into trickle down communism up and running, we run headlong into some other large problems.

I will have more thoughts on this in the coming days. Suffice it to say I think the whole thing is evil.

-TTB

PS: Don't trust a word from anyone at a bank, on Wall Street, or at a firm like PIMCO, Blackrock or TCW. They are all completely and utterly comprimised by this bailout. Wall Street and commercial banks all stand to sell assets to tax payers at inflated prices and investment management firms like PIMCO and Blackrock stand to be hired by Treasie Mae as external managers to run the process. I expect a thorough knob slobbing until this is over.

Having just killed AIG, bloodthirsty media barron CNBC sets its sights on Morgan and Goldman

Have you noticed that CNBC seems to be creating self-fulfilling prophecies with each failure?

It always seems to begin with them quoting some unnamed source with a fairly innocuous statement like, "AIG is contemplating ways to raise capital." Next, CNBC will put that company's ticker symbol in emergency orange at the top of its screen on the rolling bar such that its stock price is highlighted every 30 seconds or so. Then, Charlie Gasparino will breathlessly and angrily tell us about what the rumors being mongered on The Street are about said company. Then the share price starts declining and credit spreads widen out a few hundred basis points. Finally, because all of these companies rely heavily on continuous access to short term funding sources for their daily survival, the death becomes almost self fulfilling as the company's alternatives for raising capital dwindle, its existing capital providers run for the hills, and the broad media becomes like a dog in heat and humps the company until its dead.

The fact that Morgan and Goldman are being attacked is as much a CNBC created problem as a problem created by the bogeyman...I mean, evil short sellers. Let's be clear, this is not a problem caused by short sellers or the media, this is a problem caused by a fundamentally flawed business model. Businesses that require access to short term leverage and invest in assets that may not be saleable at attractive prices in the short term have an inherent mismatch that leaves them constantly at risk. The business models are inherently fragile (particularly when levered as much as the investment banks are/were). Publicly traded guys may be in even more of a risky position since their stock price can work against them if they desperately need to raise capital. It is perfectly rational for capital providers to Morgan and/or Goldman to be nervous. They should be raising their prices, withdrawing their deposits, or moving the brokerage relationships. As I've said many, many times in the past, the basic blocking and tackling of i-banks and commercial banks is a commodity service. No hedge fund manager is getting paid to PB at Morgan. In fact, when Morgan's risk profile rises, the hedge fund manager is kind of getting paid to not PB at Morgan. Where's the upside?

This unwind will continue until financial institutions have delevered and changed their asset/liability mix to such an extent that their soundness is not in question.

If leverage going to be lower, if the asset side needs to be more liquid, and if the liability side needs a longer term-structure, I can assure you the price of money is going to rise. Period. Get ready for it. If you think you're going to need to borrow money in the coming few years, I recommend trying to do it now before the cost catches up with its inevitable future.

Anyway, AIG is dead. Ding dong. As I predicted in my post on AIG when people were talking about potential a "bridge loan" from the Fed but not contemplating brutal dilution/nationalization as a result, AIG got Paulsoned. I am stunned that nobody else saw this outcome coming. This was obviously the new standard. How could they possibly justify giving AIG a better deal than FNM and FRE? They couldn't. It seemed totally obvious to me that if the Feds got involved, the new methodology was nationalization.

Who knew that the US Treasury was really the world's largest LBO fund? Their sourcing edge is fantastic, they never enter a competitive process, and for some reason the targets always take their price. We may get out of this budget deficit yet! Just nationalize a few more world class insurance companies (We The People now own the three largest insurers in the world, since that's what FNM and FRE really are), flip them in five to ten years and...walla! No more deficit!

[as an aside, I'm short GS, LEH, JPM, WFC, WM and MS, so take my opinion with a grain of salt]

AIG - Imminent Doom

Having seen David Faber on CNBC say that the "private" market solution to AIG is definitively dead, we now look on at a potential government bailout of the insurance and investment behemoth.

I've handicapped the odds of a government intervention as 60%. So, that means 40% odds of an outright bankruptcy and likely zero recovery for shareholders. Within the 60 points of government intervention, I'd put 50 of them on a Fannie/Freddie type bailout, which means that equity holders get diluted into oblivian and sub-debt holders are at substantial risk. In fact, I'd suspect that the Fed loan would be super-senior to everything accept policy holders and thus everything in the capital structure would get crammed down and the profit motive of the institution will be questioned (a scenario where equity is diluted 80% but the company is worth less than if it remained private). The other 10 points of odds I'd place on a non-dilutive loan that effectively lets AIG continue to prosper and does not kill the current equity holders. In that scenario, AIG may be worth well over $20/share. So, if I probability weight the outcomes:
40% x $0 +
50% * $4 +
10% * $25 =
$4.50/share of probable value.

I'd demand a fair margin of safety to that given the risk of immediate and total loss. I'd buy at less than $1/share, hold below $2.25 and not want to be involved above that. [MY VIEWS SHOULD NOT BE CONSTRUED AS INVESTMENT RECOMMENDATIONS, JUST BACK OF THE ENVELOPE ANALYSIS]

AIG Hits for the Cycle: Downgraded by All Three Major Ratings Agencies in a Three Hour Span

Today was a big one on the richter scale. You don't get too many of these in your life, so I'm taking it all in while it is happening, painful as that may be. And the hits keep coming.

In addition to Lehman filing BK, the Dow dropping 500+ points (the S&P declined nearly 5%!), and Merrill being taken out for what was initially a 50+% premium and NOT f'ing BUDGING (it closed up $0.01 at $17.06) AIG is on the brink.

AIG is in real trouble. It is suffering from taking the wrong side of a massive, correlated bet on mortgage related assets (especially ABS CDOs) expressed via CDS. As these trades crater and create a hole in the middle of AIG's balance sheet, credit ratings agencies have threatened to downgrade AIG unless it raises funds to replenish that hole. AIG is letting on today that the size of its capital needs are somewhere between $40 billion and $75 billion. You know... pocket change.

The magnitude of AIG's potential capital shortfall combined with threat of downgrade of course has made the hole filling process much more difficult as the share price has cratered and credit spreads on AIG have launched out to distressed spreads. This has all but made raising capital via traditional means impossible. AIG is now contemplating selling some of its prized assets such as its aircraft leasing business, but a) comps are trading horribly (see ticker AYR) and b) it will take months to actually receive the cash from a sale that size.

So, AIG is in quite a bind. As a result, they asked the Fed for a $40-$50 billion loan, which it seems the Fed denied on the basis that AIG is not under the Fed's regulatory purview. AIG then managed to hoodwink the state of NY into allowing AIG to take its illiquid crap and use it as collateral to borrow $20 billion from its insurance subs. This is of course insanity as the policy holders are now being put at risk by a problem that has nothing to do with them or the entity with whom they have contracted (I smell.....lawsuits!). That of course does not solve anything as it just shuffles the losses around for a period of time. So, the Fed is apparently "encouraging" Goldman Sachs and JP Morgan to lead a consorsium in putting together a $70 billion (with a B) loan facility for AIG to tap (this of course is seperate and distinct from the cross collateralized $70 billion "Private Fed"/loan facility that 10 banks organized yesterday).

What I find just a remarkable "coincidence" about this new $70 billion facility is that it is being talked about a mere 24 hours after the Fed significantly expanded the acceptable collateral for its lending facilities. That expansion was of course a page A18 news event for the WSJ, basically lost in the commotion. However, the conspiracy theorist in me sees these two actions as highly connected. Basically, if JP Morgan and Goldman assemble this facility, my suspicion is they will take qualifying collateral from AIG, make a loan against that collateral at a modest spread to Fed borrowing rates, then take that collateral and post it to the Fed pocketing a largely risk free arb.

This of course is similar (though slightly different) to when the Fed allowed Bear to access it via JP Morgan as a conduit. The difference is a) the Bear deal was perfectly transparent; and b) JP Morgan didn't receive a spread, to the best of my knowledge.

Maybe I'm just seeing black helicopters, but it sure seems like a remarkable coincidence to me. This has Timothy Geithner's fingerprints all over it.

As an aside, I said when the Merrill deal was announced that this is the riskiest merger arb I've ever seen, so trading at a wide spread is perfectly rational. If somehow the MER/BAC deal breaks, Merrill is a zero and BAC may skyrocket. That's a dangerous deal to arb so the arbs are going to demand to get paid. The nearly $6 spread that exists today is a reflection of that. Ken Lewis today said that the break-up fee was "expensive" and intentionally so, but my guess is that he views the Merrill deal as a call option where the option price is the break-up fee. Probably a pretty rational approach, frankly.

