As of yesterday there were CALL reports from 7,287 FDIC insured banks which have been processed and released to the Central Data Repository. Using the public data collection and distribution enablement now provided by FDIC, IRA is able to retrieve these reports in real time and display preliminary ratings to users of the professional version of The IRA Bank Monitor.

We don't display preliminary ratings on our consumer portal, www.irabankratings.com, because sometimes the preliminary filings change as a result of revision or supervisory review. We can only show a final product to a retail audience. In the same way that members of the investment community have an affirmative duty of care to retail investors, in the ratings world we must also use judgment to know when a metric is too unstable for consumer use.

Based on the bank CALL reports submitted and released so far, the IRA Bank Stress Index (BSI) is now at 8.0, a significant increase in visible stress from the preliminary rating of 7.4 in Q3 2009 that we published in The IRA on November 10, 2009 ("Preliminary Q3 2009 Bank Stress Test Results; Looking for OTC Derivatives Reform").

IRA Preliminary Bank Stress Index (BSI) Grade Distributions -- Q4 2009

The reasons behind the big difference between the Q3 2009 preliminary BSI rating of 7.4 and the final Q3 BSI score of 4.44 for all 8,300 plus FDIC insured banks are several. First the preliminary BSI score excludes thrifts and mutual savings banks, which tend to be much more conservative than the average bank. For reasons understood only in Washington, the Office of Thrift Supervision will not release thrift data until the FDIC press conference at quarter end + 55 days and will not release to the public maturity data on thrift loan portfolios at all.

The preliminary BSI score also excludes the largest bank units, which as a group tend to be released near the end of the reporting cycle for reasons relating to investor relations and have better scores than the aggregate ratings for their consolidated group. For example, the largest bank CALL report released by the FDIC so far is the $97 billion asset Citibank South Dakota, the credit card specialization unit of Citigroup (C).

The Q4 2009 preliminary score for Citibank South Dakota is now over 30 vs. 23.7 in Q3 2009 (1995 = 1) or an "F" letter rating on the IRA BSI scale. The aggregate score of C was 21.9 in Q3 2009 and also rated "F" on the BSI. High loss rate credit card specialization institutions such as Citibank South Dakota or Department Stores National Bank, another C bank unit which shows a preliminary BSI score over 60 based on Q4 2009 preliminary results, tend to pull up C's overall stress score. While C itself was a 21 in Q3 2009 or an "F" letter grade on the BSI scale, the lead unit, Citibank N.A. had a slightly lower stress score.

The other reason that the final BSI score for the entire universe of FDIC insured banks tends to finish well-below the preliminary score generated by IRA is that there are hundreds of non-operating trusts in the FDIC reporting universe, entities that have insurance certificate numbers but do not operate as full blown banks. These entities tend to pull down the visible BSI score for the entire industry by virtue of sheer mass of assets.

What all of this tells you is that the operating bank units in the US were under higher levels of stress in Q4 2009 than at any time in the post WWII period. The BSI preliminary score for all US banks of 8 is almost a full order of magnitude above the 1995 benchmark year and twice the level for the entire universe of FDIC insured banks in Q3 2009.

While some 85 percent of the banks are represented in the preliminary results for the BSI. only half of industry assets are included, but this still paints a grim picture for the real economy in terms of credit availability from community and small regional lenders. If these levels of stress are maintained as we go through 2010, then look for the banking industry to continue shrinking assets and loan books, and for the number of bank resolutions to continue to climb toward our long-standing estimate of 1,000 bank failures through the cycle.

Call the collapse of New Century Financial the starting point of the lost decade but also know that the cause of the crisis, namely the closed monopoly marketplace for OTC securities and derivatives run by the largest banks and protected by the Fed, is alive and well, and calling the shots in the halls and lobbies of the national Congress.

Is the Depository Trust and Clearing Corp (DTCC) "Too Big To Fail?"

