by Anonymous on 7/17/2008 08:43:00 AM

We had so much fun--I use this word advisedly--with IndyMac and moral hazard yesterday that I have to return to the well. It's a nice deep one.

From Bloomberg this morning:

July 17 (Bloomberg) -- IndyMac Bancorp Inc.'s collapse may spur withdrawals from banks ranging from First BanCorp in Puerto Rico to Los Angeles-based Nara Bancorp Inc. as customers trim accounts below the $100,000 limit on deposit insurance, according to Sandler O'Neill & Partners LP.

``IndyMac's failure has people worried about others,'' Mark Fitzgibbon, a principal at Sandler O'Neill, said in an interview. Fitzgibbon told clients in a report this week that signs of weakness may prompt customers ``to more actively move deposits to banks that are perceived to be healthier.''

The result could be a liquidity squeeze at banks that rely on ``jumbo'' deposits, Fitzgibbon said. His report, published July 15, included more than 50 companies with jumbo time accounts, typically certificates of deposit, that exceeded 25 percent of first-quarter deposits.

Topping the list was First BanCorp at 72 percent. Puerto Rico-based Doral Financial Corp. had 60 percent and Nara Bancorp had 53 percent, according to Sandler. Bank of America Corp., the biggest U.S. consumer bank, stood at 12 percent at the end of 2007; the report didn't have more recent data.

If any of you would like my personal opinion, for what it is worth, I wouldn't put $12.72 in a bank with 72% jumbo deposits. Certainly not after this:

Alan Cohen, senior vice president of marketing at First BanCorp, said in an interview that Fitzgibbon's report contained ``grave inaccuracies.'' In an e-mailed statement, the company said Sandler should have excluded brokered CDs, ``a stable source of funding.'' Without those, jumbo time deposits equal about 8 percent of total deposits, the bank said.

Whoa, Nellie.

Really, the issue with "jumbo" deposits is, precisely, the extent to which such large deposits are "brokered" versus "core." A bank's "core deposits" are those made by individuals and businesses in the bank's local market areas who have some retail relationship with the bank--checking accounts, loans, what have you. Brokered deposits are also frequently referred to as "hot money," and the idea that First BanCorp considers them a "stable source of funding" ought to raise a few eyebrows. Here's the federal regulators' take on the subject:

Deposit brokers have traditionally provided intermediary services for banks and investors. Recent developments in technology provide bankers increased access to a broad range of potential investors who have no relationship with the bank and who actively seek the highest returns offered within the financial industry. In particular, the Internet and other automated service providers are effectively and efficiently matching yield-focused investors with potentially high-yielding deposits. Typically, banks offer certificates of deposit (CDs) tailored to the $100,000 FDIC deposit insurance limit to eliminate credit risk to the investor, but amounts may exceed insurance coverage. Rates paid on these deposits are often higher than those paid for local market area retail CDs, but due to the FDIC insurance coverage, these rates may be lower than for unsecured wholesale market funding.

Customers who focus exclusively on rates are highly rate-sensitive and provide less stable funding than do those with local retail deposit relationships. These rate-sensitive customers have easy access to, and are frequently well informed about, alternative markets and investments, and may have no other relationship with or loyalty to the bank. If market conditions change or more attractive returns become available, these customers may rapidly transfer their funds to new institutions or investments. Rate-sensitive customers with deposits in excess of the insurance limits also may be alert to and sensitive to changes in a bank's financial condition. Accordingly, these rate-sensitive depositors, both under and over the $100,000 FDIC insurance limit, may exhibit characteristics more typical of wholesale investors.

It was, after all, one of Senator Schumer's biggest complaints about IndyMac in his famous letter to the regulators that, as of June 2008, 32% of IndyMac's total deposits were brokered and that the bank was insufficiently capitalized to withstand that risk.

We had a number of folks arguing yesterday that the $100,000 insurance limit should be raised to account for inflation. Atrios suggested that yesterday. Part of my own wariness over that stems from the fact that so many of the "jumbo deposits" of these banks are, indeed, "hot money," not your basic middle-class family with $250,000 in the local bank in nice stable core deposits. At First BanCorp, it appears that only a shade over 10% of jumbo deposits are core deposits.