AIG Could Fail 48-72 Hours After a Ratings Downgrade

Wow. How do you let your business run on such a razor thin edge? This artThis article by the NY Times says that AIG will have to come up with $14-18 billion of cash upon a single step ratings downgrade. The article also states that a person "close to the firm" said AIG may survive a mere 48-72 hours if a downgrade were to occur. The implications of that are mindboggling. This is a world-caliber company.

I imagine Buffett is licking his chops. He runs the only other world-caliber re-insurer and the opportunity to either buy AIG on the cheap or take business from it while it languishes justify every dollar of capital he has kept close to the Omaha headquarters over the past six years. Has there ever been a greater investing genius - he warned us years ago about "financial weapons of mass destruction" (derivatives) and sold Freddie after it started expanding from its G-fee business. As equity markets ran up over these past few years, he has husbanded cash more and more aggressively and now it appears that Berkshire's time has come. Amazing.

HOLY F'ING SHIT

Well, I'm not even going to try to link this. Just go to any news site. Let's just say that the future of the Western financial system has clearly taken a left turn. Regulation? Taxes? Inflation? Higher borrowing costs? These are all in our future.
In the past six months:
- Bear Stearns goes down
- Lehman goes down
- Merrill goes down
- AIG tells the Fed it needs a $40 billion loan in order to keep its credit rating (doesn't that mean it has already lost its rating...can you be Double A rated if you occasionally need a $40 billion short term loan to avoid a death spiral)
- Freddie Mac goes down
- Fannie Mae goes down
- Ten investment banks pool $70 billion to protect against bank runs
- The Fed offers to take equity...Equity...EQUITY as collateral. EQUITY!?!?!?! I mean, how long until hedge funds start shooting at the Fed balance sheet? I'm guessing it's a matter of days

Can I say that Ken Lewis has no balls? There's no way that Merrill doesn't open as a low teens or lower stock price on Monday and he pays $29/share. Helicopter Ben and his Boy Wonder Tim Geithner have their hands all over this.

I put in an order for $800 calls on gold on Friday and my order never hit. Ugh. Couldn't be more pissed about that.

Addition:
It seems absolutely clear to me that the $70 billion bank capital pool is in place to protect the next weakest player. I suspect Morgan Stanley and, to a lesser extent, Goldman Sachs are shitting their pants. This is a Morgan Stanley prop. And they are smart to do so. Without this, Morgan Stanley would be under attack on Monday. And, frankly, they may very well still be under attack. And if the attack happens fast enough and hard enough, it will weaken several of the other members of the liquidity pool.

Strap your boots on. Hope everyone is prepared to be a fully equitized buyer of assets going forward...

Barclays Pulls Out of Lehman Talks AND AIG Needs to Raise $30-$40 BILLION

"Nothing to see here. Nothing to see here. Don't worry, the 'subprime crisis' is contained. Keep moving. Nothing to see here."

Honestly, the guys who were trying to sell us this pile of shit are either morons, totally removed, or liars. Given that the group includes Hammerin' Hank Paulson, Helicopter Ben Bernanke, Glorified Jamie Dimon, and Ken Dancing Fool Lewis, I'm going to have to guess that it's some combination of the latter two choices plus some willful self dilusion. If it is not clear to everyone that we are facing an epic financial crisis triggered by loose credit on assets at inflated prices in virtually every asset class, then it will never be clear.

In the past WEEK, we have seen Fannie and Freddie merged with the US Gov't (heretofore Treasie Mae and Feddie Mac), Lehman's effective failure, allegations that AIG needs to raise $30 to $40 billion in order to avoid a "severe credit downgrade", Merrill Lynch gathering some taint, and Washington Mutual approaching the edge. And the US stock market barely budged from last Friday's close to this past Friday. Down a smidge, but not much.

[See NY Times article on Lehman and AIG here]

At some point, people are going to realize that a persistently dwindling availability of credit and that credit which is available is only at more expensive prices (gov't subsidies not withstanding - GSEs) is extremely bad for asset prices of all kinds. When we begin a society where valuations are predicated on attractive returns to an all over primarily all equity buyer, we will have achieved a real bottom. Until then, I think we should remain a bit worried.

The coming week should be exciting.

Lehman on the Brink

First off, I'll say that the odds of Lehman making it to next Monday bearing semblance to its current self are 50:50, at best. Honestly, they are probably lower than that. As the old Wall Street adage goes (paraphrasing), "once you have to defend your financial reputation, you have lost it." Tomorrow at 7:30, Lehman appears prepared to vigorously defend its financial reputation after its 50+% stock price decline from yesterday's early morning peak (immediately after the GSE bailout) of $17.40 or so to today's close of seven dollars and change ($7.79).

First off: wow.

Second off: honestly, wasn't it so obvious that Lehman was in trouble as soon as Bear went down? Aren't they the next logical domino?

I emailed my Little Brother (LB) today when Lehman was somewhere around ten bucks and said, "this feels a lot like March 14th." If you read the email I sent around on March 16th about 30 minutes before Bear was purchased (though penned hours before), so much of the same applies. If you haven't read that post, and I suspect you haven't, please take a few minutes to do so.

If you are a hedge fund manager, it's been a rough year. Long days, sleepless nights. The volatility seems unending. Huge commodity rally. Huge commodity collapse. Financials just keep trending down, but occasionally interspersed are "12 sigma" rallies in the sector. Seems like everyday has been some new pain. Well, let me tell you what ails Johnny Hedge Fund Manager today: he is being pinged by client after client with the following simple question: "what is your counterparty and prime brokerage exposure to Lehman?" Let me tell you what he wants to answer: "zero exposure." Worst case, his response is, "we have some modest amount of exposure that we are in the process of unwinding."

There goes Lehman's liquidity. An institutional run on the bank. Again, I will state: IT DOES NOT MATTER THAT FEDDIE MAC OR TREASIE MAE ARE PROVIDING LIQUIDITY TO LEHMAN, NOBODY IS GETTING PAID TO TAKE LEHMAN COUNTERPARTY EXPOSURE. IN SOME SENSE, HEDGE FUND MANAGERS, ET AL, ARE GETTING PAID TO NOT TAKE LEHMAN EXPOSURE.

Just think about it. If I have some swaps on with Lehman, why on f'ing Earth would I not either just unwind the trade or, since they both claim to be perfectly happy taking Lehman counterparty exposure, novate the trade to JP Morgan or Goldman. Let someone else deal with it. Johnny Hedge Fund Manager is not getting paid for his Lehman counterparty exposure, so he's either already walked or is tying his laces right now.

The more you think about it and the more obvious it becomes. Nothing that any of the dealers or big bank counterparties provide is of anything more than a commodity value. Hedge funds and other investors do not get paid to take counterparty exposure, so they want as little counterparty risk as possible. Period.

Lehman? Dunzo.

It's a Wonderful Life, aka The Nationalization of Bear

Given the precipitous decline in the value of Lehman today, I thought I'd reprise an email I sent around to most of my co-workers and a bunch of friends and family on Sunday March 26th, 2008 at exactly 7:00 pm EST. About 25 minutes later the news broke that JP Morgan was going to buy Bear for $2/share with Fed and Treasury backing. Now, in retrospect, my email may not seem so crazy, but I can assure you that when I first sent the email, it was basically an alarmist missive. $2/share was not in the collective consciousness and Bear's collapse, much less acquisition, was still anything but a certainty. Anyway, I wasn't actively blogging then, so it's not on The Investment Linebacker. It applies virtually in its entirety again today. As an aside, I went short Lehman that next day in the high $20s/share. Lehman proceeded to rally all the way into the $40s before collapsing back down to today's close (I have not added to nor covered any of my position). Here's what I wrote:

All weekend I've been thinking about the fact that on Friday, our Federal government basically offered to nationalize Bear Stearns and that nobody is talking about it. People are saying the Fed is "providing liquidity to Bear" via the JP Morgan conduit, but, barring a deal for someone to buyout Bear by Monday before the market opens (and perhaps even that won't matter - more on that below), I cannot see how that liquidity conduit doesn't become a defacto nationalization.

Bear's problem is perception. As Robert Rubin says (paraphrasing), "liquidity is a psychological phenomenon, not a monetary phenomenon." I was using that quote a year ago when we were pitching the puts to clients who were wary of betting against the "Wave of Liquidity" in the market [TTB - long story, but suffice it to say that is a position that worked out well]. Well, psychology has changed and Liquidity seems to be rooming with the dodo and Amelia Earhart in the Lost City of Atlantis for the time being.

It is a fact that as of Wednesday a.m., Bear had ample "liquidity" but rather than a wave of liquidity, a tsunami of rumors and fear hit the Street sometime on Wednesday or Thursday and there was effectively a run on the bank. George Bailey's, I mean Alan Schwartz's, best efforts aside, the reality is most banking services are commodity-esque and no client is getting paid to use Bear. Every manager we know is taking actions to shut down all relations with Bear. And why shouldn't they? What's the upside? You can get the exact same product across The Street from any number of competitors.

