October 5, 2022

US Treasury Calls TARP Repayments A “Milestone” While Ignoring The Elephants In The Room

Treasury’s Victory Call On Financial Bailout Premature

The Treasury Department’s latest public relations effort to highlight the success of the financial system bailout focuses on the amount of TARP repayments versus total debt outstanding.  In addition, the Treasury, which had previously estimated the cost of the TARP program at $341 billion, has now lowered that estimate to only $105 billion.

Wall Street Journal – The U.S. Treasury Department said Friday the total amount repaid to taxpayers for government funds used to bail out U.S. companies has surpassed, for the first time, the amount of outstanding debt.

The Treasury, in its May report to Congress on the Troubled Asset Relief Program, reported TARP repayments reached $194 billion, which has exceeded by $4 billion the total amount of outstanding debt—$190 billion.

Treasury’s assistant secretary for financial stability, Herb Allison, in a statement described the totals as a “milestone” and said this is “further evidence that TARP is achieving its intended objectives: stabilizing our financial system and laying the groundwork for economic recovery.”

Does the general public accept the Treasury’s view that the bailout was a resounding success at a relatively modest cost?  Recent Pew Research data, which reveals overwhelming negative public opinion for both the government and the banks, suggests that the Treasury’s spin on the bailout will be given little credence by the public.

Large majorities of Americans say that Congress (65%) and the federal government (65%) are having a negative effect on the way things are going in this country; somewhat fewer, but still a majority (54%), say the same about the agencies and departments of the federal government.

But opinions about the impact of large corporations and banks and other financial institutions are as negative as are views of government. Fully 69% say that banks and financial institutions have a negative effect on the country while 64% see large corporations as having a negative impact.

In March, during the final debate over health care reform, just 26% of Americans offered a favorable assessment of Congress – by far the lowest in a quarter-century of Pew Research Center polling.

Large majorities across partisan lines see elected officials as not careful with the government’s money, influenced by special interest money, overly concerned about their own careers, unwilling to compromise and out of touch with regular Americans.

The skepticism regarding the ability of government to operate honestly in the public’s best interest is well founded and the latest Treasury report on progress of the TARP program bears this out.  While the Treasury reports on the “success” of repayments under the $700 billion Troubled Asset Relief Program, other government bailouts and guarantees that are far exceed the cost of the TARP program are conveniently ignored.   If the Treasury really wants to provide a comprehensive accounting of what the financial system bailout will cost the American taxpayers,  here’s my short list of additional items to address in their next report.

1.  The amount currently owed under the TARP program does not include amounts committed by the US Treasury but not paid out.   According to the WSJ, “the outstanding debt amount does not include $106.36 billion that has been committed to institutions but has yet to be paid out by the Treasury. Factoring in that amount, the outstanding debt would be roughly $296 billion.”

2.  Two of the biggest ongoing bailouts in history go unmentioned.   The  Housing and Economic Recovery Act of 2008 provided for a $400 billion bailout of Fannie Mae and Freddie Mac.   The Government subsequently granted Fannie and Freddie an unlimited line of credit with the Treasury.   Fannie and Freddie have already drawn $145 billion and according to Bloomberg, the final cost to bailout out the two agencies could approach $1 trillion.

3.  Future banking failures constitute another sizable risk for increasing the cost of bailing out the US financial system.   The FDIC has been able to resolve banking failures to date using premiums collected from the banking industry, including a special assessment of $46 billion at the end of 2009.   While the FDIC has not yet had to tap its $500 billion line of credit with the US Treasury, future banking failures may require it to do so.

In its latest quarterly report, the FDIC reported an increase in the number of problem banks to 775, out of a total of 7,932 FDIC insured banks.  Assets at the problem banks total $431 billion.  Total deposits insured by the FDIC now total $5.5 trillion.   The amount of reserves in the FDIC Deposit Insurance Fund total negative $20.7 billion.   Liquid reserves of the FDIC total a mere $63 billion.   If the US economy weakens and more banks fail, the FDIC’s only option will be a costly bailout by the US Treasury.

The government seems to believe they can fool all of the people all of the time. Whatever happened to “change you can believe in”?