Of course, it's hard to say how stable core depositors are, these days. The trouble with trying to assess the risk of bank runs or deposit destabilization is that people are, well, people, and they can respond very differently to the same situation. From Bloomberg:

Martha Duran made the 75-mile drive from Running Springs, California, to close her CDs. She waited from 8:30 a.m. to 4 p.m. on July 14, ending up with sunburn on her neck and an appointment for noon on July 15.

``This is a scare of a lifetime,'' said Duran, a 70-year-old retired office administrator. ``I worked hard for my money. I may not be a millionaire, but every little bit counts.''

Not everyone visiting the bank was there for withdrawals. Sanford Mazel, a 74-year-old retired U.S. Postal Service employee from Altadena, California, came to make a deposit, saying he was reassured by the government protection.

``It's FDIC, so who gives a damn?'' Mazel said. ``Let the world go to hell. The money will be there.''

I think it would be hard to write any banking policy that would discourage Martha from being part of a bank run or encourage Sanford to panic.

by Calculated Risk on 7/17/2008 08:42:00 AM

From the WSJ: J.P. Morgan's Net Falls 53%. A few excerpts:

Chief Executive Jamie Dimon said he expects "the economic environment to continue to be weak -- and to likely get weaker -- and for the capital markets to remain under stress." He added that "since substantial risks still remain on our balance sheet, these factors will likely affect our business for the remainder of the year or longer."
...
[C]redit-loss provisions more than doubled to $3.45 billion but fell 22% from the first quarter. Home-equity charge-offs surged to 2.16% from 0.44%, while subprime-mortgage charge-offs quadrupled. Charge-offs for prime mortgages surged to 0.91% from 0.05%.
...
The [credit card] charge-off rate surged to 4.98% from 3.62% a year earlier and 4.37% in the first quarter.

From the conference call (hat tip Brian):

Analyst Mike Mayo: Can you elaborate more, you mentioned home equity might be a little bit better than you expected. But prime mortgage going from 48 basis points up to 91 base business points linked quarter, can you just elaborate more on what you're seeing there and why?

JPM: Mike, it's exactly the same risk factors and all the other things. It's high LTV, it's stated income, it's California , Florida , Arizona . I you agree with you they're track staggering numbers. It's just really hard for us to tell. Our current expectations of those losses can triple from here. We're prepared for that and we will reserve for that appropriately going forward.

Mayo: Prime mortgage losses could go from 91 basis points to 270 basis points?

JPM: Yes. We had 100 million a quarter and we could go to 300 million a quarter. Not next quarter. But if you look at current trends, maybe we're being overly conservative, that could be 300 million a quarter sometime in '09.

We are all subprime now!

by Calculated Risk on 7/17/2008 08:35:00 AM

The key number in the release was that single-family starts were at 647 thousand in June; the lowest level since 1991. Single-family permits were at 613 thousand in June, suggesting starts will fall even further next month.

Multi-family starts is volatile month-to-month, so the headline number for starts increased.

Also employment (in residential construction) tends to follow completions. Completions will follow starts lower over the next few months. Single-family completions are still at 847 thousand - well above the level of single-family starts.

Click on graph for larger image in new window.

The graph shows total housing starts vs. single family housing starts.

Single family starts are at the lowest level since 1991.

Note that the current recession on the graph is not official.

Here is the Census Bureau reports on housing Permits, Starts and Completions.

Building permits decreased:

Privately-owned housing units authorized by building permits in June were at a seasonally adjusted annual rate of 1,091,000. This is 11.6 percent above the revised May rate of 978,000, but is 23.9 percent below the revised June 2007 estimate of 1,433,000.

Single-family authorizations in June were at a rate of 613,000; this is 3.5 percent below the May figure of 635,000.

The declines in single family permits suggest further declines in starts next month.

On housing starts:

Privately-owned housing starts in June were at a seasonally adjusted annual rate of 1,066,000. This is 9.1 percent above the revised May estimate of 977,000, but is 26.9 percent below the revised June 2007 rate of1,458,000.

Single-family housing starts in June were at a rate of 647,000; this is 5.3 percent below the May figure of 683,000.

