What happens if a bank goes bust?

edwinac_2

More worries that FDIC could buckle under the strain..

FDIC May Need $150 Billion Bailout as More Banks Fail (Update3)
By David Evans



Sept. 25 (Bloomberg) -- Deborah Horn tugs on the handle of the glass-paned entrance of the IndyMac Bancorp Inc. branch in Manhattan Beach, California. The door won't budge. The weekend is approaching, and Horn, 44, the sole breadwinner in a family of three, needs cash.

A small notice taped to the window on this Friday afternoon in mid-July tells her why she's been locked out. IndyMac has failed, the single-spaced, letter-sized paper says; the bank is now in the hands of the Federal Deposit Insurance Corp.

``The Receiver is now taking possession of the Bank,'' the sign says.

``I'm physically shaking,'' says Horn, an academic tutor, as she peers into the bank. Inside, an FDIC examiner is talking to six stone-faced IndyMac employees. ``I don't know when I'm going to be able to get my money,'' Horn says. ``I'm a single mom. This is the money I live on.''

Don't worry about Horn. She'll be all right, as will most of Pasadena, California-based IndyMac's 200,000-plus customers.

That's because the FDIC, created in 1934, insures all accounts up to $100,000 at its member banks, and it has never failed to honor a claim. The people to worry about are U.S. taxpayers.

The IndyMac debacle is taking a large bite out of FDIC reserves, and if scores of other banks fail in the year ahead, the fund will be depleted. Taxpayers will have to step in.

Worst Wave

Americans had gotten used to the idea that bank failures were as rare as a category five hurricane. No banks went bust in 2005 or 2006. Seven collapsed in 2007 as the credit crisis began to exact a toll. So far in 2008, 12 more, with total assets of $42 billion, have fallen -- that's the worst wave of bank failures since 1992.

IndyMac, which had $32 billion in assets when it went into receivership, is the most expensive bank failure the FDIC has ever covered. And that record may not stand for long.

By the end of 2009, about 100 U.S. banks with collective assets of more than $800 billion will fail, predicts Christopher Whalen, managing director of Institutional Risk Analytics, a Torrance, California-based firm that sells its analysis of FDIC data to investors.

``It's not going to be Armageddon,'' says Mark Vaughan, a financial economist at the Federal Reserve Bank of Richmond, Virginia and a senior lecturer in economics at Washington University in St. Louis. ``But it's going to be bad.''

FDIC's Secret List

The FDIC knows which banks are at risk; it has a watch list with 117 institutions. The agency won't disclose their names because doing so could cause depositors to panic and pull out all of their funds.

It won't take many more failures before the FDIC itself runs out of money. The agency had $45.2 billion in its coffers as of June 30, far short of the $200 billion Whalen says it will need to pay claims by the end of next year. The U.S. Treasury will almost certainly come to the rescue by lending money to the FDIC.

Regardless of who wins control of the White House and Congress in November, no politician is likely to vote in favor of leaving federally insured depositors out in the cold.

A taxpayer bailout of the FDIC would come on the heels of intervention by the U.S. Treasury Department and Federal Reserve to save investment bank Bear Stearns Cos., mortgage giants Fannie Mae and Freddie Mac and the world's largest insurer, American International Group Inc.

Uninsured Deposits

Emergency federal lending to the FDIC could swell the cost of government rescues of failed financial institutions to more than $400 billion -- not including the $700 billion general Wall Street bailout now under discussion in Congress. Under federal statute, the FDIC must pay back any loans from the Treasury.

That number would be even higher if the government were on the hook for uninsured deposits -- which amount to $2.6 trillion, 37 percent of the total of $7 trillion held in the U.S. branches of all FDIC member banks.

The subprime crisis -- which started in the suburbs of California and Florida and migrated through the alchemy of securitization to Wall Street investment banks -- has come almost full circle, spreading its toxins to the very lenders who first extended those teaser-rate, no-document mortgages to homeowners.

In 2006, IndyMac was the largest provider of mortgages that didn't require borrowers to provide proof of their incomes. And as of mid-September, investors were worried that Washington Mutual Inc., the biggest thrift in the U.S., would be the next bank to go belly up.

A federal takeover of Washington Mutual, which has assets of $310 billion, could cost taxpayers $24 billion more, according to Richard Bove, an analyst at Miami-based Ladenburg Thalmann & Co.