Thanks to the Fed liquidity conduit, Bear is taking illiquid/trashy assets, sending them to the Fed via JPM as collateral and turning them into cash to handle the run on the bank. Great for customers of Bear and possibly for equity holders of Bear, bad for equity holders in the company that goes by the ticker "USA". It is as if the Fed is running a pawn shop minus the profit motive and asset assessment capabilities. Thus, as the run on Bear accelerates, you and I (via our gov't) will increasingly be exchanging more and more of our cash for Bear's assets. I'm afraid our citizenry has unwittingly entered the Loan to Own business but we don't have David Tepper making the loans, we have Chairman Bernanke and his foresight is obscured by the clouds of freshly minted cash raining from his helicopters. In the end, when Bear declares bankruptcy (I give it a week), the Fed will be holding most of Bear's collateralizeable assets and it will have basically nationalized Bear via that liquidity conduit. It should be Bear's equity holders, customers and counterparties that take that risk, but the moral hazard inherently produced by the Fed is being run through a Cuisinart, sucked into a syringe and mainlined by the market right now "...oh, it feels so good...oh, I need another hit...don't make me wait...what do you mean only the first one was a freebie?!?!"

There are lots of rumors swirling that Bear is going to be acquired. It better happen before the start of business tomorrow (Monday a.m.) or else that swirling sensation won't be rumors, it will be a turd-shaped Bear Stearns spinning down the toilet and flowing into a governmental sewage treatment plant. But the reality is, it is too late already. They can announce a deal tonight or Monday, but the deal won't close for a month (and one month from announce to close would set a new land speed record).

So what happens during that month? What client is going to stick around saying, "well, even though EVERYBODY else is pulling their money from the bank, I'm going to hang around because I'm dying to be a J.P. Morgan Stearns & Co. client"? What counterparty is going to say, "sure, I'll take Bear's credit for the next month...I mean, what can change in a month"? I honestly cannot imagine any rational (or irrationally fear driven, for that matter) person saying that to themselves. Why not take Goldman's credit, or JP Morgan directly, or B of A, or Morgan Stanley, or even Citi? Why on Earth would you take Bear? It's not as if Bear offers some magical access that those players can't match? Every manager we have is walking from all things Bear. So, even if John Pierpont Morgan & Company announces the acquisition, The Bear is Dead. If you want to deal with JP Morgan, pull your assets from Bear and pick-up a phone. I suspect someone at Morgan will answer the other end. I also presume JP carved out "bankruptcy" as a MAC clause.

That comes back to our nationalization.

It also leads to the inevitable next question of "who is next?" Welcome to the hell Lehman Brothers is about to face. My $100 bet against my [Little Brother] notwithstanding, he is right that they are perceived as the next weakest player in our game of Wall Street Roulette. Would you want Lehman credit risk right now? Me neither. We are not the sharkish killers that encircle the island of Manhattan. If the allegedly "contained subprime problem" (which one of those words is least accurate? Seriously, that's a tough question!) lethally infects anyone else, it is Lehman. And as we saw with Bear, it only takes some rumors mixed with some fear to create a lethal dose. I would not want to go into the week short a Rumors and Fear ETF, that's for damned sure. Conversely, I absolutely want to go into this week short Lehman.

A Lehman failure would surely test our Fed. Could they even afford to bailout two major Wall Street banks in less than one month? I'm sure they are asking "can we afford not to?"

From a Main Street perspective, these are two of the banks that caused the problems we are facing in the first place. And if one bailout could not stop the contagion, why do we think two will? Will the more voter-sensitive parts of our government have the cajones to let that happen? Fascinating questions that I am hoping will not have to be answered. Sadly, I am worried that unless everything goes the collective's way, those question are going to be unavoidable.

As an aside, I don't know if anyone noticed but there is a presidential election going on right now and the race to create the most populist platform may, ironically, lead to the most capitalistic outcome: "screw Wall Street, let those companies fail." Who knows?

So, what do we do? Can we profit from this or at least protect value?

Well, the puts will help, but if we have a major Wall Street bank or two fail, I suspect we will blow through the short/spread part of the sale, so they will only help in a limited way. We could short a basket of financials, but that's truly a speculation at this point and we clearly won't be able to get client approval in any reasonable time frame. The distressed mortgage arena will get cheaper, as will distressed assets of all kinds. But they may be cheap for a good reason. If credit ceases to be available for anything other than assets with a ton of equity and at higher interest rates, asset values will rightly fall to a range that generates a return for less levered owners. That part of the credit unwind may, in and of itself, cause more pain.

The Fed is running dangerously low on ammo. We already have negative real rates on Treasuries and TIPS. The Fed has created hundreds of billions of dollars of liquidity availability for Wall Street. They have offered to nationalize a major Wall Street investment bank. Nothing's worked. The Federal government is literally printing money and mailing it to Main Street to stimulate spending via the one time tax "rebate" (is it really a rebate if you don't pay taxes in the first place or is that just confiscating from the wealthy to give to the majority?). Just what Johnny Consumer needs to do: spend more! Isn't that part of why we are in this hell hole to being with?

So, I may be Chicken Little looking up at the sky and warning that the end is nigh, but the tenuous strings of massive leverage that Wall Street has built its sky scrapers on certainly seem to be straining.

In summary, I would be short the dollar, short the long bond, short stocks, long currencies of creditor nations, long inflation (after a potential period of deflation, due to the credit unwind), long liquidity, and I'd continue to prepare to be long distressed credit assets.

Strap your boots on, the ride is about to get rocky.

-[TTB]

Treasie Mae's GSE Bailout Threatens the Solvency of Dozens of Banks

This morning's Washington Post has a front page story on the difficulties several small banks are facing as a result of Treasie Mae's decision to crush the preferreds as part of its GSE intervention. A CEO of a Virginia based bank that is quote, "on the bubble" put it this way. "I'm angry." Indeed.

Hammerin' Hank and Jim Lockhart Shed Light on the Merger of the US Gov't and the GSEs

Scary stuff (full text below). Paulson tries to assure folks that these institutions are different than banks, so don't worry about banks. He's of course right. On the negative, they have more leverage. On the positive, they have a much better funding source and generally better assets. Lockhart (the new regulator in charge of the GSEs) goes on to say that they've done an analysis and they believe only a few small banks will be badly damaged by the losses the GSE common and preferred are likely to eat. He then goes on to say that this should not reflect on the market for preferreds in general, that the GSEs are unique in their badness.

It seems that the basic structure is not what was rumored. In fact, Treasury Mae has created a new more senior preferred equity that will ensure that the net worth of the entities relative to sub-debt and senior is positive. Not good for the common equity or the existing preferred equity!:

Basics of the deal:
- Allow the GSE mortgage portfolios to modestly grow through the end of next year so as not to shock the housing market with a mortgage vacuum, then begin shrinking the portfolios at 10% per year [hopefully the market's discounting mechanism doesn't take that into account!]
- Gov't funds new senior cumulative preferred securities on an as needed basis and receives a 10% annualized return plus warrants
- Gov't provides secured line of credit for continued funding of core mortgage business
- Gov't going to start buying GSE MBS to support that market

I like this Jim Lockhart guy that runs the new GSE regulator. Seems like a straight shooter. Statements below:
Link here to Bloomberg Article

Paulson Statement on U.S. Action on Fannie, Freddie: Text
Sept. 7 (Bloomberg) -- Following is the text of a statement by U.S. Treasury Secretary Henry Paulson on the U.S. government takeover of mortgage companies Fannie Mae and Freddie Mac:

Good morning. I'm joined here by Jim Lockhart, Director of the new independent regulator, the Federal Housing Finance Agency, FHFA.

In July, Congress granted the Treasury, the Federal Reserve and FHFA new authorities with respect to the GSEs, Fannie Mae and Freddie Mac. Since that time, we have closely monitored financial market and business conditions and have analyzed in great detail the current financial condition of the GSEs - including the ability of the GSEs to weather a variety of market conditions going forward. As a result of this work, we have determined that it is necessary to take action.

Since this difficult period for the GSEs began, I have clearly stated three critical objectives: providing stability to financial markets, supporting the availability of mortgage finance, and protecting taxpayers - both by minimizing the near term costs to the taxpayer and by setting policymakers on a course to resolve the systemic risk created by the inherent conflict in the GSE structure.

Based on what we have learned about these institutions over the last four weeks - including what we learned about their capital requirements - and given the condition of financial markets today, I concluded that it would not have been in the best interest of the taxpayers for Treasury to simply make an equity investment in these enterprises in their current form.

The four steps we are announcing today are the result of detailed and thorough collaboration between FHFA, the U.S. Treasury, and the Federal Reserve.

We examined all options available, and determined that this comprehensive and complementary set of actions best meets our three objectives of market stability, mortgage availability and taxpayer protection.