And on completions:

Privately-owned housing completions in June were at a seasonally adjusted annual rate of 1,167,000. This is 1.2 percent above the revised May estimate of 1,153,000, but is 21.7 percent below the revised June 2007 rate of 1,491,000.

Single-family housing completions in June were at a rate of 859,000; this is 2.9 percent below the May figure of 885,000.

Notice that single-family completions are still significantly higher than single-family starts. More on starts and completions later.

by Calculated Risk on 7/16/2008 11:13:00 PM

Form Bloomberg: China's Economic Growth Cools to Slowest Since 2005

China's economic expansion cooled to the slowest pace since 2005, handing more ammunition to Chinese officials calling for reduced gains by the yuan as the outlook for exports dims.

Gross domestic product grew 10.1 percent in the second quarter from a year earlier, down from 10.6 percent in the first ...

This isn't much of a slowdown, but growth in the Chinese economy will probably continue to slow in the 2nd half of 2008 as demand from the U.S. and Europe slows.

by Calculated Risk on 7/16/2008 05:27:00 PM

Reading the Fed minutes today, it appears that as of the last FOMC meeting in June, most FOMC members were once again missing the downside risks to the economy. Chairman Bernanke somewhat corrected that mistake in his testimony over the last two days as he acknowledged the "significant downside risks to the outlook for growth".

As of yesterday - before the stock market rally today - market participants were expecting the Fed to hold rates steady at 2.0% through September, and a rate cut is now more likely (in their view) than a rate hike by the September meeting.

Click on graph for larger image in new window.

This graph from the Cleveland Fed shows the implied probability of what Fed Funds futures market participants expect the most likely outcome to be at the Fed meeting in September.

I also think the Fed will hold rates steady - probably through the end of the year.

by Calculated Risk on 7/16/2008 02:32:00 PM

Note that foreclosure resales were 41.1% of all resales in June!

From DataQuick: Southland home sales drag along bottom

Home sales in Southern California continued at their slowest pace in more than two decades last month ... A total of 17,424 new and resale houses and condos sold in Los Angeles, Riverside, San Diego, Ventura, San Bernardino and Orange counties last month. That was up 3.0 percent from 16,917 the previous month and down 13.6 percent from 20,166 for June a year ago, according to DataQuick Information Systems.

While last month's sales were the highest in ten months, it was still the slowest June in DataQuick's statistics, which go back to 1988. The June average is 28,488 sales, the peak was reached in 2005 when 40,156 homes sold.
...
The median price paid for a Southland home was $355,000 last month, down 4.1 percent from $370,000 in May and down 29.3 percent from $502,000 for June 2007. The peak of $505,000 was reached in March, April, May and July of last year.

The median has fallen because of depreciation, especially in inland markets, and because of the steep dropoff in home financing in the so-called jumbo category, which until recently was defined as loans above $417,000.
...
Foreclosure resales continue to be a dominant factor in today's Southern California market accounting for 41.1 percent of all resales. That was up from 39.2 percent in May, and up from 7.3 percent in June a year ago. Foreclosure resales ranged from 18.9 percent in Orange County last month to 62.3 percent in Riverside County.
...
Foreclosure activity is at record levels ...

by Calculated Risk on 7/16/2008 01:44:00 PM

M&I reported this morning. From MarketWatch: Marshall & Ilsley posts second-quarter loss of $394 million

Here are some comments from the conference call:

As we discussed earlier this month, M&I, like other banks, has experienced continued deterioration in the national residential real-estate markets during the second quarter. In addition, we have noted some stress among our consumers with conventional non accruals picking up but with home equity remaining stronger. Our commercial lending portfolio has maintained its strong credit profile

We have already realized partial charge-offs of $386 million against our nonperforming loans, representing a 27% haircut, which is up from 18% last quarter. Within our loan portfolios, we continue to focus on our residential related construction and development categories. These loans are in both our commercial real estate and residential real estate portfolios depending on the underlying collateral. As of quarter end we had had $661 million in construction and development loans on nonperforming status representing 63% of our total nonperforming loans. ... [O]f these nonperforming construction and development loans, two-thirds are in the Arizona , west coast of Florida , and correspondent businesses.