Slower To Hit

The reckoning that has run through Wall Street, claiming investment banks Lehman Brothers Holdings Inc. and Bear Stearns among its victims, has been slower to hit Main Street. In mid- 2007, Wall Street firms began disclosing losses on their packages of securitized home loans.

From August 2007 to September 2008, banks worldwide wrote down more than $500 billion. Regional banks, by contrast, have waited to write off their bad mortgages, hoping the housing market would improve and defaults would level off. Instead, they've risen.

FDIC-insured banks charged off $26.4 billion of bad loans in the second quarter of 2008, the most since 1991.

U.S. lenders, in their embrace of subprime lending, committed the same analytical fallacy as their Wall Street counterparts. When it came to assessing risk, they relied on the recent past to predict the near future.

Living in the Past

They were blinded by years of rising home prices and low mortgage default rates.

The FDIC fell into the same trap. As recently as March, an internal FDIC memo estimated the cost to cover bank collapses in 2008 would be just $1 billion, dropping to $450 million in 2009. It wasn't even close.

The IndyMac failure alone, which happened four months after that memo was circulated, will cost the FDIC $8.9 billion -- and the bill for all 12 collapses will be about $11 billion, the FDIC says.

FDIC Chairman Sheila Bair says the agency's forecast was based on models using data from the past 20 years, which included long periods with few bank failures.

``Given the change in economic conditions, we need to weight the more recent data more heavily,'' Bair says. ``You also need a good dose of common sense.''
Bair says depositors shouldn't fret about their banks. ``We do have a handful with some significant challenges,'' she says. ``Overall, banks are quite safe and sound.''

Bair is duty bound to say that, says Joseph Mason, an economist who worked for the Treasury from 1995 to 1998. Part of the FDIC's job is to reassure the public and prevent runs on banks. Mason says Bair's rhetoric masks the agency's inability to grasp the scope of the coming crisis.

`Ignoring the Problem'

``The FDIC and the banking regulators are ignoring the problems, hoping they'll go away,'' he says. ``They won't.''

The quake that shook markets in September may make the FDIC's task more complicated and expensive. With investment banks in eclipse, deposit-taking institutions will now play a larger role in financing the economy.

Earlier this month, Bank of America Corp. agreed to buy Merrill Lynch & Co. for $50 billion, and Wachovia Corp. and Morgan Stanley were in talks about a potential merger.

'Would Be Miraculous'

From 2002 to 2007, U.S. lenders made a total of $2.5 trillion in subprime mortgages, according to the newsletter Inside Mortgage Finance. ``Given the magnitude of the bad loans still on bank balance sheets, it would be miraculous for the FDIC to squeak by with losses of less than $200 billion,'' Whalen says.

On Sept. 18, in yet another stunning turn of events, Paulson proposed a plan that would cost the government, if not necessarily the FDIC, hundreds of billions of dollars more.

The Treasury secretary says the government will purchase toxic mortgage debt from banks in an effort to cleanse the financial system. In an unprecedented move, the Treasury also pledged $50 billion to insure nonbank money market funds.

Bair says Paulson's plan won't reduce the number of banks on the FDIC's watch list.

One reason the rolling financial crisis is hitting regional banks later than it walloped Wall Street is because the very system that is meant to protect depositors -- federal insurance -- has also served to prop up weak lenders. So has the ready supply of credit extended to banks by another government-chartered group, the Federal Home Loan Banks.

Because all deposits up to $100,000 are insured, most savers can be agnostic about where they put their money. They don't have to know -- or care -- whether a bank is making sound or foolish loans.

Unlike buyers of stocks or bonds, people who put their money in banks rarely do research about the soundness of the institution. That makes it easy for banks -- both prudent and reckless ones -- to raise cash.

Brokered Deposits Loophole

Banks have taken the FDIC's protection and run with it, thanks to the phenomenon of brokered deposits -- and a giant loophole in federal regulations.
As of June 30, Whalen says banks held $644 billion from brokers who offer customers a way to gain FDIC insurance for multiple accounts.

Promontory Interfinancial Network LLC, an Arlington, Virginia-based company founded in 2002 by former federal officials --including some from the FDIC itself -- has figured out how to help wealthy clients insure as much as $50 million each by putting their money into separate accounts at 500 different banks.

While the law does limit insurance to $100,000 per account, it places no ceiling on the number of different banks where an individual can hold accounts -- a loophole Congress failed to close even after the savings and loan debacle of 1984-1992.

Missing Discipline

Bair says brokered deposits can provide quick cash but also create potential danger.

