Was it the hedge funds that, in 2004 and 2005, made banks suddenly want to make so many bad loans? The ability to resell loans so they could be packaged and sold to hedge funds certainly made some lenders less concerned about the quality of loan origination, and more concerned about volume. It looks like the preferential tax treatment of hedge funds is about to end, and that might slightly reduce this particular disturbance in the banking system. And if the hedge fund market is the root of the problem in home loans, then we might look at all the other loans that got the same treatment, to see if they offer the same risks for the financial system.
Of these, credit card debt seems the most problematic. Arianna Huffington this week called credit cards “the next economic domino.” Banks that issue credit cards have gone to extraordinary lengths in the last three years to increase fees, and this year, to raise interest rates. This might bring the banks more money in the short run, but it increases the risk of credit card defaults, which are already occurring at an alarming rate and can be expected to go higher as the unemployment rate increases.
Banks are not unaware of this risk and are taking steps to reduce their exposure. The number of new credit card offers sent by mail has plummeted since August. Banks are lowering credit limits for many cardholders and allowing inactive card accounts to expire. American Express is going to the unusual step of paying selected cardholders a bonus to pay off their balances and close their accounts next month. This is essentially a preemptive settlement offer from American Express for customers who are able to pay quickly. It’s a strange thing to see when you know that barely two years ago, banks were paying an average of nearly $1,000 for each credit card customer they acquired.
The U.S. Treasury seems not to be giving much weight to credit card risks in its “stress test” for banks, which according to published reports is based on quite a gloomy scenario for real estate prices, alongside the comparatively rosy prediction that unemployment never rises above 10 percent. I call that prediction rosy because even if the economy bottoms as hoped in the first quarter of 2010, unemployment would probably continue to rise well into 2011. It is easy to understand why. The number of workers naturally increases by about 2 percent per year, so the economy has to grow at a faster rate to take on those additional workers. On the far side of this recession, the economy might expand for quite some time before getting up to a 2 percent growth rate.
The “rising groundswell of anger against banks” has become potent enough that President Barack Obama mentioned it in his address to Congress this week. He and Congress must not govern out of anger, he said as he emphasized the importance of banks. I am not sure Obama recognizes that the disaffection people feel is directed, in many cases, toward their own banks, and he risks rescuing banks this year and next only to have them fade away in the near future due to the indifference of their customers. On the message boards this year, when people say, “I paid off my last credit card,” it is not to say, “Look at what I accomplished with my personal discipline and perseverance,” but rather may be accompanied by a line such as, “Those bastards won’t get another dime from me!”
According to the FDIC’s Quarterly Banking Profile, banks lost $26 billion in the fourth quarter of 2008. Just three large banks provided half of those losses, with Citigroup losing $8.3 billion, Bank of America, $2.4 billion, and Wells Fargo, $2.6 billion. In the previous quarter, banks collectively barely broke even. The quarterly loss is the first since 1990.
The pattern of losses has especially hurt the stock prices of the largest banks. Citigroup, with a market value of $8 billion, no longer has a realistic prospect of raising the additional capital it needs from private sources, so it has obtained $25 billion from the U.S. Treasury. In exchange, the U.S. government will increase its ownership share in Citigroup to 36 percent. This deal, announced this morning, is a further step toward nationalizing Citi unless its fortunes turn around sharply in the next few months. Citi CEO Vikram Pandit seems to be the only one who sees it differently: “In many ways for those people who have a concern about nationalization, this announcement should put those concerns to rest.”
Some banks, feeling more stable than three months ago, are returning the bailout money they got last fall. Iberiabank appears to be the largest of these so far, returning $91 million in bailout money that it had intended to use to fund increased lending (though apparently it did not do so). The bank issued a statement trying to be gracious about it, but not quite succeeding as it offered a series of oblique criticisms of banking policy. The bank will buy back $91 million in preferred stock and pay $575,000 in accrued dividends. More banks are likely to return bailout money, as it is now possible for the strongest banks to borrow money on much more favorable terms, with the Fed Funds target rate having fallen to zero in December.
No one seems to know quite what Treasury Secretary Tim Geithner meant by a “public-private partnership,” but maybe it’s something like what the FDIC is doing. The FDIC has set up an LLC to sell a 20 percent share in the mostly nonperforming real estate loans it acquired from First National Bank of Nevada when it failed. The FDIC is retaining an 80 percent share in the portfolio, but won’t have to administer the loans. Though the deal is structured as an LLC, a cross between a partnership and a corporation, it is more like the FDIC went out and hired an agent on commission.
Tonight, another bank failure, that of Security Savings Bank in the Las Vegas suburb of Henderson, probably leaves the FDIC with more Nevada real estate loans to dispose of. The FDIC transferred all its deposits and sold about half its assets to Bank of Nevada. Security Savings Bank had two offices and $175 million in deposits. Bank of Nevada is a Western Alliance subsidiary with 15 offices around Las Vegas, including three in Henderson.
The new president of Security Savings Bank, Jesse Torres, considers himself an expert in viral marketing, and has written a book on social network marketing for community banks. Awkwardly, the bank failure comes in the middle of a series of speaking engagements by Torres to promote the book.
In the suburbs of Chicago, Heritage Community Bank failed. It had four offices and deposits of $219 million. The FDIC transferred all its deposits to MB Financial, a bank with $9 billion in assets and 70 offices in the Chicago area, along with one in Philadelphia. MB Financial is also buying 99 percent of the assets at a 6 percent discount, with the FDIC sharing in losses on most of the assets.
The FDIC expects to face losses of $100 million on these two closures.
The two banks that failed were essentially running out of money because of loan losses.
Security and Heritage are both very common names for banks, and these closings do not affect banks in other areas that share the same names.