March 8, 2010
Some folks trust to reason
Others trust to might
I don't
trust to nothing
But I know it come out right
Say it once again now
Oh I hope you understand
When it's
done and over
Lord, a man is just a man
The Grateful Dead - "Playin' in the Band"
Lyrics by Robert
Hunter. Music by Bob Weir
First a couple of updates. On Sunday The New York Times published a map prepared by graphics editor Hannah Fairfield using the data from the division of insurance and research at the FDIC and analytics from The IRA Bank Monitor showing the distribution of banks large and small across the US. The map illustrates the fact that most of the communities in the US are served by smaller regional and community banks, which hold more than half of total deposits. While large banks account for half of total assets in the banking system, their liabilities tend to be only about half deposits, thus the apparent disparity. To view the map, click the link below:
http://www.nytimes.com/interactive/2010/03/07/business/07metricsg.html?ref=business
Second, last week the Los Angeles City Council voted 12-0 to pass Councilman Richard Alarcon's motion to require banks doing business with the City, or seeking to do business with the City, to report on the details of their local reinvestment in the community. To read the blog post by IRA CEO Dennis Santiago, who attended the City Council meeting, click the link below:
http://www.huffingtonpost.com/dennis-santiago/los-angeles-pushes-for-re_b_488126.html
In this issue of The Institutional Risk Analyst, we feature a guest comment regarding mark-to-market accounting by Brian Wesbury Brian S. Wesbury, Chief Economist, and Robert Stein, Senior Economist, of First Trust Advisors LP in Chicago. But before we go to our feature, we thought we'd take a look at the Q4 2009 results for OneWest Bank, FSB, from The IRA Bank Monitor.
Bank Profile: OneWest Bank, FSB
OneWest has been the center of a storm of controversy in the conspiracy theorist community, much of it erroneous, because of the fact that the acquirer is sponsored by some of the biggest names on Wall Street and in Silicon Valley. OneWest Bank Group LLC (OWBG), which wholly owns OneWest Bank, FSB, is a privately-held thrift holding company whose investors include Steven Mnuchin, entities advised by J.C. Flowers & Co. LLC, Paulson & Co., MSD Capital, L.P (Michael Dell), Stone Point Capital LLC, SSP Offshore LLC (Soros Strategic Partners) and SILAR MCF-I LLC.
A year ago, OWBG purchased the banking operations of IndyMac Federal Bank, which was being operated in conservatorship by the FDIC. When the Office of Thrift Supervision closed the $32 billion asset IndyMac FSB in July 2008, there were no buyers for the bank, period. The FDIC selected conservatorship instead of an immediate liquidation in an effort to safeguard the deposits and maximize the recovery to the Deposit Insurance Fund (DIF).
Even when OWBG acquired IndyMac in March 2009 from the receivership created by the FDIC prior to the sale, there were only two bid groups: the winning group led by former Goldman Sachs investment banker Steve Mnuchin and a group led by Goldman Sachs (GS). But the real significance of the sale of IndyMac was that it began to thaw the market for dead banks. Today there is a large crowd of funds gathering in the hope of buying a dead bank, but most of the opportunities to buy failed depositories will go to other banks. See our post on ZeroHedge last week (The Newest Scam from Wall Street: Investing in Private Equity Funds that Acquire Failed Banks) in this regard.
IRA Bank Stress Index Rating - OneWest Bank FSB Q4 2009
This institution exhibits significantly lower stress than the industry average. |
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While FDIC may eventually need to make payouts under the loss share agreement with OneWest and other acquirers of dead banks, most of the loss on IndyMac has already been realized. Indeed, we begin to suspect that many of these loss sharing agreements will not be significant compared to the cost of resolution of the failed bank. Based on preliminary analysis performed by the FDIC at the time of closure, the estimated cost of the IndyMac resolution to the Deposit Insurance Fund was between $4 and $8 billion. At the time of the sale to OWBG, the estimate loss to the DIF was over $10 billion or one third of the assets of IndyMac. Losses to the DIF in this cycle are averaging over 30% of the assets of failed banks vs. 11% in the S&L crisis of the 1980s.
Now a lot of observers have argued that the FDIC cut OWBG a sweetheart deal. Compared to merely buying a troubled bank this side of a resolution, buying IndyMac was sweet, but not because the FDIC has given special treatment to OneWest Bank. No, the vigorish in buying dead banks comes from the wonders of purchase accounting via the Financial Accounting Standards Board. Next time you banksters walk past the FASB HQ in Norwalk, CT, step inside for a moment and put a few dollars in the collection box underneath the statue of St. Robert of the Revised Basis.