We frequently receive calls from clients and readers asking about the likelihood of the passage by the Congress in Washington of reform legislation regarding over-the-counter (OTC) derivatives, financial regulation and/or mortgage securitization. Our answer is small to none given the political trends and the state of the lobbies in Washington, most specifically the large bank lobby that protects the Sell Side monopoly in OTC derivatives and securities. The fact that Senator Richard Shelby (R-AL) is still apparently not comfortable with the entirely watered down House proposal to reform OTC derivatives, for example, tells you all you need to know. Stick a fork in it.

Regarding OTC derivatives, for example, the proposed reforms already are so feeble and ineffectual that whether they pass the Congress or not hardly matters. Financial services reform, you see, is less important that innovation in today's global marketplace, innovations such as centralized clearing for OTC derivatives and quantitative easing for fixing the related problem of widespread global insolvency. And the pace of innovation in the world of OTC markets is accelerating with or without the consent of the Congress thanks to the hard work of the economists who populate the Federal Reserve Board's division of supervision and regulation.

The latest signs of "innovation" on Wall Street can be seen in the announcement last week by the Fed Board of Governors approving the application by something called The Warehouse Trust Company LLC to become a Fed member bank. Warehouse Trust proposes to operate a central trade registry for credit default swap (CDS) contracts and to offer related services, including the processing of lifecycle events for the contracts and facilitation of payments settlement. The membership status becomes effective when Warehouse Trust purchases shares in the Federal Reserve Bank of New York.

Warehouse Trust is a wholly owned subsidiary of DTCC Deriv/SERV LLC (Deriv/SERV), which in turn is a wholly owned subsidiary of The Depository Trust & Clearing Corporation (DTCC). When it opens for business, Deriv/SERV's Trade Information Warehouse (TIW), which currently matches 95% of all CDS trades, will be transferred to Warehouse Trust.

DTCC, in case you are not familiar, clears most of the cash securities volume in the free world. DTC is a limited-purpose trust company organized under the New York banking law, and is a member of the Federal Reserve System. It is owned by the banks that it serves. DTC, and Fixed Income Clearing Corporation and National Securities Clearing Corporation are registered as clearing agencies with the Securities and Exchange Commission. Got it?

The creation of Warehouse Trust as a Fed member bank marks the latest attempt by the large dealer banks and the DTCC to cover the retrograde OTC derivatives market in the clothes of modern respectability. The solution to all things bad in the world of OTC derivatives, you see, is centralized clearing. DTCC has lent its considerable credibility to the large bank cause because, after all, its clients are large banks. Indeed, if you listen to the folks at the Fed, the DTCC and the large OTC dealer banks, the advent of centralized clearing is just barely less momentous than the second coming of the Messiah.

One of the benefits of spending a lot of time talking and writing about centralized clearing as the solution to all known troubles and woes in the world of OTC derivatives and especially in CDS contracts is that it keeps the attention of the Big Media, the Congress and the regulators away from the front office and the process of creating and selling complex structured securities and derivatives. It is in the front office where the true problems reside, but notice that none of the OTC reform proposals nor the Volcker Rule go anywhere near the sales and trading desks at the large banks.

Based on our study of the Volcker Rule, which proposes to strip all of the largest banks of their proprietary trading arms, we know that solving the problem is not the real object of financial reform in Washington. Just as the Volcker Rule does no violence to the sales and syndicate function of the largest Sell Side banks, the proposed OTC derivatives reform legislation leaves the dealer monopoly in OTC intact and just barely improves the degree of regulatory oversight of these closed, private markets.

In technology terms, fixing the back office issues of OTC derivatives or securitizations with innovations like Warehouse Trust is akin to announcing a new venture to build cars with internal combustion engines. The evolution of DTCC into the de facto back office of an equally de facto market known as OTC is nothing more than recreating the wheel of multilateral exchanges and joint and several liability of clearing members, albeit one inch at a time.

The advantage of slow motion innovation is that the large dealer banks get to extend the date of true reform of OTC markets by years and pretend to be dealing with the systemic issues created by these unregulated, deliberately opaque OTC instruments, all the while harvesting supra-normal returns from these high-risk, high margin activities. Consider that all of the activities now conducted by TIW and that will be assumed by Warehouse Trust are considered routine at any of the multilateral exchanges, but at the Fed and among the large dealer banks, this is called innovation.

