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Nathan’s Economic Edge

Last Friday seven more banks failed bringing the total bank failures to 103.

U.S. bank failures this year have surpassed a bleak milestone of 100 as regulators shut down banks in Georgia, Florida, South Carolina, Kansas, Nevada, Minnesota and Oregon.

The seven bank seizures announced Friday bring to 103 the failures so far in 2010. The pace of bank closures this year is well ahead of that of 2009, which saw a total of 140 banks shuttered amid the recession and mounting loan defaults. That was the highest annual tally since 1992, at the height of the savings and loan crisis.

The number of banks on the FDIC’s confidential “problem” list jumped to 775 in the first quarter, from 702 three months earlier, even as the industry as a whole had its best quarter in two years.

More Failures Coming

The FDIC is now deep in the red and the situation is getting worse every week. The situation would be even worse were it not for widespread “extend and pretend” tactics that keep woefully insolvent banks in business.

FDIC Shell Game To Hide Bad Assets

To address the situation, the FDIC is going to start selling U.S.-guaranteed FDIC senior certificates. However, it has no Congressional authority to do so according to former thrift regulator William Black.

Unlimited Taxpayer Bailout

Black claims an “unlimited taxpayer bailout” of the FDIC is on the way.

Barrons discusses the situation in Uncle Sam Rides Again: Banking on a Bailout?

BEFORE THE FINANCIAL CRISIS is unwound, the Federal Deposit Insurance Corp. expects to have taken over some 300 failed banks. The rapid closures have drained the agency’s cash reserves.

The FDIC must sell assets to continue the closings. It has about $37 billion of bad-bank assets to sell, but the stockpile would bring only 10 to 50 cents on the dollar.

Enter the FDIC’s Securitization Pilot Program, the sale of U.S.-guaranteed FDIC senior certificates. This enables the FDIC to push much of the losses off its books, thanks to the U.S. guarantee of principal and interest. The program starts with a $500 million issue.

“They aren’t really selling the bad assets. They’re selling the equivalent of a Treasury bond without congressional approval,” says William Black, a former thrift regulator. “It hides the economic substance of what’s really happening—an unlimited taxpayer bailout.”

The FDIC contests the characterization, saying it doesn’t expect a claim on the guarantee because of an equity cushion to absorb the losses, and the use of only performing mortgages in the pools. The agency says a lot of resources stand between it and the taxpayer.

Foot in the Door Ploy

Notice how the $500 million start gets the FDIC foot in the taxpayer’s door. At some point Congress will probably grant authority to the FDIC just as the Fed got unlimited funding for Fannie Mae.

President Obama and the Democrats are making matters worse by permanently upping the FDIC limit to 250,000 in the financial reform legislation that just passed.

Moral Hazards

FDIC is a moral hazard. Many banks that failed were able to stay in business because of taxpayer deposits at above market rates. For example, no one in their right mind would have had deposits at Corus Bank, a bank with many troubled loans to Florida and Nevada condo developers.

Corus bank would have failed long before it did, without the FDIC guarantee. Not only was the bank able to attract funding by offering above market rates, Corus contributed to the enormous property bubble in Florida and other places.

Instead of preventing risky bank practices in the first place, or upping the insurance rate on risky bank practices to cover excessive risk, the FDIC is about to get an unlimited taxpayer sponsored bailout by selling U.S.-guaranteed FDIC senior certificates, even though it has no authority to do so.

FDIC Legacy

As a result of the inept policy decisions by the FDIC, instead of having small bank failures widely spread out over time, we have had concentrated bank failures in a short period of time.

Taxpayers will be the ones to pay the price. This is the legacy of FDIC and its failed moral hazard policies.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
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I recently had a conversation with a retired neighbor, a former Navy vet who worked most of his life at a local grocery store.  I wouldn’t call him wealthy but he has his financial house in order; he paid off his home in the early 1990s, has no other debts, and lives well below his means.  His big source of income comes from Social Security.  We talked about the current economy and the strain we are facing.  It was a good conversation and ultimately the mathematical problems we are facing for the working and middle class become extremely obvious when confronted face to face.  We both conceded that government retirement programs will have problems in one or two decades (doesn’t help many who are still working).  The economic issues faced between the generations will cause many hard decisions down the road.

