Developments this week: More evidence that AIG’s insurance operations are a tangled mess, as one of the insurance units admitted it had guaranteed billions in credit default swaps. ◾ Citigroup plans to address the conflicts of interest inherent in private equity by selling or spinning off that business unit. Observers estimate that Citi’s private equity business could be worth $10 billion. ◾ Venezuela’s government has been weakened politically by the banking crisis there, with President Hugo Chavez’s approval rating falling below 50 percent for the first time. It didn’t help that a few of the owners of the failed banks had close ties to the government. ◾ There are new New York State civil charges against Bank of America and two of its executives, adding to the growing pile of legal headaches at the bank. The main significance of the new charges is they could lead to additional charges against other bank executives and possibly government officials, if more of the story of the bank’s dealings comes out. ◾ Argentina has appointed a new central banker, a move that investors worry will open the door to a new inflationary spiral in that country.
Another bank failed tonight because of loan participations. Officers at 1st American State Bank of Minnesota, a small bank with $16 million in deposits and offices in Hancock and Benson, in the western part of Minnesota, thought they were minimizing risk by buying small shares in loans for real estate projects all over the country. Instead, so many of the projects failed that, tonight, the bank failed.
Just the vacant land left behind by some of the failed projects is worth more than the total assets of the failed bank, and I have to ask whether it makes sense for a bank this small to be lending to a project that is so much bigger than it is. The idea behind loan participations makes sense, at least it sounds like it does, but as the number of banks killed by loan participations continues to grow, I am forced to conclude that there is something terribly wrong with the way banks have been conducting loan participations. It seems to me that the reason the originating banks were so eager to syndicate some of their loans was that the loans had obvious problems from the outset. In other words, the availability of syndication seems to lead originating banks to go ahead with loans that they would never approve if they knew they would be stuck with them. The correct course of action in this case is not to syndicate the loan, but to decline it. The participating banks, for their part, sometimes seem to view loan participations as a way to get out of the expense of underwriting loans. The recent evidence, though, is that careful underwriting of loan participations is more important than for original loans.
In a way, these are the same problems we see in mortgage-backed securities, but the difference is that loan participations occur entirely within the banking system and lead not to investor losses, but to bank failures. If the loan participation business too often ends up in the question of who is left holding the bag, tonight the answer is, again, the FDIC.
The successor bank for 1st American State Bank of Minnesota is Community Development Bank, also based in western Minnesota. It is taking over the deposits and purchasing the assets.