Throughout this process we have been in close communication with the GSEs themselves. I have also consulted with Members of Congress from both parties and I appreciate their support as FHFA, the Federal Reserve and the Treasury have moved to address this difficult issue.

Before I turn to Jim to discuss the action he is taking today, let me make clear that these two institutions are unique. They operate solely in the mortgage market and are therefore more exposed than other financial institutions to the housing correction. Their statutory capital requirements are thin and poorly defined as compared to other institutions. Nothing about our actions today in any way reflects a changed view of the housing correction or of the strength of other U.S. financial institutions.

***

I support the Director's decision as necessary and appropriate and had advised him that conservatorship was the only form in which I would commit taxpayer money to the GSEs.

I appreciate the productive cooperation we have received from the boards and the management of both GSEs. I attribute the need for today's action primarily to the inherent conflict and flawed business model embedded in the GSE structure, and to the ongoing housing correction. GSE managements and their Boards are responsible for neither. New CEOs supported by new non-executive Chairmen have taken over management of the enterprises, and we hope and expect that the vast majority of key professionals will remain in their jobs. I am particularly pleased that the departing CEOs, Dan Mudd and Dick Syron, have agreed to stay on for a period to help with the transition.

I have long said that the housing correction poses the biggest risk to our economy. It is a drag on our economic growth, and at the heart of the turmoil and stress for our financial markets and financial institutions. Our economy and our markets will not recover until the bulk of this housing correction is behind us. Fannie Mae and Freddie Mac are critical to turning the corner on housing. Therefore, the primary mission of these enterprises now will be to proactively work to increase the availability of mortgage finance, including by examining the guaranty fee structure with an eye toward mortgage affordability.

To promote stability in the secondary mortgage market and lower the cost of funding, the GSEs will modestly increase their MBS portfolios through the end of 2009. Then, to address systemic risk, in 2010 their portfolios will begin to be gradually reduced at the rate of 10 percent per year, largely through natural run off, eventually stabilizing at a lower, less risky size.

Treasury has taken three additional steps to complement FHFA's decision to place both enterprises in conservatorship. First, Treasury and FHFA have established Preferred Stock Purchase Agreements, contractual agreements between the Treasury and the conserved entities. Under these agreements, Treasury will ensure that each company maintains a positive net worth. These agreements support market stability by providing additional security and clarity to GSE debt holders - senior and subordinated - and support mortgage availability by providing additional confidence to investors in GSE mortgage backed securities. This commitment will eliminate any mandatory triggering of receivership and will ensure that the conserved entities have the ability to fulfill their financial obligations. It is more efficient than a one-time equity injection, because it will be used only as needed and on terms that Treasury has set. With this agreement, Treasury receives senior preferred equity shares and warrants that protect taxpayers. Additionally, under the terms of the agreement, common and preferred shareholders bear losses ahead of the new government senior preferred shares.

These Preferred Stock Purchase Agreements were made necessary by the ambiguities in the GSE Congressional charters, which have been perceived to indicate government support for agency debt and guaranteed MBS. Our nation has tolerated these ambiguities for too long, and as a result GSE debt and MBS are held by central banks and investors throughout the United States and around the world who believe them to be virtually risk-free. Because the U.S. Government created these ambiguities, we have a responsibility to both avert and ultimately address the systemic risk now posed by the scale and breadth of the holdings of GSE debt and MBS.

Market discipline is best served when shareholders bear both the risk and the reward of their investment. While conservatorship does not eliminate the common stock, it does place common shareholders last in terms of claims on the assets of the enterprise.

Similarly, conservatorship does not eliminate the outstanding preferred stock, but does place preferred shareholders second, after the common shareholders, in absorbing losses. The federal banking agencies are assessing the exposures of banks and thrifts to Fannie Mae and Freddie Mac. The agencies believe that, while many institutions hold common or preferred shares of these two GSEs, only a limited number of smaller institutions have holdings that are significant compared to their capital.

The agencies encourage depository institutions to contact their primary federal regulator if they believe that losses on their holdings of Fannie Mae or Freddie Mac common or preferred shares, whether realized or unrealized, are likely to reduce their regulatory capital below "well capitalized." The banking agencies are prepared to work with the affected institutions to develop capital restoration plans consistent with the capital regulations.

Preferred stock investors should recognize that the GSEs are unlike any other financial institutions and consequently GSE preferred stocks are not a good proxy for financial institution preferred stock more broadly. By stabilizing the GSEs so they can better perform their mission, today's action should accelerate stabilization in the housing market, ultimately benefiting financial institutions. The broader market for preferred stock issuance should continue to remain available for well-capitalized institutions.

The second step Treasury is taking today is the establishment of a new secured lending credit facility which will be available to Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. Given the combination of actions we are taking, including the Preferred Share Purchase Agreements, we expect the GSEs to be in a stronger position to fund their regular business activities in the capital markets. This facility is intended to serve as an ultimate liquidity backstop, in essence, implementing the temporary liquidity backstop authority granted by Congress in July, and will be available until those authorities expire in December 2009.

Finally, to further support the availability of mortgage financing for millions of Americans, Treasury is initiating a temporary program to purchase GSE MBS. During this ongoing housing correction, the GSE portfolios have been constrained, both by their own capital situation and by regulatory efforts to address systemic risk. As the GSEs have grappled with their difficulties, we've seen mortgage rate spreads to Treasuries widen, making mortgages less affordable for homebuyers. While the GSEs are expected to moderately increase the size of their portfolios over the next 15 months through prudent mortgage purchases, complementary government efforts can aid mortgage affordability. Treasury will begin this new program later this month, investing in new GSE MBS. Additional purchases will be made as deemed appropriate. Given that Treasury can hold these securities to maturity, the spreads between Treasury issuances and GSE MBS indicate that there is no reason to expect taxpayer losses from this program, and, in fact, it could produce gains. This program will also expire with the Treasury's temporary authorities in December 2009.

Together, this four part program is the best means of protecting our markets and the taxpayers from the systemic risk posed by the current financial condition of the GSEs. Because the GSEs are in conservatorship, they will no longer be managed with a strategy to maximize common shareholder returns, a strategy which historically encouraged risk-taking. The Preferred Stock Purchase Agreements minimize current cash outlays, and give taxpayers a large stake in the future value of these entities. In the end, the ultimate cost to the taxpayer will depend on the business results of the GSEs going forward. To that end, the steps we have taken to support the GSE debt and to support the mortgage market will together improve the housing market, the US economy and the GSEs' business outlook.

Through the four actions we have taken today, FHFA and Treasury have acted on the responsibilities we have to protect the stability of the financial markets, including the mortgage market, and to protect the taxpayer to the maximum extent possible.

And let me make clear what today's actions mean for Americans and their families. Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe. This turmoil would directly and negatively impact household wealth: from family budgets, to home values, to savings for college and retirement. A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance. And a failure would be harmful to economic growth and job creation. That is why we have taken these actions today. While we expect these four steps to provide greater stability and certainty to market participants and provide long-term clarity to investors in GSE debt and MBS securities, our collective work is not complete. At the end of next year, the Treasury temporary authorities will expire, the GSE portfolios will begin to gradually run off, and the GSEs will begin to pay the government a fee to compensate taxpayers for the on-going support provided by the Preferred Stock Purchase Agreements. Together, these factors should give momentum and urgency to the reform cause. Policymakers must view this next period as a "time out" where we have stabilized the GSEs while we decide their future role and structure.

Because the GSEs are Congressionally-chartered, only Congress can address the inherent conflict of attempting to serve both shareholders and a public mission. The new Congress and the next Administration must decide what role government in general, and these entities in particular, should play in the housing market. There is a consensus today that these enterprises pose a systemic risk and they cannot continue in their current form. Government support needs to be either explicit or non-existent, and structured to resolve the conflict between public and private purposes. And policymakers must address the issue of systemic risk. I recognize that there are strong differences of opinion over the role of government in supporting housing, but under any course policymakers choose, there are ways to structure these entities in order to address market stability in the transition and limit systemic risk and conflict of purposes for the long-term. We will make a grave error if we don't use this time out to permanently address the structural issues presented by the GSEs.

In the weeks to come, I will describe my views on long term reform. I look forward to engaging in that timely and necessary debate.

Editor: Christopher Wellisz

To contact the reporters on this story: Craig Torres in Washington at +202-654-1220 or ctorres3@bloomberg.net

To contact the editor responsible for this story: Chris Anstey at +1-202-624-1972 or canstey@bloomberg.net

Last Updated: September 7, 2008 11:31 EDT

Announcement: Treasury and Fed Merge with Fannie and Freddie. New Entities to be Called Treasury Mae and Feddie Mac

I am really considering this as a merger of equals between the GSEs and the Federal Government, rather than a takeover. They have approximately the same amount of debt and, arguably, the GSEs are better run: they only recently began generating losses.