FDIC Considers Borrowing From Treasury As Banking Failures Increase

FDIC May Request Treasury Loan As Losses Grow

The FDIC always takes pride in noting that it is self funding and covers failed bank losses by assessments on FDIC insured member financial institutions.

Congress created the Federal Deposit Insurance Corporation in 1933 to restore public confidence in the nation’s banking system. The FDIC insures deposits at the nation’s 8,195 banks and savings associations and it promotes the safety and soundness of these institutions by identifying, monitoring and addressing risks to which they are exposed. The FDIC receives no federal tax dollars – insured financial institutions fund its operations.

How much longer the FDIC can continue to fund itself based on fee assessments is questionable.  For the second quarter of 2009, the banking industry as a whole lost $3.7 billion dollars and second quarter FDIC assessments totaled $9.1 billion.

FDIC Insurance Fund Nearly Depleted

The FDIC did borrow money from the Treasury during the last banking crisis in the early 1990’s and later paid the money back.  The escalating number of costly bank failures over the last two years has reduced the FDIC Deposit Insurance Fund (DIF) to only $10.4 billion which  covers potential losses on almost $5 trillion dollars in FDIC insured deposits.  In addition, the number of banks on the FDIC Problem Bank List continues to expand.

The Problem Bank List grew to to 416 institutions from 305 last quarter.  The total assets at Problem Banks increased to $299.8 billion from $220 billion last quarter.  This is the largest number of problem banks since June 30, 1994.  The number of FDIC  insured institutions declined to 8,195 from 8,247 last quarter.

Earlier this year the FDIC’s line of credit at the Treasury was increased to $100 billion and up to $500 billion with the consent of both the Federal Reserve and the Treasury.  With a nearly depleted  DIF fund and the prospect of hundreds of additional banking failures, the FDIC may have no choice but to borrow from the Treasury as noted in the Wall Street Journal.

WASHINGTON –– Federal Deposit Insurance Corp. Chairman Sheila Bair said Friday her agency may tap its $500 billion credit line with the U.S. Treasury to replenish its deposit insurance fund, though she appeared cautious about doing so.

“We are carefully considering all options” including borrowing from the Treasury, Ms. Bair said Friday after a speech in Washington.

Ms. Bair has already warned banks that they may face an assessment increase to bolster the fund. Friday, she said there are also other little-known options available to the agency, including requiring banks to prepay assessments. The FDIC board of directors will meet at the end of this month to consider how to replenish the fund, she said.

Ms. Bair appeared cautious about resorting to the Treasury credit line, saying there are different views on when it should be used. She said some believe it should be reserved for emergencies only, rather than for covering losses that are already known.

Surging loan defaults show no sign of leveling off which in turn puts more banks at risk of failing.  The FDIC will need a Treasury bailout – the only question is will $500 billion be enough?

Noncurrent Loan Growth

Noncurrent Loan Growth

The FDIC Deposit Insurance Fund (DIF) – A Risky Game Of Confidence

FDIC Rightly Worries About Public Confidence

Due to the large number of bank failures during 2009 the FDIC Deposit Insurance Fund (DIF) has fallen to the lowest level since March 1993.  Numerous headlines are screaming that the FDIC is bankrupt and that the DIF fund is depleted.  Considering the perilous financial condition of the banking industry and the possibility of perhaps another 1,000 or more bank closings, the FDIC is probably not capable of fulfilling its mission without substantial loans from the US Treasury.  (The last time this happened was in the early 1990s during the savings and loan crisis when the FDIC had to borrow $15 billion from the US Treasury.)  This does not mean, however, that the upcoming FDIC  Quarterly Banking Profile will report a negative balance in the DIF.

The FDIC has made it clear that they consider it important to maintain a positive DIF number to avoid causing a lack of confidence in the banking system by the public.

The FDIC believes that it is important that the fund not decline to a level that could undermine public confidence in federal deposit insurance. A fund balance and reserve ratio that are near zero or negative could create public confusion about the FDIC’s ability to move quickly to resolve problem institutions and protect insured depositors.

In addition, the FDIC has increased assessments on FDIC insured institutions to replenish the DIF fund and predicted that the DIF would remain positive in 2009.

