by Calculated Risk on 7/13/2008 10:02:00 PM

There have now been 5 FDIC insured bank failures in 2008, the most since 2002 (11). But this is nothing compared to number of failures during the S&L crisis in the '80s and early '90s.

Click on graph for larger image in new window.

To put the 2008 failures into perspective, here is a graph of bank failures since the FDIC was created in 1934. The 5 failures this year hardly show up on the graph.

Note: thousands of banks failed during the Depression, and bank failures were very common even before the Depression, with about 600 banks failing every year during the Roaring '20s. And, yes, there is a Bank Implode-O-Meter that includes credit unions and other banking problems too.

One of the interesting aspects of the IndyMac failure was the average size of the insured deposits. According to the FDIC, there were $18 billion in insured deposits and "over" 200,000 depositors. If we divide $18 billion by 200 thousand, this gives an average deposit of $90,000. This average seems very high; I'd expect most banks would have many depositors with just a few thousand dollars - and, therefore, a far lower average insured deposit size.

***********

This suggests that many of these deposits were from conservative investors chasing the highest FDIC insured yields. Banks that rely on this type of deposit (and pay the highest yields) would seem to be the most susceptible to online bank runs. These relatively high yield FDIC insured deposits are an example of moral hazard.

In the insurance context, the term "moral hazard" refers to the tendency of insured parties to take on more risk than they would if they had not been indemnified against losses. ... The moral hazard problem is particularly acute for insured depository institutions that are at or near insolvency but are allowed to operate freely because any losses are passed on to the insurer, whereas profits accrue to the owners. Thus problem institutions have an incentive to take excessive risks with insured deposits in the hope of returning to profitability.

Although I believe deposit insurance is an important safety net - because many depositors cannot fully evaluate the safety and soundness of their bank - I'm not convinced this is working properly when investors can easily place just under the FDIC limit at multiple banks and chase yield.

Note: the reason investors usually deposit under the limit (say deposit $95,000) is to keep the earned interest insured too.

From Robin Sidel, David Enrich and Jonathan Karp at the WSJ: Bank Fears Spread After Seizure Of IndyMac

[Banks] wooed customers with new high-yield savings accounts and certificates of deposit, and special Internet-only promotions. ... Regional and specialized institutions that have been battered by soured loans have been among the most aggressive in luring new money. Last week, IndyMac was offering 4.35% interest on a one-year online CD.

Surprisingly the WSJ reports that the percentage of uninsured deposits has been growing rapidly:

[T]he percentage of uninsured deposits has doubled since 1992, climbing to about 37% of the nation's $7.07 trillion in deposits at the end of the first quarter, according to an analysis of data reported to the FDIC.

And from Louise Story at the NY Times: Analysts Say More Banks Will Fail

[T]he troubles are growing so rapidly at some small and midsize banks that as many as 150 out of the 7,500 banks nationwide could fail over the next 12 to 18 months, analysts say.

“Everybody is drawing up lists, trying to figure out who the next bank is ...” said Richard X. Bove, the banking analyst with Ladenburg Thalmann, who released a list of troubled banks over the weekend. ... In his “Who Is Next?” report ... Mr. Bove listed the fraction of loans at banks that are nonperforming ... He came up with what he called a danger zone, which was a percentage above 5 percent. Seven banks fell in this category.

Jane Wells at CNBC has Bove's list: After IndyMac, Who's Next?. Here is Bove's list of banks in the 'danger zone' according to Wells: Downey Financial, Corus Bankshares, Doral Financial, FirstFed Financial, Oriental Financial, and BankUnited Financial.

Then Bove ran a second set of numbers dividing a bank’s non-performing assets by its reserves plus common equity. ... You have all the same names as listed before, PLUS WASHINGTON MUTUAL.

And just today, from MarketWatch on Downey Financial:

Downey Financial said Sunday that its nonperforming assets hit 14.33% of its total assets in May, up from 10.75% at the end of February. A year ago, Downey's nonperforming assets were 1.3%.

Going forward, I expect many more bank failures, although probably far fewer than in the '80s and early '90s. Unlike IndyMac that failed mostly because of bad Alt-A mortgage loans, most of the coming bank failures will probably be small regional banks with too much exposure to Construction & Development (C&D) and Commercial Real Estate (CRE) loans. Clearly there is the possibility of a huge failure too. FDIC Chairman Sheila Bair told a Senate Banking Committee in early June:

"There is also the possibility that future failures could include institutions of greater size than we have seen in the recent past."

