Friday, February 20, 2009

This Week in Bank Failures

For once, it was the Securities and Exchange Commission (SEC), and not banking regulators, shutting down a bank. On Tuesday, federal agents raided offices of the Stanford Group and seized assets of Antigua-based Stanford International Bank and two affiliated companies. A court-appointed receiver took custody of the bank assets. Three bank officers, billionaire founder Allen Stanford, chief financial officer James Davis, and chief investment officer Laura Pendergest-Holt, effectively became fugitives when they failed to respond to subpoenas in the case. Allen Stanford was found late yesterday in Virginia, apparently on his way to Washington, and served with papers by the FBI. The SEC has called the bank’s certificates of deposit, sold mainly to U.S. customers through Stanford Group and affiliated companies, “a fraud of shocking magnitude that has spread its tentacles throughout the world.”

Stanford International Bank recently reported $8.4 billion in deposits. It claims that affiliated companies manage $51 billion in client assets. The SEC says Stanford Group was also running a second fraudulent scheme involving a mutual fund with false historical performance data. It also says the bank misled investors with a December 17 letter that said, “Stanford International Bank did not have any exposure to the Madoff Fund.” The letter is dated two days after the SEC says an analyst told the bank of a $400,000 loss tied to Madoff.

The Stanford banks are located in various countries, mostly around the Caribbean, but not the United States, and the countries that have Stanford banks are looking at them closely. Regulators moved to freeze Stanford offices in Panama, Ecuador, and Peru. Then Venezuela was the first country to seize its local Stanford bank. Tonight, Antigua was the second. The move in Antigua is particularly significant, as Stanford owns much of that island.

I wrote previously about new Internal Revenue Service (IRS) rules intended to prevent U.S. residents from passing themselves off as foreigners in order to invest in U.S.-based securities markets without the transactions being reported to the IRS. The IRS said Swiss banking giant UBS was involved in this, and the Swiss government has now come to the same conclusion, and has okayed a $780 million payment by UBS to the IRS to settle the charge. In addition, the Swiss banking authorities have found that in hundreds of cases involving billions of dollars, this kind of scheme represented not mere tax evasion, but actual fraud, and ordered the release of secret account holder information to the IRS. Swiss banking laws ordinarily keep bank accounts anonymous, but those rules do not apply in “clear” cases of fraud, and the thought that the Swiss banking authorities may be taking the fraud exception seriously is sending shivers through international banking circles.

It has been estimated that wealthy U.S. taxpayers may have evaded hundreds of billions of dollars in income taxes in schemes involving assumed offshore identities, and if the IRS can start collecting some of those taxes, it could help shore up the U.S. dollar (if you’ll excuse the pun). But it could, at the same time, pull the rug out from under some of the offshore banks, and offshore banking centers are a little nervous waiting to see what might fall down.

The financial press was talking openly this week about the possibility of the two largest banks in the United States being nationalized, to be followed, presumably, by dozens of others. The talk of nationalization gained momentum after Alan Greenspan suggested that it was an option to consider. Some talking heads have even suggested this was inevitable, not wanting to breathe a word of the simpler, less risky, less expensive scenario of liquidating the banks that fail. There was an effort midweek to come up with a softer word than “nationalization” in order to make the process more politically palatable. My suggestion, “bankruptcy,” does not seem to have gained any significant support.

The White House this afternoon tried to reassure Wall Street on the subject of nationalization with a statement that it prefers a privately held banking system. Obviously, though, it could not spell out the steps that might be taken for a large faltering bank, so its statement did not exactly address the issue at hand.

The bailout index (Nasdaq QGRI) fell below 500 this week, meaning that the largest bailed-out companies have lost half their market value since the beginning of the year (compared to a 10 percent decline in other stocks). Apparently, government bailout money isn’t so good for business after all.

Tonight, Silver Falls Bank was the third bank to fail this year in the Portland, Oregon, metro area. Silver Falls Bank had three offices in towns south of Portland. Citizens Bank, a community bank located a little further south in Oregon with its headquarters in Corvallis, is assuming all the deposits of Silver Falls Bank. Don’t confuse this Citizens Bank with the many other banks in other parts of the country that also use the Citizens name.

Silver Falls Bank had $116 million in deposits. Citizens Bank is acquiring about 10 percent of its assets. The FDIC is expecting a cost of $50 million as it disposes of the bank’s other assets.

Silver Falls Bank was founded in 2000 was considered one of Oregon’s rapidly growing banks. It reported record earnings in 2007 and was paying an unusually high dividend. The high earnings were illusory, however, as many of the bank’s loans started to go bad last summer. By the end of 2008, it was being closely watched by regulators, and employees were starting to depart. The bank agreed to stop paying sales bonuses that were based strictly on loan volumes, and to keep closer tabs on its operations. Bank executives admitted the bank had made too many construction loans, but in the end, it was apparently just one large construction loan that defaulted early in 2008 that made the difference between continuing and closing.

This is a story typical of recent bank failures. If you have been following the bank failure saga, you have surely noticed a disconnect between the public story about the financial crisis, which focuses mainly on home mortgages, and the actual bank failures, which are mostly caused by loans to real estate developers. Part of the reason is political. It is easier for politicians to point the finger at homeowners, most of whom are middle-income families, than at real estate developers, which are mostly controlled by millionaires who are far more likely to fund political campaigns. But part of the reason is structural. Banks routinely resold their home mortgages, especially the smaller ones, in a complicated securities arrangement that started to fail spectacularly about two years ago. When those loans started to go bad, it was companies that were deep in this secondary market, like Fannie Mae and AIG, not the banks that originated the mortgages, that failed. But banks have always been pretty much stuck with their larger loans. And a small bank with $100 million in deposits is reeling after just two or three $5 million loans go bad.

It is easy to make the case for tighter regulation. Part of the reason so many more bank failures are likely is that, the way the system works now, regulators can’t take any meaningful action until after the damage has already been done. If there were tighter regulations, and regulators could seize banks preemptively, just because bankers were disregarding the rules of banking left and right, there would be a lot fewer bank failures, because bank executives and officers would run their banks like their jobs depended on it.