Heretofore, it will be Treasury Mae and Feddie Mac run by their respective bureaucrats Hammerin' Hank and Helicopter Ben.

Here is this a.m.'s NY Times article on the subject by Gretchen Morgenson. It begins to lay the legal groundwork for Treasury Mae's action: the companies were stretching the truth about their capital position (something the shorts have been saying publicly for a year, so to this is just an excuse). The article actually implies holders of the common and the preferred will suffer, which contradicts yesterday's leaks. I don't see how the common keeps any value if the preferred suffer. More fodder for lawsuits if they decided to ignore seniority and subordination within the capital structure.

Also here's an article from Business Week about how the GSEs were blind to the housing crisis.

US Treasury to Officially Merge with Fannie and Freddie

WASHINGTON -- The U.S. Treasury today announced its intention to take a majority stake in two formerly "private" institutions, Fannie Mae and Freddie Mac.

Secretary of the Treasury, Henry "Hammerin' Hank" Paulson said of the merger, "this is an exciting day for taxpayers. We arbitrarily decided to nationalize two companies that had not failed and had maintained capital at ratios that we had mandated for them to maintain. While some people, particularly the companies' existing shareholder base, may believe this is at best an inappropriate use of The Treasury's power and at worst illegal, we believe that nationalizing valuable assets at cheap prices is GRRRRRR-EATT! for tax payers, of which I have been and expect to continue to be a large one."

CEOs Danny Mudd and Dick Syron released a joint statement on the matter. "We are really excited for the new shareholders - US Taxpayers. While we both will be fired for no apparent reason, we think it is totally appropriate that Fed. Chairman Ben S. Bernanke is the person who actually gave us our pink slips. It is appropriate because of the embedded irony given his heavy involvement in the Fed's inflationary policy that led to the speculative bubble in housing in the first place. In some sense, he is a genius, albeit an evil genius, for his ability to avoid all the blame that he is rightfully due and actually end up with substantial control over the entire "private" US Financial system. He fascinates us. Oh, and f*$% you Hank."

Here's the WSJ's take on the Treasury's plan.

Now that the US Treasury controls the entities responsible for keeping the domestic housing market from collapsing, I am sure that a profit motive will continue to guide the businesses. I'm sure that our government will make nothing but rational economic decisions with regards to who will receive financing and the terms on which they will receive it.

I have, since July 23rd, owned Dec. 08 $6 puts on Freddie given the Treasury was basically telling us that equity holders were going to eventually be wiped out (or massively diluted). Despite my sarcasm above, I actually think this is a creative solution to the problem as the dilution will only occur on an "as needed" basis. It appears that Hammerin' Hank will only add capital as holes appear, so the ultimate dilution/ownership by the Treasury is TBD. However, I strongly suspect that the market is going to crush the shares as people come to the realization that persistent dilution is a near certainty. The problem is, the lower the stock price, the greater the dilution will be as the Trerasury will acquire more shares per dollar injected as the share price declines. Due to this self fulfilling dilutionary death spiral, I think most equity holders will choose not to take the risk of being diluted into oblivion.

Really, my biggest issue with this entire plan is that the government appears ready to protect the preferreds and sub-debt holders.

As I discussed a few weeks ago, a huge portion of the preferreds is in the hands of regional banks and foreign governments/Sovereign Wealth Funds. The Treasury depends on those same foreignors to continue to fund our government's profligate spending and many banks that own these securities are already suffering from capital shortages. So, the Treasury is understandably concerned about wiping those securities out. HOWEVER, that means that you and I, John Q. Taxpayer are going to take the hit. In order to protect these idiots from their own stupid capital allocation decisions, we will yet again subsidize their existence. We already subsidize them through underpriced FDIC insurance, artificially low interest rates (this basically takes money from savers and uses it to line the pockets of banks), and a Federal lending backstop. Well, these preferreds are only a mere $36 billion and the sub-debt is Lord knows how many tens of billions more. I mean, what's $50 to $100 billion amongst friends? It's just money that our citizenry is giving to foreign governments and private companies.

Happy Birthday China! Merry Christmas Regions Financial!

On another note, these preferreds have been popular shorts amongst hedge funds. Sucks to be those shorters! The preferreds, in broad strokes, have been trading at 50% of face. If the Fed is going to take them out at par (I can't imagine they guarantee them, or else they'll trade way past par), then that's an up 100% move which will sting a little tiny bit. If, for some reason, the Fed doesn't actually call them at par but instead guarantees them, they should trade through par until the dividend begins to converge with Treasuries, which would be much more than a 100% move (closer to a 300% move!).

Of course, some hedge funds almost certainly have on long preferred/short equity paired trades. For those with that combo on, this will be an epic homerun of an investment. This should be fascinating.

Strap your boots on.

Silver State Bank Put to Sleep By State of Nevada Regulators and FDIC

Well, #49 on our bank failure watchlist, Silver State Bank, was killed off yesterday. It is a $2.0 billion asset bank with $1.7 billion of insured deposits. I haven't done the analysis, but I suspect the greater the ratio of insured deposits to total assets, the worse it is for the FDIC. The FDIC expects to lose $450-550 million on this nationalization. That's 22.5% to 27.5%, which reflects the general upward trend in expected losses that we've noticed over the past month.

On a personal note, it's good to see Nevada put another point on the board. Up until now, they'd only had one of 2008's ten bank failures happen in their state. Given it is home to one of the four epicenters of the housing debacle (Inland Empire, South Florida, Pheonix, Vegas), I'd hate to see them get lapped by some of their rivals.

Here is the WSJ's take on the Silver State Bank collapse.

The Unders have had quite a run with one bank being taken down basically every week for two months. I expect the pace will do nothing but grow over the next six-plus months.

Adendum
It has occurred to me that really the loss rate is not insured deposits to total assets but (insured deposits + FHLB and other senior to the FDIC borrowings) / total assets.

Bank Failure Watchlist

Saw this bank failure watchlist and thought I'd share it. I think it's not as up to date as it ought to be, as Vineyard Bancorp's numbers appear to be too high (it's ranked #107 last I checked with Tier I capital and leverage ratios that appear much stronger than they reported in their recent 10-Q). That said, it is a pretty good automated list to work from and I expect that most of the top 150 (and more) either outright fail or are "acquired".

It doesn't look pretty. Better go home and get your boots.

Integrity Bank in Alpharetta, Georgia Goes Down. Any more to come?

FDIC website. A $1.1 billion asset bank. I'd guess a $200 million to $250 million loss to the FDIC insurance fund. Good to see some geographic diversity to the failures. Not just California and Florida. Last week Kansas, this week Georgia. Diversity rules.

Correction:
Somehow I missed in my first scan of the press release that the FDIC expects losses to range from $250 million to $350 million which is 23%-32% of assets. This indicates that loss ratios are getting worse, not better. Particularly when considered in the context of the IndyMac trend referred to in my prior post.

FDIC Announces IndyMac Losses Approaching $9 billion; Predicts Depositor Insurance Will Need to be Socialized

Seriously? $9 billion of losses on IndyMac? When they took IndyMac down, they announced losses would be between $4 and $8 billion. After a few weeks, they announced it would be over $5 billion. Now, just two months later, we are at $9 billion?

How on Earth does anyone trust the balance sheet of any bank???!!!???!!! This is coming from the FDIC. Sheila Bair has been nothing if not straightforward. They don't have the same incentive to lie and deceive that bank management teams have. So, even in their effort to be realistic, they've mis-estimated the magnitude of the problem at one medium sized bank by a mile.

Makes me wonder if perhaps one lesson they have learned is to euthanize broken banks sooner...

It is not as if we are talking about Bank of America where a couple billion is just basis points on its balance sheet. We are talking about a $32 billion asset institution and in two months, the value of its assets has ranged by $4+ billion. If you are levered 12:1 (as a well capitalized bank) and your assets are fluctuating in value by over 10% in two months, your business is broken.

IndyMac is not alone. It does not own uniquely bad assets. While it may be far out on the bad spectrum, it is certainly not alone in its positioning.

What's even scarier is the thought of how much capital it would require to get IndyMac back to "well capitalized". We start with the $9 billion of insured losses (assuming the FDIC doesn't bump this further yet!), add $1 billion of uninsured losses. No we are at a zero equity position. In order to be well capitalized and have some margin for continued deterioration, it probably would require another $2.5 - $3.0. So, just to get the bank back to minimum operating standards, IndyMac would have needed a $12.5 billion injection. Well, that doesn't work from a return standpoint, so nobody in their right mind would be willing to plug that sort of hole (particularly given its lack of any meaningful franchise value).

Now, imagine our good friend Snashington Futual (or SnaFu). SnaFu is 10x the size of IndyMac but claims to have "recapitalized" by raising $7.5 billion. Ha! I laugh at that $7.5 billion. Per the FDIC's own work, that $7.5 billion is nothing in the context of this situation. It is a rounding error.