We have seen further deterioration in the residential land portfolio during the second quarter. ... M&I has $2.3 billion in residential land loans to individuals and developers. $1.5 billion, or 66%, are located in Arizona . The bulk of the Arizona loans, nearly 70%, are in Maricopa County . ... LTVs are approximately 115%. Residential land accounts for $219 million of nonperforming loans of which 55% are based in our Arizona business unit. ...

With regard to conventional mortgages, we have noted deterioration as individuals are feeling increased economic stress. As we've noted before, we maintained our underwriting discipline through the cycle, have never originated subprime loans, and have avoided many of the more risky loan products. Nonetheless, during the quarter, our nonperforming residential loans have increased to $21 million, or 2.1% of the portfolio. Within the residential portfolio, we have seen some deterioration in many of our markets with the Arizona market being most notable. We continue to aggressively monitor and manage this portfolio. To provide further granularity on our Arizona residential portfolio, the average loan is around $300,000, and the average nonperforming loan is slightly higher. The average refreshed FICO score on this portfolio is 716. The average updated LTV is approximately 90%.
emphasis added

Note the large concentration of land loans in Arizona with LTV of 115%. Ouch. During housing busts, land prices usually fall a great percentage than existing home prices. So many of these 115% LTV loans will probably be much higher soon.

Also note that M&I is fairly conservative, and the nonperforming residential loans are NOT subprime.

From the Q&A:

Analyst: Can you give us [the loss severity] number on Construction & Development (C&D)?

M&I: You know, I would rather not put that out there. I would tell you that the C & D haircut is going to be higher than the 27%.

by Calculated Risk on 7/16/2008 01:00:00 PM

The NAHB reports that builder confidence was at 16 in July, down from 18 in June. Usually housing bottoms look like a "V"; this one will probably look more like an "L". (this refers to activity like starts and sales, but will probably also be apparent in the confidence survey).

Current sales activity is at a record low of 16. Traffic of Prospective Buyers
at a record low of 12!

NAHB Press Release: Builder Confidence Declines Further In July (excerpts below graph)

Builder confidence in the market for newly built single-family homes fell for a third consecutive month in July, according to the National Association of Home Builders/Wells Fargo Housing Market Index (HMI), released today. The HMI fell below its previous record low of 18 in June to a new record low of 16 in July, with each of its three component indexes also hitting record lows.

“The worsening housing slump and the near-meltdown in financial markets last week makes it even more urgent for Congress to complete action on the housing bill now, a move that will help stabilize and restore confidence in housing and the U.S. economy,” said NAHB President Sandy Dunn, a home builder from Point Pleasant, W.Va.
...
“Builders are reporting that traffic of prospective buyers has fallen off substantially in recent months,” said NAHB Chief Economist David Seiders. “Given the systematic deterioration of job markets, rising energy costs and sinking home values aggravated by the rising tide of foreclosures, many prospective buyers have simply returned to the sidelines until conditions improve,” he said.
emphasis added

by Calculated Risk on 7/16/2008 10:57:00 AM

From MarketWatch: Crude falls over $6 as inventories show surprise increase

U.S. crude inventories gained surprisingly in the week ending July 11, up 3 million barrels to 296.9 million, the U.S. Energy Information Administration reported on Wednesday.

As I noted yesterday, the difference between a moderate and severe recession might be what happens with oil prices:

One of the keys to the base case is that oil prices decline in the 2nd half of 2008 (something I've been predicting for some time). This prediction is based on demand destruction, lower subsidies in certain Asian countries, weaker demand growth in China, and a few other reasons. The fundamentals of supply and demand for oil suggests a small decrease in demand could led to a fairly large decrease in price. If this happens, then that will hopefully lead to Kasriel's "sharp deceleration in inflation".

Usually the headline measure of inflation (CPI) and the core inflation measure (CPI less food and energy) track pretty well with just short periods of divergence due primarily to changes in oil prices. But for the last few years oil prices have risen relentlessly, and CPI has been substantially above Core for an extended period as shown on the following graph.

Falling oil prices would move CPI below Core inflation and might keep the economy out of a severe recession (although the period of economic weakness would still linger for some time).

by Anonymous on 7/16/2008 08:14:00 AM

And the results are, of course, ugly. The LAT reports on police calls to restore order to lines outside some IndyMac branches yesterday. The surliness seems to have stemmed from actual or perceived instances of someone cutting in line.