First, we should examine income levels in the U.S.:

Source:  Bankrate

The bulk of American households bring in $65,000 a year or less.  The current tax rate for FICA (Social Security and Medicare taxes) comes in at 7.65% with the remainder paid by the employer.  So the family making $65,000 a year is paying roughly $5,000 a year into FICA.  With the employer match, this figure comes out closer to $10,000 going into the system.  If we look at the current amount paid out to Social Security beneficiaries it is roughly the same per year:

The average monthly benefit paid out is $1,067.  Over 53 million Americans receive some form of Social Security benefits.  The working and middle class have had an implicit agreement with the government that if they work for many decades that in the end there will be some sort of safety net to protect them.  Yet the system was designed at a time when people died at earlier ages and we had many more workers than we had beneficiaries.  The math now is tipping in a very unfortunate direction:

As of today, nearly 19 percent of all Americans receive some form of Social Security.  Compare this to 1970 when only 12 percent of all Americans received some form of Social Security.  The above chart is merely going to grow even faster as many more baby boomers enter into retirement.  For those in the working to middle class the prospect of a secure retirement is looking more and more remote.  It would be one thing if people had the ability to trust in Wall Street and invest into the market.  Yet Wall Street with no real reform is largely a predator casino as we have seen with flash crashes and large hedge funds making billions of dollars betting on the failure of Americans.

The original Social Security Act was signed in back in 1935.  The initial design was to help the old, widows, and children of the poor to have at least some basic safety net.  It was never designed as a long-term retirement program.  Today, over 50% of those that receive Social Security benefits in retirement use it as their primary source of income.  With Americans living longer, the strain on the system is largely taken on by the working generations.

Here is an interesting chart showing the progressive growth of the tax over the century:

Initially, the amount taken out of a typical worker’s paycheck was 1 percent.  Today it is up to 7.65 percent (not factoring in the employer’s portion).  It is also the case that SS is capped at a certain income level so the wealthy actually stop paying above a certain level (as of 2010 this level is $106,800).  Going back to a previous chart, you see that nearly $57 billion was paid out in May alone.  The demographics of the system only point to larger and larger monthly payouts:

The above chart is similar to charts in Europe although not as extreme.  But we see a shift to more and older Americans.  By default, many of these people will start drawing more and more on the already strained Social Security system.  And younger workers in our current economy are facing a much deeper impact of the current recession.  Even before the collapse of the system, the young were already losing ground:

The median net worth of Americans from 25 to 34 has consistently dropped since 1985.  There was a big drop from 2000 to 2004 and I would imagine the trend has accelerated in the current recession.  Yet how were people able to continue buying more and more?  It was all fueled by access to debt.  It was largely a debtor mirage that kept the economy going in the last decade.  In fact, the median amount Americans have saved in a retirement account (those still working) is $2,000:

Source:  BLS

The fact that the mean is $50,000 tells us we have massive income disparities in the system and it also helps to point to the fact that most stock wealth is concentrated in the hands of a very few.  Another deceiving factor that was brought into the net worth equation was the net worth figure used housing values during a bubble to calculate net worth:

A giant part of net worth was pulled from housing equity that has now largely evaporated.  The fact that half of U.S. households only have $2,000 in retirement accounts tells us that many are close to a zero net worth after the housing bubble burst:

“(National Review) The macroeconomic consequences of this shift toward low-equity homeownership are visible in research from the Federal Reserve that examines the assets and liabilities of U.S. households. In the first quarter of 2001, U.S. households’ home equity stood at $7.7 trillion, or 61 percent of the value of all residential real estate. By the third quarter of 2008, it had declined to $7.6 trillion, even as outstanding mortgage debt increased by $5.6 trillion over the same period. By the first quarter of 2009, home equity was $1.35 trillion lower than it had been in 2001. Put another way: Despite the housing boom, the portion of residential real estate actually owned by households declined. This means that the increase in homeownership rates (and the subsequent rise in housing prices) was entirely debt-financed.”