Maybe she was thinking of IndyMac.Read on ... there is much more.

by Calculated Risk on 7/13/2008 07:14:00 PM

Update2: NY Times report: Rescue Sought for Fannie and Freddie

WSJ report: U.S. Announces Rescue Plan For Fannie Mae, Freddie Mac

Update: From the Fed Board grants Federal Reserve Bank of New York the authority to lend to Fannie Mae and Freddie Mac should such lending prove necessary

From Bloomberg: Paulson Statement on Freddie Mac, Fannie Mae: Full Text

... I have consulted with the Federal Reserve, OFHEO, the SEC, Congressional leaders of both parties and with the two companies to develop a three-part plan for immediate action. The President has asked me to work with Congress to act on this plan immediately.

First, as a liquidity backstop, the plan includes a temporary increase in the line of credit the GSEs have with Treasury. Treasury would determine the terms and conditions for accessing the line of credit and the amount to be drawn.

Second, to ensure the GSEs have access to sufficient capital to continue to serve their mission, the plan includes temporary authority for Treasury to purchase equity in either of the two GSEs if needed.

Use of either the line of credit or the equity investment would carry terms and conditions necessary to protect the taxpayer. Third, to protect the financial system from systemic risk going forward, the plan strengthens the GSE regulatory reform legislation currently moving through Congress by giving the Federal Reserve a consultative role in the new GSE regulator's process for setting capital requirements and other prudential standards. ...

The two keys points are: "temporary authority for Treasury to purchase equity", and an "increase in the line of credit". I think we need more specifics.

by Calculated Risk on 7/13/2008 04:25:00 PM

From the FDIC: FDIC Chairman Sheila C. Bair Issues Statement on IndyMac Federal Bank, FSB, Conservatorship

FDIC Chairman Sheila C. Bair said, "Over the past weekend, I have seen news reports which have fairly and accurately reported on the conversion of Indy Mac Bank into a conservatorship operated by the FDIC. I have also seen inaccurate and inflammatory reporting which could well cause needless, unnecessary worry and angst among bank depositors throughout the country.

That fact is that for insured depositors, IndyMac's conversion has been largely a non-event. The more than 200,000 customers of IndyMac with deposits of $18 billion are fully protected. It's important to keep in mind that the small percentage of uninsured are still covered for their insured amounts and half of their uninsured money. As assets of IndyMac are sold, they may receive even more. They have had continued access to their funds through ATMs, debit cards, and writing checks over the weekend, and on Monday morning, it will be business as usual.

All bank depositors should understand that their insured deposits are safe. IndyMac is only one of 8,494 depository institutions operating throughout the country and represents only .2 percent of banking industry assets. The overwhelming majority of banks in this country are safe and sound. The chance that your own bank will be taken over by the FDIC is extremely remote. And if that does happen, you will continue to have virtually uninterrupted access to your insured deposits. ...

I haven't seen the "inaccurate and inflammatory" reports. According to the FDIC, there are about $1 billion in uninsured deposits held by about 10,000 depositors. These depositors will receive all of their insured deposits, plus 50% of the amount over $1 billion (with some possibility of receiving more).

The FDIC has estimated the cost to the Insurance Fund is between $4 and $8 billion. Those are the key numbers.

Why anyone had more than the insured limit at IndyMac, with all the negative news, is definitely baffling. It looks like government officials are working on Sunday again ...

by Calculated Risk on 7/13/2008 02:41:00 PM

From the WSJ: Treasury to Issue Statement Supportive of Mortgage Giants

The Treasury is expected later today to make a statement supportive of beleaguered mortgage giants Fannie Mae and Freddie Mac ...