And why are all these people spending days in line at a bank already operated by the FDIC? More than a few of them appear to have accounts over the insured limit. Perhaps. Sort of.

Take Mr. Bash (no, really, that's his name):

Todd Bash, a 43-year-old teacher from San Gabriel, was worried about IndyMac's viability after reading about its woes in the media, so he had gone into his branch in West Covina on July 8 -- three days before regulators seized the bank. He had two certificates of deposit, a savings account and a checking account, totaling more than $180,000.

Bash said he had been ready to pull his funds, but the teller told him that he could add beneficiaries to get extra insurance. He added his mother to one account and his sister to another.

But after IndyMac was seized, an FDIC hotline operator said the extra insurance wasn't necessarily valid, Bash said. That landed him in line Monday. After eight hours, the bank closed and he went home.

He went on the FDIC website again and used the system's deposit insurance calculator, which said all of his deposits were fully covered.

Bash returned to the bank Tuesday more confident, but when he finally talked to a teller, she showed him that more than $80,000 was missing from one account. Why? The teller didn't know. She referred him to an FDIC official in the branch, who also couldn't tell him what happened, he said.

"One person finally suggested that maybe there was a hold on my account, but when I asked if it was a hold, why wouldn't they just say there was a hold? . . . Nobody could give me any answers," he said.

FDIC spokesman David Barr said most of the problems stemmed from trust accounts that have been put on hold until the agency determines that beneficiaries have been properly named. In most cases, those funds will be released in full after the depositor confers in person with the FDIC, he said.

Frozen trust accounts also caused tellers to fail to credit interest payments to some borrowers. "We apologize for that," Barr said, adding that the FDIC is checking accounts where that may have occurred and will mail missing interest to depositors. "It may take us a few days, but we will get it out."

I love this little anecdote. It has everything in it.

The big moral hazard problem that existed back when deposit insurance was first invented was, of course, the nasty information asymmetry between depositors and the banks. The banks knew what ridiculous risks they might be running with your savings account, but you didn't. "Bank runs" start because the information about risk gets out suddenly (and often incompletely) to depositors at the moment of crisis, leading to depositor panic.

In the New Era here, Mr. Bash actually got information from the media about the riskiness of his bank before it managed to create widespread depositor panic. So he goes to the bank to withdraw his money--or at least that part of it over the $100,000 deposit insurance limit--but when the helpful teller points out to him that he can make perfectly meaningless changes to names on his accounts and get more "free insurance," he decides that makes more sense. His concern about the management of his bank and its risk tolerance does not extend to looking that gift horse in the mouth.

Then IndyMac compounds the "problem" by, you know, having to treat this sham transaction (adding names to an account just to get around insurance limits) by, you know, having to pretend like it's really a transfer of ownership of funds and putting the old perfectly usual "hold" on the account until . . . well, you know. Until the bank has verified that this is not a "fraudulent" transaction. Whatever that means in the current environment.

Mr. Bash is quite upset that the price of nearly doubling his deposit insurance coverage at no monetary cost to him is several days worth of red tape. Defeating the purpose of deposit insurance limits should, we all know, be smooth and flawless. For heaven's sake, this is 2008. Can't someone just type in some numbers and hit the "enter" key? It's one thing to read in the WSJ that your bank's lending activities may be jeopardizing its safety and soundness--to the point of Congress asking some nasty questions about it in public--and to remain calm enough to believe that the teller can fix your problem by adding your mother's name to an account. It is another thing entirely to get cruddy customer service from the damned FDIC.

Of course all the FDIC can do is abjectly apologize and pretend like anybody should really care about Mr. Bash's tribulations at this point. It has to: the rule of the day is No More Panic and FDIC officials and staffers manning those teller lines will have to play the whole "customer service" game until their back molars grind down to stumps and they've emptied all the bottles of Pepcid they keep next to the check printers. One cannot lecture people like Mr. Bash about moral hazard and the costs of free insurance in the middle of a bank takeover.

Not when the other "overinsured" are out front starting to throw their lawn chairs at each other, you can't.