In other words, say someone bought a home in 1998 for $100,000 and took out a $95,000 loan.  At purchase, they have a net worth of $5,000 (assume no other assets).  Fast forward to 2006 at the peak of the bubble and the home is now “worth” $250,000.  Seeing that they now have $155,000 in equity, they decide to pull out $75,000 pushing their total loan amount to close to $170,000.  The money is used to buy goods, take a vacation, and generally injected into the economy.  The housing bubble explodes and the home is now worth $150,000.  Yet they have $170,000 in outstanding loans.  This family went from having a $155,000 in equity (net worth) to suddenly going to a negative equity position of $20,000.  Today, one out of three U.S. homes with a mortgage is underwater.  This is why actual wealth is a better measure of financial well being than simply looking at home values especially in a bubble.

The higher unemployment for younger generations is making it harder to put more money into the Social Security money funnel. The low savings from the working generations tells us that many simply cannot save given the current economy.  Ironically, this means that many more will be dependent on government programs.  The calculus is troubling.  There are no easy answers to this.  A few of them include raising the cap to tax higher incomes or cutting benefits.  Seeing how powerful groups like the AARP are, it is doubtful benefits will be cut.

As I think back on the conversation with my neighbor that has served our country proudly in combat, how can you begrudge him?  He is living modestly, paid off his house, and let us be honest, $1,100 a month isn’t exactly Donald Trump territory.  Yet as I go out to work with millions of others, we wonder how things will be in one, two, or even three generations.  Having a paid off home and no debt actually sounds like the apex of a good retirement given our current financial predicament.

MyBudget 360

An interesting item in the Federal Register. This notice: (Link to FHA/FR)

SUMMARY: A recently issued independent actuarial study shows that the Mutual Mortgage Insurance Fund (MMIF) capital ratio has fallen below its statutorily mandated threshold.

We can pretend that that the FHA does not need a bailout, but it does. Unlike its bad siblings, Fan and Fred, there has never been a question whether Uncle Sam is on the hook with FHA. We don’t need a fancy conservatorship this time. Tim Geithner over at Treasury will just write the checks to cover the shortfalls. The good news is that those debts will not show up on the Federal balance sheet. They don’t count because there are “assets” behind these loans.

The Notice would appear to be a requirement of some sort to solicit public opinions on policy changes at FHA. The proposed changes would (supposedly) address the high default rates that the FHA is experiencing. What have they proposed to achieve this? Surprise surprise, they are going to instill some sanity into their lending program.

This kills me. I, and a hundred others, have been writing and screaming that FHA was just a ‘bailout to be’ for a few years now. This was an easy call. FHA was making 96 ½% LTV loans to borrowers with low FICO scores. They did this in a period where RE values fell by 25%. Their business plan was, “How To Take a Bath on the Tax-payer Dime”.

Don’t look for these changes to come anytime soon. I suspect that this will not evolve to a point where actual adjustments are made until after the next election. But these changes are coming. Real equity of 10% will be required for borrowers with low credit scores. There will be restrictions on seller equity, or “concessions”.

My read on the proposals is that the FHA is getting out of what I call “Silly Lending”. If they actually do take these steps it will mitigate future losses. It will also sharply restrict the availability of mortgage credit. Similar steps are being taken by F/F. The implementation will be felt this fall. By spring time mortgage land could look quite different. The D.C. lenders are 95% of the mortgage market today. There are no willing private sector lenders. If Washington steps back RE will get illiquid.

Central to our problems is the fact that for many years a social agenda and lending standards were mixed. The goal was admirable. Make mortgage credit available to all so that everyone could enjoy a leveraged bet on home appreciation. What a terrible bet the feds have financed. There are very few winners in this story. I read the following as a mea culpa. I think FHA accepts that bad lending standards have ended up hurting those they intended to aid. And along the way it hurt all of America’s homeowners.

Given FHA’s mission, allowing the continuation of practices that result in such a high proportion of families losing their homes represents a disservice to American families and communities. It is FHA’s intent to eliminate this portion of its business, and utilize other established methods to reach and support these families.

In the end the mortgage mess will cost us nearly a trillion. A very big price. For that tab we should learn a lesson. Soft lending to achieve broad social goals is a mistake. Tell that to Barney Frank. This was his dream.