Also ignored by the mainstream press is that the FDIC is basically stating they expect to blow through their entire deposit insurance fund and may need to rely on the good graces of the American Taxpayer (not that there are many of us left, it seems...and wait until Obama becomes President) via the Treasury to insure further losses. Well, the deposit insurance fund is still about $45 billion strong. Given that losses are averaging more than 20% of assets, the implication of more than $45 billion in losses still to come means that the FDIC is expecting depository institutions with at least $225 billion in aggregate assets to fail in the coming year!!!

How is this not news?! That is failure on a massive, massive scale!

Strap your boots on, the carnival is just getting underway.

Fannie and Freddie Preferreds Could Cause Bank Failures

Honestly, this is all so awesome in some horrible way.

I understand that dealing in schadenfreude is a dangerous game, but really, was this so hard to see coming?

This excellent Washington Post article from today's paper talks about the fact that the preponderance of the $36 billion of Fannie and Freddie preferreds issued in the past year are in either foreign hands or are owned by US banks!

Yes, you read that right. US banks, in the midst of the worst housing crisis since the 1930s, bought billions of preferreds from FNM and FRE despite knowing that both GSEs were suffering enough problems that they needed to recapitalize! Further, the problems Fannie and Freddie are suffering from that caused the need to issue preferreds are housing related...do banks really need to take more US housing market risk? Why add super-levered and super-correlated housing risk to your already troubled balance sheet?

Despite the fact that these preferreds were A rated pieces of paper, the real calculus is this: Fannie and Freddie are massively levered (depending on how you calculate leverage, somewhere between 40:1 and 100:1). That leverage is basically collateralized by mortgages with initial LTVs of somewhere between 20% and 10% as well as a good chunk of third party issued ABS that the GSEs bought for investment purposes (oops!). Freddie and Fannie both had very slim equity cushions supporting the preferreds at the time of issuance and that equity is basically entirely comprised of mortgage/housing related risk.

So, for purposes of this analysis, we can imagine that if FNM and FRE equity (the publicly traded stock) is in the "first loss" position on housing defaults, the preferred is right behind it (second loss), with the US government in the larger "third and final loss" position via its increasingly explicit guarantee of GSE guarantees. Thus, the preferred is much more risky than a diversified pool of mortgages with 20% equity that a bank might typically own, though the preferred holders are compensated by some modest extra yield. Unlike the preferreds, a diversified pool of mortgages represents the entire capital structure of a home behind the owner and any mortgage insurance. So to the extent a bank ties up $500 million of capital in said diversified pool of mortgages, the odds of losing much of it are fairly low. A 5% loss on the pool equates to a $25 million loss to the mortgage holders.

However, by being in the second loss behind the equity in FNM and FRE via the preferreds but in front of $5 or $6 trillion of other folks, the risk of losing a lot on that investment are much, much, much higher. Your $36 billion preferred is less than a 1% sliver in that $5 trillion stack! That relative "thickness" (or, in this case, thinness), is key when compared to the absolute thickness of retaining 100% of a diversified pool of mortgages. The ability to lose your money happens so fast in the preferred that it is basically binary: you either come out whole or lose all your money. That is not the business that traditional banks normally operate within. Given that a bank's own capital structure is already levered 12:1, binary outcomes on large investments are anathema to solvency.

In fact, to the extent that the diversified pool of mortgages is representative of the mortgages FNM and FRE touch, you can imagine that just a small but fast single digit loss on the pool of mortgages may equate to a total wipeout of the equity and the preferreds of the GSEs.

That negative leverage seems to scream to me: Danger, Will, Danger!

It stuns me that folks were still "reaching for yield" from two entities positioned near the eye of the storm while the hurricane was already apparent, gaining strength, and heading for landfall. It is as if a homeowner in New Orleans, on the eve of Katrina, offered All State a little extra premium in order to insure his or her home against a hurricane. Under no circumstance short of enormous premium would All State take that risk and even then, I doubt they'd do it.

But regional banks?

No wonder these banks are all in trouble - they are run by folks that do not understand risk. They literally believe that buying a FNM or FRE A-rated preferred (while the GSEs were already in trouble, so the risk was not exactly a secret) has a similar risk profile to making actual mortgages.

Sadly for the US banking system, on Friday Moody's downgraded all $36 billion of preferreds from A1 to Baa3 (which is kind of like "BBB-" or the lowest investment grade rating). That is a very bad event from a mark to market and a capital requirement standpoint for any banks that own these securities (e.g., Regions, M&T, Astoria).

Those also happen to be banks that don't exactly have capital to spare, due to their own lending struggles.

Strap your boots on.

So Far, Only One Bank is Reported as Dead...

Columbian Bank and Trust in Topeka, Kansas of all places was finally put to sleep tonight by the FDIC.

Columbian Bank is a small $752 million asset bank funded overwhelmingly by deposits ($622 million). Bank collapses in recent months have led to losses to the FDIC of 15%-28% of assets. The greater the portion of the balance sheet that is funded by deposits, the greater the losses to the FDIC tends to be. In any case, we can expect the FDIC insurance fund to eat another $113 - $210 million of losses. Every few dollars that the FDIC absorbs via its insurance fund is a few dollars closer to tax payers socializng future losses.

We also continued to build the backlog, as Bank of the Bluegrass in Kentucky received a Cease and Desist order from the FDIC. Hilariously, they apparently had outsourced their "loan review" and are now going to bring it internal. Seriously?

The over/under remains 1.5 bank failures per week. The unders have been taking it for a few weeks, but the backlog is growing rapidly and I expect we are at the edge of a deluge of failures. Strap your boots on.

It's 4:20 Dude!

For many people, 4:20 on a Friday means it's time to kiss work goodbye and roll a fattie. For me, it means time to start hitting the refresh button on my GoogleNews stream and look for bank failures. Will the overs finally put one on the board against the unders? It's been nearly a month and both housing and credit spreads have done nothing but deteriorate since then. Time to get excited (in a bizarre way)...

Fannie and Freddie or Phonie and Fraudie?

As equity values for Fan and Fred plunge and the stock prices become optically embarrassing (e.g., Freddie is now a $3.16 stock with a $2.0B market cap), it is worth asking "so what?"

So what if they are nationalized? What's the downside?

Some equity holders get wiped out. Who cares? Freddie has a $2 billion market cap; a year or so ago, it was about $40 billion. So the damage is already done on that front. The remainder is just a rounding error.

What else happens? Well, the preferreds will get wiped out and the sub-notes may as well. But that's fine. Corporate bankruptcies happen regularly and the owners of those securities accept that risk. The senior notes will be made whole by you and me via our government's now explicit enough guarantee. So our foreign creditors will be fine (in fact, they'll be better off than they are today while credit spreads remain wide for the GSEs).

What about fear? Won't the "collapse" of the GSEs engender an enormous amount of fear which could lead to widespread financial collapse? Well, no. The reality is that the vast majority of our citizenry has no idea who Fannie and Freddie are, much less what they do. Nobody has deposits and Fannie and Freddie. The GSEs don't have any retail branches. Nobody has a mortgage directly originated by Fannie and Freddie. The reality is that most people are never going to directly "touch" Fannie or Freddie. So, their disappearance will not cause an obvious change to life for most folks.

Won't the cost of financing a house rise? Barring the federal government continuing to aggressively operate the GSEs, yes, borrowing costs will rise. This will happen and it will obviously put pressure on house prices. A conforming 30 year for a decent credit with 20% down is going for about 6.3%. A jumbo prime (eg, a $1 million loan) with 30% (not a typo) down is going for 8.5%-9.0% these days. So, yes, financing costs and standards will likely rise. However, all this will do is eliminate a silly and unnecessary subsidy.

There will be a one-time nationwide home price adjustment, but I want to be crystal clear, Fannie and Freddie DO NOT MAKE HOME OWNERSHIP MORE AFFORDABLE (same goes for the tax deductibility of mortgage interest). While they artificially push the rate on a given mortgage down, all that does is artificially push the price of a given house up until the all in financing cost is basically neutral. While that one time reversion will be a painful experience for existing owners, it is not the government's place to provide a house price subsidy that clearly a) is adding to systemic risk and b) makes each new home buyer more and more trusting of those falsely inflated prices.

My strong suspicion is that the gov't will do everything in its power to prevent this change despite it being a logical step on the road to recovery.

The Unders Take It! Small Florida Bank Collapses

Well, The Brothers Linebacker had set the bank failure weekly over/under at 1.5 institutions (inclusive of banks and thrifts, exclusive of credit unions, which is probably worth another 0.5 or 1.0 per week). The week of August 15th had a bank failures happen in a non-traditional manner: Federal Trust (ticker FDT ) of Florida was a de facto failure. However, rather than actually collapsing, it was re-capped and taken over at tiny share prices. Amazingly, no banks actually were off'ed by the FDIC. I keep re-reading my blog on Vineyard National and I continue to be baffled as to what will actualy catalyze the FDIC to takeover a bank.

