Saturday, July 24, 2010

Another Guaranteed Box Full of Crap - via FDIC

This is now the EIGHTH time I've used the Tommy Boy analogy on my blog (type Tommy Boy in my search box for the others):

"Because they know all they sold ya was a guaranteed piece of shit. That's all it is, isn't it? Hey, if you want me to take a dump in a box and mark it guaranteed, I will. I've got spare time."

Today's reference comes courtesy of a Barrons article (h/t Barry Ritholtz)

"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.

And who makes up the losses? The notes are backed by loans that are bundled into agency-administered pools. But ultimately, the losses could be absorbed by Uncle Sam"

To summarize - the FDIC has been taking over the crappy assets of tons of failed banks.  There is a problem - they are running out of money (or ran out, long ago) with which to do this.   Thus, they need to sell the assets they've taken over to raise more funds to take over more failing banks.

Problem: the assets aren't worth much - 10c-50c on the dollar, according to Barrons.  Solution?  Mark that box full of crap GUARANTEED!  Remember, the FDIC is supposed to be funded by the banking industry.  How then, do they get a government guarantee?   Of course, with the guarantee, the assets will sell for a price much higher than 10c-50c, after all, it's GUARANTEED by the USA!  So, the FDIC gets paid a much higher price, and who eats the losses?  Uncle Sam, of course.  The FDIC is supposed to be an agency that is self-funded by the institutions it insures.  From an old Bloomberg article:

“Our operating budget does not come from taxpayers,” Bair said during the meeting. “We are completely self-funded in that regard.”

And yet, here we see that the FDIC is looking to benefit from a guarantee by the taxpayers!  That doesn't quite meet my definition of "self-funded."  

Even more absurdly, unless you believe that the "market" is crazy in pricing these assets at 10c to 50c on the dollar, and that they are really worth more but are somehow depressed due to liquidity or other fantasy nonsense, this government guarantee is GUARANTEED to result in payouts from the government to the purchasers of these assets who will be overpaying for them (knowingly, but not caring so much because they are guaranteed!).

Back to the Barrons article:

"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."

and the final word from the FDIC:
"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."

Wait wait wait... The FDIC doesn't expect a claim on assets trading at 10c on the dollar because of an equity cushion to absorb the losses?  Where have I heard this before... thinking... scratching my head... furrowing my brow pensively.  OH YES!   Collateralized Debt Obligations!  The equity tranche and the diversification made it impossible for higher rated tranches to lose money!  (SARCASM ALERT!)  There was only one problem: "impossible" turned out to be "absolutely certain."
Jeezus.  The scam goes on.  Government subsidies of the FDIC, which of course, is another indirect bailout of the banks who are the ones who are supposed to be funding the FDIC.



EconomicDisconnect said...

This "liquididty" crisis sure looks more and more like a solvency one but those in charge will never admit it. I wonder what will be the story in 5 years when the crap is still worthless.

Wilson said...

This is totally hilarious. I wonder how they have chosen to define 'getting away' with this? Surviving until 2011?

IF said...

I still don't see the problem. It all depends on the price this stuff gets "resold". You seem to assume it will be too low. But as long as it conforms with treasuries, there is nothing wrong with it. Lets say there were 100 dollars worth of mortgages paying 6 percent for 30 years. Bank folds. FDIC takes over. The mortgages (at whatever discount or failure rate) would not fetch more than 10 dollars right now. Hence FDIC guarantees them and sells them at 134 dollars (discounted to be comparable to 30 year treasuries at 4 percent). No money left on the table! The outrage would only be understandable if they would guarantee *and* sell at 10 dollars. That would be criminal. But the damage due to the loss of the bank already happened when the FDIC took over. Too late to complain.

Kid Dynamite said...

IF - no - i don't think that's it at all. I"m assuming that these assets are correctly priced by the market - in other words, they will return between 10c and 50c on the dollar. well, once the government slaps a GUARANTEE on them, they trade like treasuries - say, 90c on the dollar... then the government eats the difference when it makes the purchaser whole on the losses from defaults. get it? so, the government's guarantee (which the government eats the loss on) induces the purchaser to vastly overpay (the purchaser doesn't care of course, since the gov't guarantees it!) and the FDIC (and hence: THE BANKS!) are the beneficiary - since the banks are the ones who are supposed to be funding the FDIC - not the taxpayers.

IF said...

So, I guess we mostly agree on that point. But isn't that how the FDIC is supposed to work (for the last 77 years)? It seems nothing has changed recently.

The final point seems to be

“Our operating budget does not come from taxpayers,” Bair said during the meeting. “We are completely self-funded in that regard.”

Which everybody knew and knows to be a lie. But a noble lie if there is any. I wouldn't have minded the tax payer eating some bigger losses after the FDIC took over Shittibank et al. Of course this way there is an illusion that the loss recognition is being pushed further out into the future and that congress is not being asked. But again, this was the plan (and law) all along for 77 years, this is what the FDIC guarantee really means in practice. E.g. this is the cost society bears for avoiding bank runs.

Kid Dynamite said...

IF - first of all, i think the FDIC is necessary - yes, to avoid bank runs. but i don't think it was like this for the last 77 years - it's kinda like an SRO - self regulating organization - in the sense that its own members are supposed to be the ones paying the fees that allow it to provide the confidence to the industry so that said members can operate!

the banks are putting up big profit numbers. why don't they fund their underwater insurance agency?

i see no reason, and no logical defense for the government stepping in to provide this guarantee (note: the gov't seems certain to have to pay out on this guarantee - it's not just a case of them providing a seal of approval so that more debt can be sold and default avoided - this is a case of selling assets that are almost certain to default) - UNLESS, of course, the banks can't provide the insurance - which is PROBABLY the truth, DESPITE the fact that we've been fed the bullshit line by everyone involved for the last 18 months that the banks are fine. this again proves that they are NOT fine.

IF said...

Well, yes I agree. It is a mess. And yes, the banks should be paying for it as long as they show an official profit. Which means the problem starts here.

As a side note, Germany has several strange insurance schemes where the banks are supposed to pay for each other. I forgot the details, but there is a small one which has been overwhelmed by claims and people are not getting their money back. And as it is too small and happened before the crisis, the government never intervened.

But most of the big banks are supposed to guarantee each other. It is understood that if a big one goes down, this will immediately take down all. So why is this guarantee worth something? People know it is not worth anything on its own, but assume the government will backstop (which indeed Angela has promised). Bingo, profits for banks!

All this goes back to the point where one can't allow the individual banksters to loot for profit. Unfortunately it is too late to nudge the institutions with some small insurance fees. And the looting seem to keep doing as long as the FDIC pays the tab for them while they show a "profit" (your main point). Hey, they call it "too big to fail" for a reason. But even if one keeps the zombie banks around as organizations (a choice that seems to be fixed in stone), the individual bankers should not be too well connected to avoid jail. I am still waiting for indictments, sentences, new structures in Guantanamo etc.