``It is quite easy to get brokered deposits, and there's not a lot of market discipline with the brokered deposits,'' she says. ``When there's excessive reliance on them, particularly to fuel rapid growth on the balance sheet, that's definitely a high-risk factor.''

The other big source of money for banks is the FHLB, an under-the-radar network of 12 regional banks created by Congress in 1932 to help lenders finance mortgages. Lenders had borrowed a total of $840.6 billion from the FHLB system as of June 30, up 38 percent from $608 billion in the same period a year earlier.

Treasury Secretary Henry Paulson, in a little-noticed action on Sept. 7, the day after he announced the bailout of Fannie and Freddie, extended a secured credit line to the FHLB to provide an emergency source of funding if needed.

FHLB Advances

Vaughan says credit from the FHLB is keeping some sick banks afloat and postponing the inevitable.

`What's going to happen,'' he says, ``is that weak banks will use FHLB advances to avoid discipline from funding markets. In some cases, that will keep their doors open longer than they otherwise would, all-the-while offloading more and more potential losses onto the FDIC and taxpayers.''

Normally, the FDIC is no more than four initials customers see when they walk into their banks. In recent years, the agency hasn't had to close many banks, as it collected small amounts of insurance premium payments.

President Franklin D. Roosevelt signed the law creating the FDIC in the middle of the Depression. As part of the New Deal, Congress created a system of federal insurance to end bank runs by reassuring the public that depositing money in banks was safe. All banks paid the same rate for insurance.

Wave of Failures

The FDIC shares regulatory authority with other agencies. The Office of Thrift Supervision oversees federally chartered savings and loans, the Comptroller of the Currency monitors national banks, and state banking regulators review state- chartered banks.

The FDIC is the only one of these agencies that insures deposits.

By and large, the government's insurance system worked until the 1980s, when thrifts went on a commercial real estate lending binge, triggering a wave of failures and consolidation that lasted from 1984 to 1992.

In 1991, Congress changed the way FDIC premiums were assessed, requiring banks to pay rates based on how well capitalized they were for the risks they faced. As bank failures subsided to less than a dozen a year by 1995, the FDIC's reserves began to swell.

As a result, the agency cut to zero the premiums it charged to the 90 percent of the banks deemed safest. That free ride continued for 10 years.

`No Good Way'

In 2006, Congress increased insurance payments for most banks, averaging $5-$7 per $10,000 of deposits.

The insurance premiums imposed by the FDIC on the riskiest banks -- running as high as $43 per $10,000 -- are still far below the rates private insurers would charge, says Sherrill Shaffer, former chief economist of the Federal Reserve Bank of New York.

At the same time, charging struggling banks a fair price for insurance premiums may drive them into insolvency, he says.

``That can be destabilizing,'' says Shaffer, who's now a professor of banking at the University of Wyoming in Laramie. ``There's really no good way around that. It's an issue that policy makers and analysts have wrestled with for decades.''

Bair says the FDIC is gearing up for the coming wave of bank failures. She says she's developing a plan to raise insurance premiums.

The agency's Division of Resolutions and Receiverships has boosted authorized staffing levels by 48 percent, to 331, this year. It has hired 178 new financial specialists and called up 65 retirees for temporary service under a special program.

Bair vs. Enron

Bair, 54, an attorney who graduated from the University of Kansas School of Law, has challenged financial institutions as a regulator for more than a decade. President George W. Bush nominated her as chairman, and she was sworn in on June 26, 2006.

She replaced Donald Powell, a former Texas banker. In 1992, as a member of the Commodity Futures Trading Commission, Bair cast the lone vote against Enron Corp.'s effort to exempt certain energy contracts from the agency's anti-fraud and anti- market manipulation enforcement powers.

Nine years later, Enron blew up in one of the biggest financial scandals in U.S. history.

As assistant secretary of the Treasury for financial institutions in 2002, Bair criticized abusive subprime mortgage brokers.

``Lenders have made loans with little or no regard for a borrower's ability to repay and have engaged in multiple refinance transactions that result in little or no benefit to a borrower,'' she told the Pittsburgh Community Reinvestment Group on March 18, 2002.

`Rock and Brock'

Bair has published two children's books. One of them, ``Rock, Brock, and the Savings Shock'' (Albert Whitman, 2006) is a tale of two twins -- Rock the Saver and Brock the Spender

To contact the reporter on this story: David Evans in Los Angeles at [EMAIL="davidevans@bloomberg.net"]davidevans@bloomberg.net[/EMAIL]

Last Updated: September 25, 2008 19:54 EDT

roddydogs

fatpig wrote: »

You wouldn't have to wait to get your money back. Northern Rock savers didn't have to wait so you wouldn't have to wait either.