Today most Americans are completely obsessed with the silliest of things.  They wonder how Lindsay Lohan is going to fare in jail and they agonize over who LeBron James is going to play basketball for.  But when it comes to the things that really matter, most Americans are completely clueless.  For example, while most Americans would agree that we are experiencing difficult economic times right now, most of them would also argue that our economic system is in fundamentally good shape and that things will get back to “normal” at some point.  Those of us who are trying to warn America of the impending economic nightmare are dismissed as “doom and gloomers” and “conspiracy theorists”.  But of course, as with so many things, the passage of time will tell who was right and who was wrong.  Below there is a chart that I want all of you to burn into your memory.  It is a chart of total U.S. debt as a percentage of GDP from 1870 until 2009.  This chart clearly and succinctly communicates the horror of the debt bubble that we are currently dealing with.  When this debt bubble pops, it is going to make the Great Depression look like a Sunday picnic.

As you can see from the chart below, the total of all debt (government, business and consumer) is now somewhere in the neighborhood of 360 percent of GDP.  Never before has the United States faced a debt bubble of this magnitude…. 

Most of us were not alive during the Great Depression, but those who were remember how incredibly painful it was for America to deleverage and bring the economic system back into some type of balance.

So if our current debt bubble is far worse, what kind of economic horror is ahead for us?

But the truth is that we are facing some circumstances that even the folks back during the Great Depression did not have to deal with….

1 – Back in the 1930s, tens of millions of Americans lived on farms or knew how to grow their own food.  Today the vast majority of Americans are totally dependent on the system for even their most basic needs.

2 – A vast horde of Baby Boomers is expecting to retire, and the “Social Security trust fund” has nothing but 2.5 trillion dollars of government IOUs in it.  According to an official U.S. government report, rapidly growing interest costs on the U.S. national debt together with spending on major entitlement programs such as Social Security and Medicare will absorb approximately 92 cents of every dollar of federal revenue by the year 2019.  This is a financial tsunami the likes of which Americans back in the 1930s could never have even dreamed of.

3 – American workers never had to compete for jobs with workers on the other side of the world back in the 1930s.  But today, millions upon millions of our jobs have been “outsourced” to China, India and a vast array of third world nations where desperate workers are more than happy to slave away for big global corporations for less than a dollar an hour.  How in the world are American workers supposed to compete with that?

4 – Back in the 1930s, there was nothing like the gigantic derivatives bubble that hangs over us today.  The total value of all derivatives worldwide is estimated to be somewhere between 600 trillion and 1.5 quadrillion dollars.  The danger that we face from derivatives is so great that Warren Buffet has called them “financial weapons of mass destruction”.  When this bubble pops there won’t be enough money in the entire world to fix it.

5 – During the Great Depression, the United States economy was relatively self-contained.  But today we truly do live in a global economy.  Unfortunately that means that a severe economic crisis in one part of the world is going to affect us as well.  Right now, the United States is far from alone in dealing with a massive debt crisis.  Greece, Spain, Italy, Hungary, Portugal and a number of other European nations are in real danger of actually defaulting on their debts.  Japan (the third biggest economy in the world) is on the verge of complete and total economic collapse.  So what happens to the U.S. economy when the dominoes start to fall? 

The truth is that by almost any measure, we are in worse economic condition than we were right before the beginning of the Great Depression.  We have been living way beyond our means and the debts we have been piling up are clearly not anywhere close to sustainable. 

Did you think that we could just continue to run deficits equal to 10 percent of GDP forever?

Of course not.

The U.S. economy is being driven off a cliff, but America’s ”ruling class” has insisted all along that they know better than we do. 

But the truth is that in the final analysis it is not us that they care about.

What they do actually care about is getting more money and more power for themselves and for other members of the ruling class.  Today, 10,000 people make 30% of the total income in the United States each year.

That leaves 70% of the pie for the remaining 99.99% of us to divide up.

The reality is that however you want to slice it, the U.S. economic system is broken.  However, considering the fact that America’s ruling class has a stranglehold on both major political parties, we are not likely to see any fundamental changes any time soon.

That is very unfortunate, because time is running out on the U.S. economy.

The Economic Collapse