Here is the Treasury News page.

by Calculated Risk on 7/13/2008 02:35:00 PM

"No flooring ... let's see, a little mountain view looking that way, but no flooring ... no kitchen!"

by Calculated Risk on 7/13/2008 10:46:00 AM

From Jeffrey Birnbaum and Steve Mufson at the WaPo: Freddie Mac's Next Hurdle: Raise Cash (hat tip SS)

Treasury Department officials were working the telephones yesterday to make sure that Freddie Mac ... will be able to sell $3 billion of its securities tomorrow in a previously scheduled sale that has now become a crucial test of investor confidence.
...
Treasury officials were considering several options to backstop the sale in case they discover that interest in the securities is flagging ... Under one alternative, the Treasury or Fed would purchase the securities directly.

Other possibilities are allowing the Federal Reserve Bank of New York to buy the debt indirectly through private brokers or asking private firms to purchase the debt while extending to them either a public or private assurance that the government would back the securities if Freddie were ultimately unable to cover its obligations.

This is a previously scheduled debt sale, and should be very doable.

More concerning is the planned stock offering.

by Calculated Risk on 7/13/2008 01:18:00 AM

From The Times: US Treasury rescue for Fannie Mae and Freddie Mac

US TREASURY secretary Hank Paulson is working on plans to inject up to $15 billion of capital into Fannie Mae and Freddie Mac to stem the crisis at America’s biggest mortgage firms.
...
Under the terms of the proposed move, the US government would receive a new class of shares in exchange for the capital, which would be hugely dilutive to shareholders.
...
The capital injection would also see both lenders granted permission to use the Federal Reserve’s discount window - a short-term emergency funding source.
...
Some in Wall Street believe a rescue plan may be announced ahead of tomorrow’s US market opening to calm nerves and support the debt auction.

Note: I just got back from a great hike in the Sierras and I'm definitely a little tired. Wow, I knew the news would be exciting while I was gone (with breaking news on IndyMac, Fannie and Freddie). Thanks to Tanta and everyone who sent me emails.

If this story is accurate, this bailout will be announced Sunday evening or Monday morning. The Bear Stearns announcement was on a Sunday around 7PM ET, so I would expect a Sunday announcement this time too (if this is going to happen).

by Anonymous on 7/12/2008 03:49:00 PM

My somewhat tenuous attention was captured this morning by this little parenthetical in the NYT story on the IndyMac failure:

The bank, once part of the Countrywide Financial Corporation, is the first major bank to shut its doors since the mortgage crisis erupted more than a year ago. (IndyMac is not related to Fannie Mae and Freddie Mac, the big mortgage finance companies that alarmed the stock market this week.)

Are we worried that the public will think all Maes and Macs are the same? And whose reputation would be more endangered by this, IndyMac's or Freddie Mac's?

The ironies of history. Trivia buffs will know that once upon a time there were three "agencies": the Government National Mortgage Association, the Federal National Mortgage Association, and the Federal Home Loan Mortgage Corporation. It didn't take all that long for market participants to start coming up with pronunciations for the abbreviations GNMA (Ginnie Mae), FNMA (Fannie Mae), and FHLMC (Freddie Mac, which makes no sense whatsoever except that nobody liked "Filly Mac." I once overheard an old hand in the loan delivery department helpfully explaining to a new recruit how to remember the difference between Mornet (FNMA) and Midanet (FHLMC), the GSEs' pool delivery software systems. "It's easy to remember," she said. "Midanet has a 'd' in it, just like 'FHLMC.'"). Old farts whose favorite childhood treat was a box of Pixies will remember the old-time candy company Fannie May, whose name is said to have inspired the whole thing, probably in the throes of a major sugar rush.

Anyway, the players long ago accepted the nicknames to the extent of actually legally changing their names to Ginnie Mae, Fannie Mae, and Freddie Mac, which was great for those of us who had to type Assignments of Mortgage. At some point the student loan corporation climbed on board and we got Sallie Mae, plus the agricultural loan guarantor known as Farmer Mac. By the mid-80s, if you were a government agency or GSE involved in the secondary loan market, you were almost always a Mae or a Mac of some kind. The Federal Home Loan Bank Board never did accept "Freddie Bob," which some of us thought was unsporting but there it is.

This started a fashion for private companies to put a Mae or Mac in their names, signifying that they were major players in the secondary loan market, too. Independence Mortgage Corporation named itself IndyMac. There was Ginger Mae for dicey home equity loans in the great subprime boom of the 90s. ResMae just declared bankruptcy last year, but Charlie Mac (which pools credit union loans) is still functioning as far as I know.