From yesterday's Financial times:

Alistair Darling, chancellor of the exchequer (finance minister), said last year after the run on Northern Rock that the government would guarantee every penny of savers’ money, not just at the Newcastle lender but at every other bank.

And where, precisley would the "Government" find all the Squillions if several big banks went bust at once?

ad44downey

If several big banks went bust at once, the last thing you'd have to worry about is your savings.
It would be like Zimbabwe. Money would be worthless anyway, there'd be rioting in the streets, total anarchy. Society would completely collapse.

None of this is going to happen of course

edwinac_2

ad44downey wrote: »

If several big banks went bust at once, the last thing you'd have to worry about is your savings.
It would be like Zimbabwe. Money would be worthless anyway, there'd be rioting in the streets, total anarchy. Society would completely collapse.

None of this is going to happen of course

Why? People like Buffett and Soros are not discounting the possibility.

How many "experts" now speak openly of an economic crisis as bad as, or worse than the Great Depression?

cantthinkofanickname

If subprime is the key for exposed banks where is there a list of subprime lenders so I can avoid investing in them?

Does anyone have a list of Spanish banks which are involved? I've heard that other countries are helping their banks in trouble but no news from Spain yet. Remember some of our banks are owned by the Spanish.

Some personal observations:

1. IMHO, if a banks goes bust then one will wait a long time and even then there may be nothing at the end. So any savings are at risk. Rule: no more than 10% invested in one bank (and check who owns the bank so that an investment elswhere is not under the same umbrella).

2. Politicians promises about protecting the public are hollow. They are not in control. They will be protecting their personal fortunes though. It's Everyone for themselves.

3. Have some investments in nsandi even though the interest rate is usually lower.

4. Have some direct cash if/when the whole banking system collapses (20% of your savings).

5. What happens when the money used to bail out banks runs out?

stubex

We have savings in Kaupthing Edge and given this mornings news about the 3rd biggest Icelandic bank being in trouble we are concerned. What should we do - Help!

monkeyspanner

Can someone enlighten me?

We are being told the problem is the banks are not lending to each other and that the inter-bank lending rate is very high. This implies the banks or at least some of them have funds they could lend but are reluctant to do so.

Also we have a series of banks failing. So does this mean they ran out of money or were strangled to death by the banks that have spare funds?

So is the banking crisis being deliberately worsened by banks with spare funds waiting for their smaller and less secure competitors to get into difficulties so they can be bought up for nothing?

cantthinkofanickname

monkeyspanner wrote: »

Can someone enlighten me?

So is the banking crisis being deliberately worsened by banks with spare funds waiting for their smaller and less secure competitors to get into difficulties so they can be bought up for nothing?

It's a jungle out there full of wild animals! Don't expose yourself!

altocumulus

stubex wrote: »

We have savings in Kaupthing Edge and given this mornings news about the 3rd biggest Icelandic bank being in trouble we are concerned. What should we do - Help!

If KE is in any trouble, then withdrawing all savings will only exacerbate the situation.

If the Icelandic government stepped in for their 3rd largest bank, one would hope they will step in for others....

After all, governments seem to be made of money these days, or if not they print more.... :rotfl:

nicko33

formulaonefan wrote: »

So all we are saying is if a bank goes bust then forget about your saving as it might take forever or never to get your money back? I thought up to £35K is safe is too good to be true.

No we're not all saying that.
The Govt would print up some more money to repay depositors "in a timely manner"

As reported on this site

" in May 08, as part of my ‘How Safe are your Savings’ programme I managed to get an interview with the Cabinet Minister responsible, Chief Secretary to the Treasury Yvette Cooper, MP.

During the interview, as I pushed, I was told the government would ensure the £35,000 was paid out, yet I couldn’t get an answer on how… then just before the programme went out we got this statement The Treasury gave us the following statement

• "In the unlikely event a major bank became insolvent the Government would ensure that the FSCS has access to enough immediate funding to pay out depositors in a timely manner, through borrowing from the Government or Bank of England. The FSCS could then levy up to £4 billion per year from the financial services industry to cover the costs of compensation"

In plain English, this means that in the unlikely event of a bank collapsing and requiring more than £4 billion of compensation, the FSCS would be lent the money to compensate consumers up to £35,000 each, and it would have to pay back to loan in subsequent years, by continuing levies."