As with the purchase of Washington Mutual by JPMorgan Chase (JPM), the subsidy in these deals comes from the write-down of the assets of the failed bank. JPM, don't forget, paid just cents on the dollar for the assets of WaMu that it acquired from the FDIC and the same holds true of the acquisition of IndyMac by OWBG. That means that if a loan defaults and the recovery is above the new cost basis for the loan, JPM or OneWest does not lose money. They make money.
Indeed, a foreclosure on a home secured by a mortgage loan that has been written down can actually generate an accounting gain for the bank. On a short sale, for example, even if the proceeds don't cover the old loan balance, JPM, OneWest and all of the other acquirers of failed banks take an accounting gain vs the new cost basis for the loan. But again, this was not the doing of the FDIC or the result of loss sharing, but rather stems from the purchase accounting rules put in place years ago by the FASB.
Even with the extreme mark down of the WaMu transaction, because well less than half of WaMu's liabilities were comprised of insured deposits, the FDIC did not take a loss on that transaction. The assets of WaMu were cleansed of legacy liabilities, including unliquidated liabilities like loan rescission claims from securitizations. In fact, all of the potential claims against the parent companies of WaMu and IndyMac for rescission of securitized loans are sitting in bankruptcy court, where they will likely remain and effectively die.
The same cannot be said about Bear, Stearns & Co., however, a fact that is going to be causing JPM considerable heartburn in future quarters. The JPM bankers thought they were ever so clever stuffing the Federal Reserve Bank of New York with the nasty bits and pieces that were inside the Bear mortgage conduit. But they apparently overlooked the unliquidated claims against Bear's securitizations, which now have an average loss rate in the mid-20% range. We hear in the litigation channel that some Bear securitization deals have loss rates several time that average loss rate. Suffice to say that the mortgage underwriting standards at Bear seemingly left a little to be desired and now claims from that rancid corpus of mortgage securitizations are JPM's problem. We'll be discussing this in detail in a future comment in The IRA Advisory Service.
Prior to the sale to OWBG, the assets of IndyMac were written down to just about zero in the receivership, which is our guess as to why OneWest Bank is still reporting zero defaults. As in the case of Wells Fargo (WFC) and Wachovia Bank, the write down of assets to "fair value" effectively hides future losses. The FDIC and the creditors of the estate of IndyMac Bank FSB bear the real cost of the transaction so far, at least unless and until FDIC is required to participate in loss sharing. You can see the balance sheet of the estate of IndyMac Bank in liquidation here:
http://www.fdic.gov/bank/individual/failed/indymacbalsheet.html
All of the public information about the IndyMac transaction is available here:
http://www.fdic.gov/bank/individual/failed/IndyMac.html
Notice that there were $8.7 billion in unpaid deposit claims and $5 billion in assets in liquidation as of the end of Q3 2009. So far, uninsured deposits have received 50% of their claims. The FDIC has determined that insufficient assets exist in the receivership of IndyMac Bank to make any distribution to general unsecured claims, and therefore such claims will recover nothing. Uninsured depositors are first in line in terms of the priority for recoveries from the receivership.
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Guest Commentary Now to our feature. We've known Brian Wesbury since he worked on
Capitol Hill. His comments on the statement by Fed Chairman Ben Bernanke
regarding mark-to-market are right on target, but you will notice
that they conflict with current practice as described above in the examples of
JPM and OneWest. Once a bank fails and the loans are in receivership, the only
thing that matters is the cash bid for the assets -- at least under current GAAP
accounting rules. The debate over mark-to-market accounting illustrates the fact
that accounting is not science but art; merely one perspective on reality that
is always flawed. Bernanke Finally Fingers Mark-To-Market "…commercial real estate loans should not be marked down because the collateral value has declined. It depends on the income from the property, not the collateral value." Ben S. Bernanke It would have been much better for the economy if Chairman Bernanke had been this clear about mark-to-market accounting back in 2008. If he had been, the US might have avoided the Panic of 2008. But it's never too late, and now that mark-to-market ideology is affecting the ability of the Federal Reserve to exit its quantitative easing, he's finally onboard. In November 2007, FASB reinstated mark-to-market accounting for the first time since 1938. This rule uses bids (exit prices) to value assets. So far, so good. However, in 2008, the market for asset-backed securities dried up. The prices of bonds that were still paying in full fell by 60% or 70%, and those losses were often driven through the income statement. This wiped out regulatory capital, caused bankruptcies and created a vicious downward spiral in the economy. In retrospect, it is clear that this accounting rule was a potent pro-cyclical force behind the Panic of 2008. Finally, on April 2, 2009, FASB allowed banks to use "cash flow" to value bonds when the market was illiquid - exactly like Bernanke said last week. This fixed the immediate problems in the system, and the economy and financial markets have been on the mend ever since. In fact, the stock market bottomed on March 9, 2009 - the very day markets found out that Representatives Barney Frank and Paul Kanjorski would hold a hearing to force FASB to change the misguided accounting policy. However, over-zealous bank regulators are now enforcing their own version of mark-to-market accounting by using the appraisal process. Regulators are forcing banks to write down loan values and increase loan-loss reserves by using appraiser-driven valuations. Yes, that's right; these are the same appraisers who over-valued properties five years ago. Now, because they often use foreclosures and distressed sales as comparable recent transactions, they undervalue properties. To the regulators, it does not matter if the loan is still being paid on time. And it does not matter if the lower valuation of the collateral will force an already stressed borrower to come up with more cash. Regulators have decided that they want banks better capitalized and the way they can do that is to reduce the value of a bank's assets and then force these banks to raise money from shareholders. This, in turn, is undermining bank lending, hurting small business and making it more difficult to reduce unemployment. The worst part is that it is not necessary. Banks are better capitalized today than they were in the early 1980s when banking losses were significantly worse. Back then, we did not have mark-to-market rules forcing banks out of business; instead we allowed the actual performance of loans to determine the viability of these institutions. Banks could not "make-up" loan values in the 1980s and 1990s. In fact, more than 2,700 banks and S&L's eventually failed even though we did not have mark-to-market accounting. Mark-to-market accounting does not solve problems, it creates them by acting as a pro-cyclical force. Milton Friedman understood this and wrote about the devastating link between mark-to-market accounting and Great Depression bank failures. Franklin Delano Roosevelt finally figured this out in 1938 and suspended the rule. The Depression ended soon after. Coincidence: We think not. Similarly, in 2009 with mark-to-market rules in place, two stimulus bills totaling over $1 trillion, a $700 billion TARP, zero percent interest rates, and trillions in other Fed and Treasury actions did not turn the market around. Private money did not flow into the banking system until FASB finally allowed cash flows to be used to value assets (when markets were illiquid). Once the rule was changed, banks were able to raise $100 billion in private capital. And since then, TARP has been repaid by institutions that were forced to take it, while PPIP never got off the ground. It was mark-to-market accounting that created the Panic of 2008, not a failure of the capitalist system. But these overly strict accounting rules still have many adherents, bank regulators among them. And as long as it remains a threat to the system, the system will not fully heal. For example, a viable market for the securitization of asset-backed loans is highly unlikely to reappear until mark-to-market accounting is dead and buried. Why would anyone buy asset-backed securities when there is the potential (readily witnessed over the past few years) for market-driven declines in value to undermine the ability of the financial system to hold them even if cash flows are not impeded? If you don't believe this, read the following exchange from last week (February 24th) between Fed Chairman Ben Bernanke and Congressman Kanjorski (D-PA).
While Mr. Bernanke did not directly link accounting rules with his attempt to "restart" the CMBS market, it is clear that if mark-to-market accounting remains alive, this market will not be resurrected easily. No matter how much money the Federal Reserve throws at the market for securitized assets, the private sector will remain skittish if there is the potential for an accounting rule to wreck the market again. This is very important for the Fed's exit strategy and for the growth of the loan market in the years ahead. Without securitization, bank lending will continue to drag and the Fed will be worried about its withdrawal of support for the system. The US needs a viable securitization marketplace and mark-to-market accounting remains a stumbling block. Mark-to-market accounting needs to die. It should be stabbed in the heart with a cedar stake, shot through the temple with a silver bullet and then buried under six feet of garlic powder. Like the evil killer in a horror flick, we need to make sure it never gets up off the floor ever again. While we do not agree with everything Ben Bernanke is doing these days, his comments, which finger the impact of accounting rules and conventions on the economy, are right on the money. Hopefully, the SEC, Treasury, the FDIC, Congress, and FASB were listening. |
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IRA Library Service Articles: 'Reputational Risk: Living in a Derivative World', March 1, 2010 'Financial Economics, Deregulation and OTC Derivatives: Interview with Yves Smith of Naked Capitalism', February 22, 2010 'Is the Fed's Zero Interest Rate Policy Driving Global Deflation?', February 16, 2010 'IRA Publishes Basel II Ratings for Top US Bank Holding Companies -- Q1 2005', July 5, 2005 A complete archive of past IRA articles available in our Catalog. | ||||||
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