May 22, 2009 – With the special assessment adopted today, the FDIC projects that the DIF will remain low but positive through 2009 and then begin to rise in 2010. However, Chairman Bair also cautioned that given the inherent uncertainty in these projections and the importance of maintaining a positive fund balance and reserve ratio, “it is probable that an additional special assessment will be necessary in the fourth quarter, although the amount of such a special assessment is uncertain.”

Even though the FDIC has significant authority to borrow from the Treasury to cover losses, a fund balance and reserve ratio that are near zero or negative could create public confusion about the FDIC’s ability to move quickly to resolve problem institutions and protect insured depositors.  The FDIC views the Treasury line of credit as available to cover unforeseen losses, not as a source of financing projected losses.

The DIF Shell Game

So how does the FDIC manage to report a positive DIF when the March 31, 2009 balance was $13 billion and estimated FDIC losses on bank closing since March 31 total $19.3 billion?  Determining the DIF balance is not a matter of simply subtracting the banking failure losses from the DIF fund.  The FDIC uses accrual accounting to establish reserves against the DIF fund for estimated future losses.

For example, during 2008 the FDIC heavily reserved for anticipated future banking failures in 2009.  The FDIC established provisions for losses of $41.8 billion compared to actual losses on 2008 bank closings of $17.9 billion.  The reserve fund at March 31 had a balance of $28.5 billion against which the FDIC year to date losses since March 31 of $19.3 billion could be charged.  This would still leave the FDIC a reserve balance for future banking failures of $9.2 billion.

In addition, the FDIC has imposed large assessment on FDIC insured banks to replenish the DIF fund.   The assessments earned by the FDIC have increased steadily throughout 2008 as the banking crisis unfolded.   In the first quarter of 2009, the FDIC collected assessments of $2.6 billion to rebuild the DIF fund.  This compares to total assessments for all of 2008 of $2.965 billion and only $643 million in 2007.

In summary, if the FDIC offsets its losses against previously established reserves,  and collects an additional $3 billion in assessments, the FDIC could actually report an increase in the DIF fund to approximately $16 billion.   My guess is that the FDIC will only use a portion of the reserve balance, and report a DIF positive balance in the range of $10 to $13 billion when the Quarterly Banking Profile is released.   It’s all about confidence and an uneducated stupid public – the DIF balance of around $20 billion allegedly “protects” over $6 trillion in deposits! The only thing that would expose this “confidence game” is if the financial results for the banking industry come in much worse than the last quarter.  Stay tuned.

DIF

DIF

Disclosures:  None

Feds To CIT – “Your Loan Application Has Been Denied”

CIT Solution Is Bankruptcy – Not Bailout

A CIT spokesman said late today that “There is no appreciable likelihood of additional government support being provided over the near term”.   Taxpayers had previously supplied a massive $2.3 billion dollars in loans under the TARP program late last year.  The large TARP infusion did little to turn around CIT which has reported losses for the past two years of over $3.4 billion.

CIT has $60 billion in finance loans and leases outstanding, an amount that is a mere rounding error in a $14 trillion US economy.  CIT does not represent a systemic risk to the US financial system.  The large amount of losses reported by CIT over the past two years suggest that loan approvals were given to risky enterprises.  CIT would not be losing money and on the verge of bankruptcy if their lending policies had properly accounted for risk.

The weak economy certainly contributed to CIT’s losses, but they could have been mitigated by better risk management.   As a private lender, CIT has the right to lend based on whatever standards they chose.  As a private lender, they also bear the responsibility of loss.

The American taxpayer should not be stuck with the cost of bailing out every failed business enterprise.  There already is a solution for poorly run companies – the solution is known as bankruptcy.  The US Treasury can join other creditors in bankruptcy court – cutting your losses is often the best option.

CIT aggressively expanded its loan portfolio over the past fives years by almost 100% to $60 billion.   CIT attempted to rein in its lending as the recession deepened, but the losses continued.  Increased losses resulted in a dramatic reduction of new lending activity over the past year.  CIT has effectively shut down new lending to small businesses for over a year now.  Customers that qualify for financing have gone elsewhere.