Oddly enough, FDT is the stock of a business I used to own shares in at one time. I purchased FDT shares beginning on March 10, 2003 (basically the stock market bottom, as it turned out) for $5.00/share then bought a bunch more a month later at around the same price. Beginning June 20, 2005 and continuing through July 5, 2005 I sold my stake at $11.20/share, which I felt represented a full price given my increasing skepticism of the Florida miracle and worry that the state was overbanked. The company would ultimately trade in the $12+ range for a period of time before collapsing under the weight of a hideous asset base.

Now it's being acquired at distressed prices by a SPAC, which is funny for reasons I may detail in another post someday.
-TTB

More Bad News for Small Banks - Vineyard National Bancorp Says it has Going Concern Issues

Well, the hits keep coming. Vineyard National Bancorp announced in its 10-Q that it is facing going concern issues.

No shit.

On May 5th, they were informed by the Office of the Comptroller of the Corrency (OCC) they they've been deemed to be in "troubled condition".

On May 20th, the Board of Governors of the Federal Reserve System told them the same thing.

On July 22nd, Vineyard "consented" (as if they had a choice) to a Consent Order from the OCC which basically tells Vineyard exactly what they have to do to not be taken over. They are also deemed to no longer be "well capitalized".

And check out this statement from the aforementioned 6/30/08 10-Q. The understated confidence is a thing of beauty:

On a consolidated basis, the minimum ratios that the Company must meet are total risk-based capital of 8.0%, Tier 1 capital of 4.0% and a leverage ratio of 4.0%. At June 30, 2008, the Company’s total risk-based capital, Tier 1 capital and leverage ratios were 2.5%, 1.3%, and 1.2%, respectively.

Wow.

I'm sure it has deteriorated since then, which is saying something.

Stunningly, despositors have not taken well to this set of news. Here is how depositors have reacted (and other liquidity problems) as stated directly from the 10-Q. Honestly, I cannot believe the FDIC allowed the brokered deposit game to continue as long as it did. My comments are in [brackets] and are italicized:

Negative publicity relating to our financial results and the financial results of other financial institutions, together with the seizure of IndyMac Bank by federal regulators in July 2008, has caused a significant amount of customer deposit withdrawals, thus affecting our liquidity and our ability to meet our obligations as they have come due [kind of lame to put any blame on IndyMac when Vineyard so clearly was mismanaged and decaying at an accelerating rate well prior to the IndyMac issue - see the timing of the news flow from above]. During the second quarter of 2008, we obtained $266.3 million in brokered deposits to offset the $226.9 million in run-off of savings, NOW, and money market deposit accounts. [Please understand that this acceptance of brokered deposits (or any deposits for that matter) as a run on the bank is happening is 100% the result of FDIC insurance and thus is going to cost you and me - The American Taxpayer - dearly] As a result of the issuance of the Consent Order by the OCC on July 22, 2008, however, we can no longer accept, renew or rollover brokered deposits unless and until such time as we receive a waiver from the FDIC. The Bank has requested a waiver from the FDIC, but there can be no assurance that such a waiver will be granted [Lord willing, it won't be granted, my taxes are high enough already], granted on the terms requested, or granted in time for the Bank to effectively utilize brokered deposits as a source of required liquidity. If the Bank does not receive such a waiver, we will be unable to employ the use of readily available brokered deposits as a source of liquidity [bold emphasis added due to the incredibility of the fact that a bank this weak still has "readily available" access to deposits].

As of June 30, 2008, we were in default on our secured line of credit with a correspondent bank, as described in Note #10 [doh]. While we were able to negotiate a waiver of the events of default existing as of June 30, 2008, we have subsequently defaulted on the line of the credit as a result of the issuance of the Consent Order by the OCC on July 22, 2008 [double doh]. As a result, while the maturity date has been extended to August 29, 2008, the correspondent bank is entitled to declare the outstanding principal balance and all accrued but unpaid interest on the line of credit immediately due and payable and otherwise exercise its rights as a secured party against the collateral to collect, enforce or satisfy the obligations under the line of credit [triple doh]. Such rights may include foreclosing on the collateral and, subject to regulatory agency approval, acquiring 100% ownership of the Bank or selling the Bank to a third party. As a result of the regulatory restrictions discussed above, prior FRB approval will be required for VNB to make any payments on this line of credit.

Although effective April 21, 2008, the FHLB reduced the Bank’s borrowing capacity from 40% to 30% of the Bank’s total assets, the Bank’s borrowing availability was limited to the amount of eligible collateral that can be pledged to secure that borrowing facility. At June 30, 2008, based on its eligible pledged loan and investment collateral, that availability was $289.4 million of which $155.0 million was outstanding; therefore, the Bank had a remaining borrowing availability of $134.4 million. [emphasis added in bold to highlight how long ago regulators started cracking down on Vineyard]

On July 24, 2008, the Bank borrowed $126.0 million from the FHLB, consisting of four $31.5 million advances with terms ranging from 9 months to 1 year. As a result of these term borrowings, the Bank had a remaining borrowing availability of $2.2 million available against its loan and investment collateral pledged at the FHLB. The proceeds from the FHLB advances were invested in federal funds sold for liquidity needs. At July 24, 2008 the Bank had an aggregate of $178.0 million invested in federal funds sold.[emphasis added in bold: $2.2 million? I know one bank I'll be reading about some Friday in the not too distant future at about 5pm, for sure]

As of June 30, 2008, the Bank had no unsecured correspondent banking facilities with borrowing availability. However, on August 1, 2008, the Bank entered into an intercreditor agreement with the FHLB and Federal Reserve Bank of San Francisco (“FRB San Francisco”) whereby certain eligible loans pledged to the FRB San Francisco, and agreed to by the FHLB, may be utilized to support any advances from the FRB Discount Window. We have pledged loans with an aggregate principal balance of over $400 million which can be used by the FRB Discount Window in determining an available amount to us; however, the FRB Discount Window is not obligated to lend on any collateral deposited.

On July 31, 2008, the FRB notified VNB that VNB must serve as a source of financial strength to the Bank and as such, requested that management perform an analysis of the cash needs for VNB through October 31, 2008. The FRB has further requested that any amounts not required for VNB’s operations be contributed to the Bank to support its operational needs. Management is performing such an analysis at this time.

Going Concern

The conditions and events discussed above cast significant doubt on our ability to continue as a going concern. We have determined that significant additional sources of liquidity and capital will be required for us to continue operations through 2008 and beyond. We have engaged a financial advisor to explore strategic alternatives, including potential significant capital raises, to address our current and expected liquidity and capital deficiencies. However, there can be no assurance that we will be able to arrange for sufficient liquidity or to raise additional capital in time to satisfy regulatory requirements and meet our obligations as they come due. In addition, our regulators are continually monitoring our liquidity and capital adequacy. Based on their assessment of our ability to continue to operate in a safe and sound manner, our regulators may take other and further action, including assumption of control of the Bank, to protect the interests of depositors insured by the FDIC. Finally, there can be no assurance that our correspondent bank will not declare us in default or that the exploration of strategic alternatives will result in an infusion of sufficient additional capital.[bold emphasis added and, on a personal note, good luck!]

As is generally my practice, let's take a look at the losses the FDIC (ie, you and me) are going to have to eat: Vineyard is a $2.3 billion bank (by assets). If we apply the 15-28% loss rate to assets that recent failures resulted in, we are looking at a $345-644 million loss to the FDIC. Amazingly, this almost seems small with the rubble of IndyMac's $5+ billion loss still smoldering and the potential for several $10+ billion asset banks to go under (and really the potential for some $100+ billion banks to be aced).

I suppose that's the silver lining here: at least it isn't an unusually large bank.

Downey Financial - The Next IndyMac?

Well, in my post from July where I predicted the demise of WaMu I also identified three other depository insitutions that I viewed as at risk. Those were Downey Financial, BankUnited Financial, and Sterling Financial. As of now, those are seeming like a good hit-list.

Subsequent to that post, BankUnited chose to sue Dick X. Bove and his employer for its inclusion on a list he published post-IndyMac about who is next. If that doesn't that just scream "confident" to the BankUnited depositor base, I don't know what will (perhaps a government takeover?). So much for "sticks and stones may break my bones, but words will never hurt me."

Downey, however, has taken it a step further by actually suffering a variety of real damages. Since my post, Moody's has cut Downey's primary operating subsidiary's financial strength rating to D rating, it reported a substantial quarterly loss and, last night, Downey announced in its 10-Q that it has been suffering net withdrawals from its deposit base and that the OTS is beginning to limit its activities. Wow.

