Karl Denninger, "Is The FDIC Broke?"- UPDATE 8/3

"Is the FDIC broke? I have to wonder. First, we have Corus, which reported a negative Tier 1 Ratio. That is, they are formally "in the hole" in terms of assets .vs. liabilities. This is never supposed to happen - but it did, "Prompt Corrective Action" be damned.

Next, we have Guaranty Bank, which also has a negative core capital ratio. They have been trying to sell themselves (gee, I wonder why?) for a while without success. Here's the relevant quote from their 8-K: Based on these adjustments, the Bank’s core capital ratio stood at negative 5.78% as of March 31, 2009. The Bank’s total risk based capital ratio as of March 31, 2009 stood at negative 5.52%. Both of these ratios result in the Bank being considered critically under-capitalized under regulatory prompt corrective action standards. Yet Prompt Corrective Action (PCA) - a law, by the way, not a suggestion - has once again not been followed.

Finally, we have Colonial* (See UPDATE below). I made a nice chunk of coin shorting and PUTting that turkey last year, when their CEO (and a lot of other people) said they were "very conservative." Uh huh. My read of their balance sheet said they were (like many other regional banks) massively over-exposed to condo construction loans in..... you guessed it.... Florida (which incidentally is what killed Corus.) Oops. But here's the money quote on Colonial: If the FDIC were to seize Colonial, it would be the sixth-largest seizure, by assets, in American history. Such a large failure could strain the bank safety net. Colonial has $20 billion in deposits, while the FDIC insurance fund has dropped below $15 billion. The FDIC wouldn't have to cover every dime, but when Florida's BankUnited, with $12.8 billion in assets, failed earlier this year, it cost regulators nearly $5 billion. Add all three of these up and tell me what you think is going on? These three are not small banks. They are significant regional institutions, unlike the tiny little banks that we hear about every Friday after the close of business.

Here's the nut to the story above: When BankUnited was seized note that the total loss on assets was some 40%. They were not in the hole by anywhere near that much according to their so-called "accounting." Neither was IndyMac, but they also created an enormous loss. So what's going on here?

Simple: An enormous number of banks are holding loans at or close to "par" that really aren't. They're holding mortgages at massively-inflated values, even on defaulted properties, and this is why you are not seeing more foreclosure sales - that is, why inventory is being held back. If they sell it the accountants will force recognition of the loss, which will render them instantly insolvent, but so long as they "extend and pretend" they are marking these loans way, way above recovery value. The upshot of this is that these firms' balance sheet claims on asset values are massively inflated, regulators know it, and they're intentionally ignoring it.

I have been sounding the alarm on this for more than a year; it has in fact been the focus of multiple petitions to Congress and the cause of thousands of dollars of personal expense faxing letters and Tickers to members warning them of the danger of letting this sort of accounting misdirection continue. The claim of banking sector health and "successful rescue by Treasury and The Fed" is in fact false. No such thing has occurred. What's going on here is nothing more or less than intentional false claims of asset "valuation", which is repeatedly exposed when the FDIC is finally forced to seize institutions, exposing the lies. Then, suddenly, 20, 30, even 40% losses on alleged "asset books" come out into the light and the taxpayer eats them.

The bank executives and accountants that played this game with the books should have been arrested and the bank thrown into receivership over a year ago. Oh by the way, just as with all such "extend and pretend" games (otherwise known as fraud when practiced by anyone without a "government can cheat all it wants and nobody goes to jail" card) the longer you play this game, the longer you wait to do the right thing, the more money it costs you (in this case the Taxpayer gets the inevitable bill.)

For those of you who say that the FDIC is "not the responsible party", that's nonsense. OTS/OCC are the agencies that perform primary regulation for any federally-chartered bank but the FDIC is the agency that is responsible for resolution, and they are always working together in this regard. Yes, the FDIC has a "backup credit line" (a big one at that!) from Treasury, but the fact remains that about 75% of the FDIC's "insurance fund" has been depleted over the last year due to massive and intentional failures to enforce Prompt Corrective Action, with the most-expensive and most-outrageous (thus far) being IndyMac, where OTS was found (by the government's own auditors!) to be complicit in backdating deposits to "cook" capital ratios!

Riddle me this folks: What possible positive purpose can come from the FDIC refusing to seize these institutions when their capital ratios are either negative or clearly going to become negative? These banks have all been train wrecks that I and others have written about for more than a year; Colonial was referenced in a Ticker on the 14th of July of 2008, with my first warning on them more than two years ago in April of 2007.