CIT -courtesy WSJ

CIT -courtesy WSJ


For small businesses, CIT is already failing.

“In order to service its debt and meet obligations, [CIT] has been cutting back on new originations,” explains David Chiaverini, research analyst at BMO Capital Markets.

CIT CEO Jeffrey Peek said in November that his company was “the bridge between Wall Street and Main Street,” and “one of the few significant sources of liquidity for small and mid-sized businesses who are struggling to survive.” But by then, CIT was already burning down its bridge, turning away many of the small businesses that had come to rely on the company.

BMO Capital Markets’ Chiaverini sees bankruptcy as CIT’s most likely next step.

“The best case for CIT is to get its liquidity issues resolved — bankruptcy could actually get things back to normal on the lending front,” he says. “If it does go into bankruptcy, I think what will happen is unsecured debt holders will convert their debt into equity and it will emerge stronger without the overhang of debt coming due. Then, it can start lending again.”

CIT’s role in small business financing will be hard to fill, but for many companies, the damage is already happening. Saving CIT would only help Main Street businesses if the company became healthy enough to resume making loans.

FDIC Rejects CIT Loan Guarantee Request

Sheila Bair, FDIC Chairman, had previously expressed deep reservations about allowing CIT to access the Temporary Loan Guarantee Program (TLGP) due to CIT’s weak financial condition.   Due to the financial crisis, the FDIC was called upon to provide guarantees to bank issued debt under the TLGP.  This type of massive “mission creep” imperils the primary purpose of the FDIC which is to protect depositor funds.  The FDIC Deposit Insurance Fund (DIF) is nearly depleted.  Sheila Bair made the right call and so did the Federal Government.  Let the owners and creditors of CIT assume the risk of loss – not the US taxpayer.

“Cutting Your Losses”

cit-chart

Disclosures: No positions

More on this topic: Treasury Bets U.S. Financial System Can Weather CIT Collapse

TARP 2 – Will Bad Loans Wipe Out Newly Raised Bank Capital?

Are The Banks Paying Back TARP Money Too Soon?

Since the beginning of the year, major banks have raised over $200 billion in capital, far in excess of the $75 billion of new capital that the government stress tests had called for.  The market prices of major bank stocks have recovered dramatically since March, indicating that Wall Street investors see a recovery in the banking industry.

In addition, the banking industry is enjoying one of the largest net interest margins in history due to a very low cost of funds.  Wells Fargo, for example, in the fourth quarter saw its average cost of funds decline to 1.5% while its net interest margin exceeded 4%.  With banks able to access cheap funding thanks to the super low rate money policy of the Federal Reserve, banks almost have a license to print money.

The big question is will the banks be able to earn enough to offset the huge amount of future write downs that will be needed on their troubled loans?  Earlier this year, Bloomberg reported that the International Monetary Fund (IMF) estimated U.S. banking losses through 2010 at $1.06 trillion.  To date the banking industry has taken write downs of only half that amount, indicating further write downs of an additional $500 billion will be necessary.

In addition, delinquency rates on $1 trillion of commercial real estate loans held by banks have been increasing at a higher rate than anticipated.  Credit card losses for the banks have also been rapidly mounting from previous estimates.

Mortgage Default Surge Could Wipe Out Banking Capital

Total Estimated Losses

Total Estimated Losses

Courtesy:  T2 Partners LLC

The banking industry’s mortgage portfolio is the real wild card and may result in the need for huge additional write downs to cover the cost of mounting defaults.  The banking industry is facing a potential nightmare surge in mortgage loan defaults, even if real estate prices stabilize at current levels due to the large negative equity positions of many homeowners.  (The above chart shows the total estimated banking losses of which only a fraction has been realized to date.)

There is no historical model to predict the correlation of mortgage defaults to equity position, but one would expect that being deeply underwater on the mortgage will result in a strong economic motive to stop paying or simply walk away.  How many homeowners, for example, will continue to make a mortgage payment on a $200,000 mortgage when the home is valued at $100,000?  The greater the negative equity, the greater the odds of a mortgage default, especially if the homeowner is under financial stress.