This language is fascinating to read (from Note 10 - Subsequent Events in Downey's June 30, 2008 10-Q filing). My comments are inserted in [brackets] and italicized:

In addition to its deposits, Downey’s principal source of liquidity is its ability to utilize borrowings, as needed. The Bank’s primary source of borrowings is the FHLB. At June 30, 2008, the Bank’s FHLB borrowings totaled $1.5 billion, representing 12.1% of total assets. As of August 8, 2008, the Bank’s FHLB borrowings totaled $2.8 billion [holy crap. After grwoing just $400 million in the prior twelve months, Downey has tapped an additional $1.3 billion of FHLB borrowings in the last six weeks?]. Approximately half of the Bank’s increase in FHLB borrowings subsequent to June 30, 2008 is being held in cash equivalents and short-term investment securities to meet our liquidity needs [that means the other half went to fund deposit withdrawals]. The Bank currently is approved by the FHLB to borrow up to a maximum of $3.0 billion to the extent it provides qualifying collateral, providing the Bank with an additional $0.2 billion of borrowing capacity from the FHLB as of August 8 [set the bankruptcy clock to T minus six weeks]. The amount the FHLB is willing to advance differs based on the quality and character of qualifying collateral offered by the Bank, and the advance rates for qualifying collateral may be adjusted upwards or downwards by the FHLB from time to time. The Bank also is approved to borrow funds on an overnight basis from the Federal Reserve Bank of San Francisco subject to the amount of qualifying collateral it pledges. The Bank views the Federal Reserve Bank as a back-up source of liquidity. As of August 8, 2008, the Bank had no outstanding borrowings from the Federal Reserve Bank of San Francisco and the Bank’s available qualifying collateral would have permitted it to borrow up to an additional $1.5 billion. Neither the FHLB nor the Federal Reserve Bank of San Francisco is obligated to lend to us under these loan facilities. To the extent deposit renewals and deposit growth are not sufficient to fund maturing and withdrawable deposits, repay maturing borrowings, fund existing and future loans and investment securities and otherwise fund working capital needs and capital expenditures, the Bank may utilize additional borrowing capacity from its FHLB and Federal Reserve Bank borrowing arrangements.

After the end of the second quarter, the Bank experienced elevated levels of deposit withdrawals [no sh!t]. More recently, in response to steps taken by management to address the situation, the Bank has experienced net deposit inflows. If the Bank’s deposit levels continue to stabilize with withdrawals at historical levels, Downey believes its current sources of funds, including deposits; advances from the FHLB and other borrowings; proceeds from the sale of loans and real estate; payments of loans and payments for and sales of loan servicing; and income from other investments would enable Downey to meet its obligations while maintaining liquidity at appropriate levels. However, if elevated levels of net deposit outflows resume, the Bank’s usual sources of liquidity could become depleted, and the Bank would be required to raise additional capital or enter into new financing arrangements to satisfy its liquidity needs. In the current economic environment, there are no assurances that we would be able to raise additional capital or enter into additional financing arrangements.[Prediction: if the press picks up on this language, it is game over. Thusly, it is game over.]

Management believes that the Holding Company, on a stand-alone basis, currently has adequate liquid assets to meet its current obligations, which are primarily interest payments on $199 million of senior notes. Limitations imposed by the Office of Thrift Supervision (“OTS”) discussed below currently prohibit the Bank from providing a dividend to the Holding Company without prior OTS approval, and the Holding Company from paying dividends (other than the quarterly dividend payable in August 2008), and incurring and renewing debt, without prior non-objection of the OTS. At June 30, 2008, the Holding Company’s liquid assets, including amounts deposited with the Bank, totaled $53 million, down from $102 million at the end of 2007 due primarily to a $50 million capital contribution to the Bank.

Downey’s stockholders’ equity totaled $0.9 billion at June 30, 2008, down from $1.3 billion at December 31, 2007 and $1.5 billion at June 30, 2007. The Board reduced the quarterly per share dividend payment from $0.12 to $0.01 for the dividend payable in August 2008 [I love this whole concept that banks, etc. are employing of cutting dividends to one or five cents. Lord forbid that you cut to zero - then you cannot tell people "we've paid dividends every quarter for 105 years" etc.], after which no future dividends will be paid without prior non-objection of the OTS.

In light of the current operating environment and Downey’s recent quarterly losses, the Holding Company and the Bank have been working closely with the Bank’s federal banking regulators. In that regard, the OTS, the Bank’s principal regulator, has also imposed the following limitations on the Holding Company and the Bank: the Bank may not pay dividends to the Holding Company without prior OTS approval, and the Holding Company may not pay dividends without prior non-objection of the OTS; the Bank may not increase its assets during any quarter in excess of an amount equal to net interest credited on deposit liabilities without prior OTS approval; the Holding Company may not issue or renew debt without the prior non-objection of the OTS; the Holding Company and the Bank must provide prior notice to the OTS regarding any additions or changes to directors or senior executive officers (or changes in the responsibilities of senior executive officers); the Holding Company and the Bank may not pay certain kinds of severance and other forms of compensation without regulatory approval; the Bank may not enter into, renew, extend or revise any contract related to compensation or benefits with any director or senior executive officer without prior regulatory approval; the Bank must provide prior notice to the OTS (and not receive any objection) before engaging in transactions with any affiliate or subsidiary. In addition, Downey is subject to higher regulatory assessments and FDIC deposit insurance premiums than those prevailing in prior periods. [emphasis added]

In response to the challenges facing Downey in the current operating environment, Downey has formed a special Board committee to explore a range of strategic alternatives, including the raising of additional capital to levels deemed by the Board to be appropriate under the circumstances. [the end is nigh]

It is worth noting that Downey is a $12.6 billion asset base bank. If it were to be taken into FDIC receivership and the loss metrics of recent failures applied (15-28% of assets are losses that the FDIC absorbs), then the FDIC will take another $1.9B to $3.5B of losses. Also, if this list is to be trusted, IndyMac is #3 and would bump all of the others down one spot. Downey, if it were to go, would bump Homefed and all the banks below it down another notch putting Downey at #9. Not a trivial matter.

Bank Failures get the Headlines, but Credit Unions are Failing too

Occasional commentor on The Investment Linebacker's message boards, Wendell Brock, has begun blogging on his Denovo Strategy site about the difficulties that credit unions are facing. We may think banks and S&Ls are struggling, given the collapse of eight so far this year, but Brock is reporting that TWENTY ONE credit unions have already collapsed.

There's a bull market in hiring FDIC regulators, I am sure.

So, I wrote all of the above yesterday with the intent of posting it this a.m. Obviously Wendell has been all over this issue for a while now. However, I wake up this a.m. and what do I see on the front page of the WSJ? Immediately above the fold on A1 the headline, "Mortgage-Market Trouble Reaches Big Credit Unions".

While The Journal's article amazingly does not address Wendell's specific fact about the collapse of 21 small credit unions, it does highlight the reality that a number of very large credit unions have suffered enormous unrealized losses. It also gets further into the ridiculousness of GAAP accounting and the subjectivity of both Fair Value accounting and the Available for Sale vs Hold to Maturity concept. These credit unions are clearly intentionally obfuscating the facts in order to improve their GAAP accounting performance despite the fact that it may or may not reflect economic reality.

As an aside, having a front page article in The Wall Street Journal on the potential insolvency of your depository institution is probably not great for business. I'd hate to be on the front lines of client confidence assurance at U.S. Central Federal Credit this morning (or any of the other four highlighted institutions).

The Unders Take It (again)

Well, the week of August 8th has passed (yes, I now measure weeks on a Friday methodology) and we had no bank failures. As noted in prior posts, I can't help but have some amount of excitement each Friday after the close of business as we await the announcement from the FDIC as to which banks they have deep sixed. This week was a zero. "Good news, it seems the 'subprime crisis' has been contained. Nothing to see here, nothing to see here. Keep on moving."

The Brothers Linebacker have set the weekly over/under line at 1.5, thus giving another point to the unders. Somewhere in the distance, Hank Paulson does a quiet fist pump.

Is It Friday Evening Yet?

I'm sorry, but to be honest, for some reason I can hardly contain my interest/curiosity as to what banks are going to be put to sleep this weekend.

We have the over/under set at 1.5 per week for the foreseeable future. I'm going with the under yet again this week, but it's just a gut feel.

The reality is that ABS prices have continued to deteriorate and the consumer has done nothing but get weaker and weaker. That said, I think the FDIC wants to make this meltdown happen as slowly as possible initially such that depositors do not gain a fear-based momentum. This is incredibly complex and given the fragility of the typical depository institution's business model, I think fear is the rational behavior.

Anyway, schadenfreude reigns as I await my weekly bank failure news.

Strap your boots on.