The sad fact is that a great deal of the "reforms" imposed on the OTC markets over the past several years have done nothing to improve price transparency or lessen the monopoly market power of the OTC dealers. To the contrary, under Tim Geithner, first at the Fed of New York and now the Treasury, the thrust of US policy has been to protect and enhance the monopoly position of the OTC dealers, all the while limiting "novation" or assignment of contracts (and thus secondary market trading) and price discovery.

None of the technical issues that drove the Geithner OTC reforms are even issues on a multilateral exchange. Indeed, since the Fed of New York began to focus attention on the back office issues surrounding OTC markets, the dealer grip on the OTC markets has arguably gotten tighter. When a customer faces a dealer instead of an open outcry market, the situation is unfair by definition and goes against basic American practice and experience, and the law, when it comes to the organization of financial markets.

To us, the whole object of the strategy pursued by the OTC dealers and abetted by the DTCC is to adopt enough of the operational attributes of a multilateral exchange to blunt criticisms of the OTC markets with respect to systemic risk issues, but leave in place the dealer monopoly and odious front office sales practices, the rape and pillage mentality that thrives today among Sell Side firms operating in the CDS markets. Just read the Sunday New York Times article by Louise Story and Gretchen Morgenson, "Testy Conflict With Goldman Helped Push A.I.G. to Edge," to understand the relationship between American International Group (AIG) and its OTC dealer bank counterparties.

The aspects of the OTC markets which remain off the reform table includes the bilateral relationship between the client and dealer regarding credit and collateral, the lack of complete market price transparency and the lack of any significant secondary market trading, all to maintain the monopoly rents that the large OTC dealers earn from this activity. Today's OTC markets have all of the attributes of a 1920s bucket shop and now the hub of this closed monopoly market is the DTCC, especially as the clearing house evolves inevitably into a central counterparty for all OTC trades.

And now the DTCC, through OTC derivatives market evolutions such as the creation of Warehouse Trust, is become the single point of failure in the world's financial system by virtue of its role in the OTC derivatives market. Both DTCC and Warehouse Trust are Fed member banks, but the former is not considered a bank holding company because neither entity takes deposits and are thus not FDIC members.

However, in the approval order by the Fed, DTCC commits to submit to Warehouse Trust to Fed prudential supervision as though it were an FDIC insured bank. What a shame that the Fed did not instead require DTCC and Warehouse Trust to be FDIC members and thus subject them to the discipline of the joint and several liability of being federally insured depositories. That would put the entire banking industry on notice that they are on the hook for the OTC shell game rising atop the infrastructure of the DTCC. Duh!

The Fed does, after all, does have a legal responsibility to ensure the sound operation of member banks regardless of their status as deposit takers. The order states that "Warehouse Trust will be well capitalized at the time it commences operations, and it will maintain capital that is sufficient to allow for an orderly wind-down if confronted with the need to cease operations." This is what economists call a "living will" by the way. The only trouble with the Fed's thinking is that if Warehouse Trust ever had to be unwound, then the DTCC itself probably would be in trouble as well.

Since the Fed has allowed the Warehouse Trust application to be approved without imposing the de facto cross-guarantee of FDIC membership on DTCC and all of its affiliates, it seems reasonable to ask just how the Fed would unwind this new member bank without destroying the entire western financial system. More important, why has the Fed put the entity that clears every cash equity and bond trade in the civilized world at risk to also be the central nexus and perhaps eventually even the counterparty for all OTC derivatives?

As the DTCC evolves from a record-keeper today and into a central counterparty for OTC derivatives and particularly CDS in the future, the question seems to be begged: Is the Warehouse Trust and DTCC now "too big to fail?" In the DTCC and Warehouse Trust, have we arrived at the functional equivalent of a multilateral exchange, via unauthorized public bailouts and the monetization of debt by our independent central bank, but in a decidedly sloppy and haphazard fashion?

Or as one former Treasury official told The IRA: "You can't reiterate enough the point that DTCC is owned by the dealer firms and thus the NY Fed is actively and purposefully aiding and abetting the continued OTC monopoly at the expense of real reform."

We'll be talking about this further and look forward to your comments.