Unfortunately, the problem of negative equity is not theoretical.  In the latest overview of housing and the credit crisis, T2 Partners LLC, has assembled an in depth excellently documented case on why the pain in housing is not about to end quickly.  One eye opener in the report is the estimate, by type of mortgage borrower, of negative equity.  T2 shows the following stats: 73% of OptionARMs, 50% of subprime , 45% of Alt A and 25% of prime mortgage loans are underwater.  Combine this with a weak economy, job losses and negative income growth and the potential for additional huge write downs on residential mortgages seems inevitable.

The impact of a poor economy and huge negative equity is already being reflected in default rates never experienced in modern economic history.  Almost 10% of all mortgages are in some stage of delinquency or default.  The delinquency rate on prime mortgages, never expected to exceed historical delinquency rates of approximately 1%, are now over 4.5%.  Note that prime mortgage loans are the loans that were never expected to have more than a minimal default rate based on the borrower’s credit and income characteristics.

The banking industry is likely to need every dollar of newly raised capital and then some to cover future loan losses.   If future banking industry profits are overwhelmed by additional loan losses, it will be years before banks can be solidly classified as well capitalized.   A capital constrained banking industry will survive in some form, but it may not be able to provide the new lending necessary to foster future economic growth

Banks Loss Reserves Can’t Keep Pace With Troubled Loans

The latest FDIC Quarterly Banking Profile reveals that banks increased loan loss reserves by 11.5% and the ratio of reserves to total loans increased to 2.5%, an all time high.   Despite the large loan loss reserves, the ratio of reserves to noncurrent loans fell for the 12th consecutive quarter to 66.5%, the lowest level in 17 years.   This low reserve ratio, despite large increases in loan loss provisions  indicates that the banking industry’s estimates of future delinquencies has consistently been too low.

Reserve Coverage Ratio

Reserve Coverage Ratio

Even if the amount of noncurrent loans level off, the implications for future banking profits is a dismal picture.   In order to establish an adequate coverage ratio for noncurrent loans, loan loss provisions will have to rise dramatically.

Prime Mortgage Defaults – Another Black Swan

The banking industry’s low estimate for loan delinquencies may be due in large part to the unexpectedly large increase in default rates seen on prime mortgages.   Prime mortgages were never expected to have a default rate above the historical ratio of around 1% since these were mortgage loans made to the best customers.  In the past, the only defaults typically seen on prime mortgages were due to unexpected job loss, a divorce, illness or other factors beyond the control of the borrower.

The rapid increase of delinquencies on prime mortgages  has caught the banks off guard.   The default rates on prime mortgages is now almost 5% (5 times normal),  a true Black Swan event for the banking industry.  In addition, the  default rate could rise even higher since 25% of prime mortgage holders now have negative equity, a situation which enhances the odds of  delinquency and defaults.

Based on the rapidly deteriorating numbers for prime mortgages, loan loss reserves need to be increased significantly.  The myth that most of the smaller community banks are not exposed to the risks that afflicted the bigger banks is only partially true.   Banks of all sizes have significant exposure to the mortgage market and the growing number of defaults  by prime mortgage borrowers will cause significantly higher than expected losses at all banks.

Prime Mortgage Delinquencies

Prime Mortgage Delinquencies

Courtesy of:  moremortgagemeltdown.com

Problem Banks, Failed Banks Increasing Rapidly

The 36 failed banks we have seen this year has expanded dramatically from 25 for all of 2008, but has remained very low considering the extent of the losses in the banking sector.  Many very weak banks have apparently been allowed to stay open under the misguided hope that mortgage defaults would decrease as the economy improved.  The number of banks classified by the FDIC as “Problem Banks” has risen to 305 from 90 last year.  The latest surge in mortgage defaults due to job losses,  declines in real estate  prices and negative income trends will have a devastating effect on an already weakened banking industry.

The FDIC’s line of credit with the Treasury was recently increased to $100 billion from $30 billion.  The FDIC can borrow up to $500 billion with Federal Reserve and Treasury Department approval.  Expect to see the FDIC draw down significantly on their expanded line of credit with the Treasury as the FDIC is forced to close increasing numbers of insolvent banking institutions.