What do I think? I believe the FDIC is broke and knows it; that under the law they should have seized these three banks (and many dozens more, including some really big ones) some time ago, but doing so will force them to tap the Treasury "emergency" credit line. They're well-aware that this could instill quite a bit of panic in the public (never mind Congress!); as such they, along with OTS and OCC are conspiring to (once again) hide the truth and pray for an economic recovery before they are forced to act as the law demanded months or even years ago!

This is nothing more than an attempt to keep this graph from looking dramatically worse than it already does and keep the "green shoot" lie alive to pump the stock market so that Americans "feel better." Big banking and other executives are taking advantage of this lie by selling shares into an overheated market (which they have been doing, by the way: Insider sales are at levels last seen just before the top in October of 2007!)

Hint to Sheila Bair, Tim Geithner, Dugan and Ben Bernanke: It won't work and you're going to precipitate a credit and stock market meltdown worse than last fall's. You may have already passed the point where you are unable to avoid that sort of damage, but if you don't act now the outcome is virtually assured. Do your damn job and do it now; we must stop the fraud and force the insolvent into the open - all of them - if we are to have a durable economic recovery!

- Karl Denninger, http://market-ticker.denninger.net/archives/2009/08/02.html

Followup, August 3, 2009: "Now add into this the FDIC mess. After I posted my missive yesterday I was sent a table showing the FDIC's remaining funds. I have not done a comprehensive analysis on this but I did eyeball it and the quick check appears to be good; I can't vouch for this on my own detailed analysis but if this is accurate the FDIC is down to $800 million dollars, and a failure of any of the three "seriously in trouble banks" - Colonial, Corus or Guaranty - would blow that tiny little pile of money to Mars.

And oh, by the way, Colonial* (which closed at 60 cents Friday) is trading premarket at 48 cents, and reported a stunning loss of $3.02 a share after the market closed Friday - or some five times its per-share price. They also announced that a rescue financing pact they were working on has collapsed, making a FDIC take-over almost certain (if the FDIC ever does its job!)

Inquiring minds are wondering if the correct meme is in fact something like this: The economy is "improving" because the government showered borrowed money in the form of massive handouts into the economy. However, the government also allowed banks to hide stupendous losses - a trillion dollars or more - by intentionally overstating the value of assets.

"Prompt Corrective Action" is supposed to insure that when the FDIC takes over a bank it suffers little or no loss. This has worked well for over a decade and justified the FDIC holding only $50 billion in cash to insurance $8 trillion in deposits. But the government's policy of allowing these outright lies in relationship to asset values has now resulted in the FDIC taking 40% losses against assets on average for the banks it has closed since this crisis began.

The consequence is that what looked like a reasonable policy - holding some 1/2 of 1% in insurance, or a leverage ratio of almost 160:1 - has now been shown to be insanely reckless. These losses are almost entirely as of yet unrealized, but they are real and they are inescapable. They WILL be taken. The FDIC has a "credit line" with Treasury but there is no possible way for it to be able to absorb $400 billion - a rough estimate of the amount that will be absorbed - without a tremendous burst of new debt issuance and the risk of an all-on collapse in both the stock and credit markets.
Enjoy the rally, but keep your eye on the door and your path to it. The curtains are on fire."

-Karl Denninger, http://market-ticker.denninger.net

So, bottom line, the FDIC currently has $800 million to guarantee $8 Trillion in deposits, or 1/160th of what it would need if everyone took their money out of the bank. What's their motto, "Backed by the full faith and credit of the United States Government." Well, we're seeing what THAT is worth, aren't we?

*Update, 8/3/09, 2:30 PM: "From Reuters: U.S. raids Colonial Bank office in Florida (ht Jim the Realtor)

Federal agents working with the U.S. Treasury's Troubled Asset Relief Program (TARP) executed search warrants at two Florida banks on Monday and Colonial Bank (CNB.N) said one of them was its office in Orlando. A spokeswoman with the office of the Special Inspector General for the Troubled Asset Relief Program, which buys assets from troubled financial institutions to stabilize the banking industry, would only say that its agents executed two search warrants in Florida on Monday.

Colonial is operating under a Cease & Desist order, and just Friday reported to the SEC: " ... management has concluded that there is substantial doubt about Colonial’s ability to continue as a going concern." Colonial has about $25.5 billion in assets and would be the largest bank failure this year. No word on the purpose of the raid."

- http://www.calculatedriskblog.com/2009/08/us-raids-colonial-bank-office.html

So, the FDIC, with an $800 Million working balance, now "guarantees" exactly how much of Colonial's "$25.5 Billion" in assets? Aren't you glad, Good Citizen, that you didn't have your money with them?

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