Friday, October 17, 2008

This Week in Bank Failures

Authorities around the world rushed to put fixes in place, hoping to strengthen the banking system before the next bad news hits.

FDIC Changes

Two actions by the FDIC this week were designed to maintain confidence in banks.

To make it easier for banks to borrow, the FDIC is launching a plan to guarantee senior unsecured debt. Qualified debt issued by participating banks between now and June 30 will be insured against bank failure or bankruptcy through June 30, 2012. The FDIC is charging a 0.75 percent premium and other fees to pay for this coverage.

The FDIC has been talking up its debt guarantee program all week. This morning it also announced a blanket guarantee for non-interest bearing accounts. These accounts are mostly corporate checking accounts, and the move is meant to make it easier for employers to pay their employees without putting money at risk.


Another U.S. banking giant fell Monday night. Sovereign Bank, based in Philadelphia, was acquired by Spanish banking giant Banco Santander. Santander already owned 25 percent of Sovereign, and will pay $2 billion for the remaining shares. After the deal was announced, Sovereign showed its third quarter results, with a surprise loss of nearly $1 billion. Sovereign had lost two thirds of its stock value since the beginning of the year, and Santander paid a 3 percent premium over the distressed stock price. The price is at least double what the stock price could have been if the earnings report had come first, but still less than half of Sovereign’s book value.

Half of Sovereign’s losses in the quarter were tied to its sale of collateralized debt obligations (CDOs). The value of CDOs declined as the mortgage-backed securities they were based on suffered from late payments and defaults on the underlying mortgages. Most of the rest reflected a writedown of its shares of Fannie Mae and Freddie Mac. Sovereign showed a healthy profit from its current operations, but it was not nearly enough to cover its losses from its past mistakes.

Santander already has a significant presence in South America, and the Sovereign acquisition gives it its first street-level presence in the United States.

Global Concern

There were fewer surprises in Europe this week, but leaders took the relative quiet as breathing room rather than a sign that the crisis is winding down. In Sweden, Glitnir AB has found a buyer. The Swedish branch of Iceland’s Glitnir will be purchased by HQ Bank for 60 million kronor. HQ Bank, a small Swedish bank with 250 employees, calls the move a natural expansion of its operations. Iceland’s banks have been trying to raise money this month by selling off overseas operations.

Asia-Pacific countries have rushed to expand deposit guarantees this week. Hong Kong, Indonesia, New Zealand, Australia, Singapore, and Malaysia announced blanket guarantees for bank deposits through at least next year. Japan has long had deposit guarantees.

Offshore Banking and Hedge Funds

All week long world leaders wrestled with changes that might be needed in the structure of the banking system. Offshore banking was the main focus of concern, as banks that locate in countries of convenience are virtually free of regulation. French Prime Minister Fran├žois Fillon on Wednesday called for a ban on offshore banking as a preliminary step toward an international framework for rebuilding the banking system.

Offshore banking can also be a tax haven for billionaires and hedge funds. The U.S. Internal Revenue Service was forced to adopt new rules this week about offshore banking after discovering that banks were using rules intended to allow foreigners to invest anonymously in U.S. companies to help wealthy Americans sneak at least $20 billion and probably more than $1 trillion overseas. Much of that money went into hedge funds, and in the new I.R.S. rules, offshore hedge funds and similar investment vehicles owned by U.S. investors are no longer permitted to be classified as anonymous foreign investors. However, the new rules leave so many loopholes that they are probably still completely ineffective.

Hedge funds are important to watch because of the way they connect the banking system to the stock market. Distressed hedge funds are now liquidating at alarming rates according to stock traders in New York, threatening a collapse of stock markets worldwide. Could a domino-style collapse of hedge funds be next? It’s a big concern because there is little that governments can do about offshore hedge funds when something goes wrong, and no one really knows how many bank assets could be erased in a broad hedge fund collapse.

Wall Street Bailout Declared a Failure

President Bush defended the Wall Street Bailout plan this morning, saying it would take time to work, but that it was large enough and bold enough to do what was needed. He gave his speech in front of the U.S. Chamber of Commerce building, as if to say that the program is meant to enrich business owners broadly.

Nevertheless, so far, the money is going only to banks and financial institutions, and Wall Street analysts are already calling the program a failure, citing bank executives who say they are likely to sit on the new money for at least a quarter, if not a couple of years. In other words, the executives are not so sure that even with the additional capital they can keep their institutions above water. “You can’t force banks to start lending money,” is the widely repeated line that seems to sum up the situation.

One More Crisis for AIG

Tuesday is the deadline for paying on credit default swap (CDS) contracts that guaranteed bankrupt brokerage Lehman Brothers. No one officially knows who holds these contracts or how much they may owe (credit default swaps are basically secret). I have seen estimates as low as $6 billion (though the total is now known to be more than that) and as high as $270 billion. Only about $8 billion in obligations had been declared as of this morning. This has people looking at AIG (American International Group) with considerable concern. AIG was until recently the center of the CDS world, so it is hard to believe that its share of the mess will be less than a few billion dollars. AIG could easily have to pay more than enough to wipe out its remaining $6 billion in market capitalization. AIG’s statement that it will need an additional $38 billion is taken by some as a reference to its impending Lehman Brothers obligations.

AIG, you may recall, is essential to the continued existence of the world’s major banks. AIG-issued credit default swaps are guarantees that allow banks to keep trillions of dollars in obligations off their balance sheets, and an AIG insolvency would force banks to recognize all those obligations at once, making an unknown number of banks also officially insolvent. To maintain this accounting fiction that allows banks to pretend to be solvent, the U.S. government will surely be forced to fully nationalize AIG (in the past month, the government has already come to own more than half of the company).