I don't think any private loan buyer has named itself Mac or Mae since 1998 or thereabouts; in this last boom the new entrants, mostly REITs, gave themselves sparkling fresh names like New Century and Luminent and Novastar as if to maintain a light-year's distance from the old gold standard of the Maes and Macs.

And just when it might have been useful to shed the boom-era designer names and huddle up to a solid, staid, boring old Mae or Mac again, we've got the media worried that we won't be able to keep our failing Macs straight.

by Anonymous on 7/12/2008 08:48:00 AM

Which is not the name of a band but probably should be.

Via Big Picture, we find this at Bloomberg:

July 11 (Bloomberg) -- The Federal Reserve has not had any discussions with Fannie Mae and Freddie Mac about access to direct loans from the central bank, Fed spokeswoman Michelle Smith said.

``Federal Reserve officials are following the situation closely,'' Smith said in a telephone interview today. ``However, there have been no discussions'' with the companies ``about access to the discount window,'' she said.

This is what Reuters reported yesterday afternoon:

WASHINGTON (Reuters) - Federal Reserve Chairman Ben Bernanke told Freddie Mac chief Richard Syron that his company and Fannie Mae could take advantage of the emergency discount window, according to a source familiar with the conversation.

The source said that Bernanke and Syron spoke by phone Thursday afternoon and the central bank chief said in that call he intended the discount window to be opened if necessary to the two largest U.S. mortgage finance companies.

I got my first email on the subject Friday morning at 10:20 a.m., the burden of which was that opening the discount window was one of a number of proposals the Fed was "considering." I gather it took only a few hours for an anonymous source to have recollected overhearing a phone conversation between Bernanke and Syron on Thursday for Reuters that made it a done deal.

This morning, the Washington Post has managed to construct a narrative that makes it all true, you see:

Senior government officials prepared emergency steps yesterday to rescue troubled mortgage giants Fannie Mae and Freddie Mac but stopped short after a campaign of public statements eased immediate concerns about the stability of the institutions.

In this version, apparently, the Fed was ready to open the discount window but Hank Paulson's masterful calming of the waters yesterday made it unnecessary. I think. The Post story stops attributing its knowledge of Fed thinking and planning to any source rather early in the story, and having read it twice now I'm still not sure I exactly follow the bouncing ball. But it sure sounds better than saying the press credulously printed an unfounded rumor, doesn't it?

by Calculated Risk on 7/12/2008 08:00:00 AM

Note: I'm hiking in the Sierras, but I thought I'd leave some thoughts on employment. I'll be back Saturday night or Sunday morning.

I'm pessimistic on employment - I think problems in the labor market will linger - but I do not think unemployment will rise to 8% (a severe recession) during this economic downturn.

Note: just because unemployment doesn't rise to 8% doesn't mean many more people aren't hurting. Many people will probably be underemployed, and real wages (purchasing power) will decline for many employed Americans.

There are several reasons for my optimism (if you can call it that!). One of the reasons is the makeup of U.S. employment.

Click on graph for larger image in new window.

The first graph shows the year-over-year change in employment for manufacturing, construction, and everything else. Manufacturing and construction employment are more susceptible to large swings year-over-year, as these areas typically experience booms and busts.

It is reasonable to expect that construction employment will continue to decline significantly - perhaps another 1 million construction workers will lose their jobs as Commercial Real Estate (CRE) construction declines later this year and into 2009.

However manufacturing employment will probably only decline slowly for two reasons: 1) the weak dollar is helping with exports, and 2) manufacturing employment never recovered from the bust of a few years ago. So the decline in manufacturing employment will probably not be severe.

And these two volatile areas of employment make up much less of the total U.S. employment than during earlier recessions.

The second graph shows the percent of total U.S. non-farm workers employed in manufacturing and construction. Manufacturing employment has been declining steadily - and will probably continue to decline as a percent of total employment. The same percentage swing in manufacturing employment now will have a much smaller impact on total employment than during previous recessions.

Construction employment will probably decline sharply, but this only accounts for just over 5% of total employment.

The next most volatile area is retail sales employment, and the current downturn will probably see a significant decline in retail employment. And many service employees will be underemployed - and that is painful too.

But over all, total employment probably won't decline enough to cause unemployment to rise to 8%.