This Week in Bank Failures

Last weekend was the biggest so far in bank failures, from the Thursday night takeover of Washington Mutual followed to the report of a takeover of Wachovia and moves of a similar scale in Europe.

Billions for Banks in Europe

Fortis was the largest bank in Benelux and appeared close to collapse before the governments of Belgium, the Netherlands, and Luxembourg agreed to take a 49 percent stake in the company and restructure it. The Fortis story and similar news around Europe says that European banks have been hurt significantly by the collapse of the derivatives bubble based in the United States.

Iceland took over its third largest bank, Glitnir. The government paid 600 million euros for a 75 percent share in the bank, which had 3 billion euros in assets. Glitnir also operates a bank in Luxembourg and has offices in at least five other countries, with a significant presence in Norway.

Germany issued an emergency credit line to Hypo Real Estate Holding AG, which was hurt in part by bad loans for luxury and commercial real estate in Germany.

Then on Monday morning, the United Kingdom effectively nationalized Bradford & Bingley, a large mortgage lender that had mainly been hurt by mortgages on rental properties in Britain. Real estate values have fallen so much that many property owners are collecting too little in rent to pay their mortgage payments. The government took over the bank’s £50 billion loan portfolio and paid £18 billion on the sale of the bank’s branches and deposits to one of Europe’s largest banks, Banco Santander of Spain. Santander will pay less than £1 billion.

The 4th Largest Bank in the U.S.

Then in the United States, the Federal Deposit Insurance Corporation (FDIC) did not take over Wachovia, yet it and Citigroup came to a financial interpretation of Wachovia that allowed me to conclude that Wachovia was on the verge of collapse. Wachovia’s stock had fallen by three fourths since the beginning of the year as Wall Street lost confidence in its prospects. The FDIC provided a guarantee of Wachovia’s loan portfolio to Citigroup, which agreed to pay a purchase price of $2 billion — a token purchase price of $1 per share. Citi agreed to accept only the first $42 billion of losses on Wachovia’s $312 billion loan portfolio. Those losses could occur almost immediately, if the look of Wachovia’s recent financial statements is any indication, so the deal would likely have cost U.S. taxpayers $50–100 billion, in spite of the FDIC’s optimism about Wachovia. Regardless, the guarantees were necessary in order to avoid putting Citi’s own future in doubt.

By Friday morning, Wachovia had changed its mind, announcing that it instead would be acquired by Wells Fargo. Wells Fargo agreed to pay $15 billion in a stock swap and would complete the deal without government assistance. It is a surprising premium price for a company that recently had a market capitalization of $10 billion and whose book value excluding goodwill is surely much less than the $38 billion it reported at the end of June.

Wachovia was formed in a merger in 2001 and with subsequent acquisitions was the fourth largest bank in the United States. Predecessors of Wachovia include CoreStates, First Union, World Savings Bank, SouthTrust, and other large and small banks. Most of the predecessor banks were available because they were experiencing operating difficulties, and Wachovia stabilized them mainly by putting stronger operational systems in place. The combined Wachovia had a troubled loan portfolio of its own by 2006, and it compounded its troubles by acquiring Golden West. There was already a hint of Golden West’s real estate loan troubles, and analysts worried that the deal was too top-heavy and could lead to Wachovia’s collapse. Indeed, Wachovia’s combined loan portfolio quickly wiped out its profits, with no turnaround on the horizon.

Wachovia was also in trouble for possible collusion in identity theft. In April, it paid $144 million to settle a federal probe. It did not admit wrongdoing and might have lost its banking license if it had done so or had been convicted of even a slight involvement in the series of thefts. It fired its CEO a month later.

Wells Fargo was recently listed as the 6th largest bank in the United States, about three fourths the size of Wachovia, so is it large enough and stable enough to neutralize the troubles of Wachovia’s balance sheet? The answer appears to be no. At least on the surface, this is just another troubled, top-heavy merger in the long series of mergers that created Wachovia. An additional $75 billion loss from Wachovia’s loan portfolio would wipe out the stockholder equity of the combined company, and Wells Fargo has real estate exposure of its own and will surely take losses from its own portfolio as real estate values decline further. Because of this scenario, it seems possible that the Federal Reserve Bank could intervene, or that Wells Fargo shareholders could file suit to block the acquisition, which otherwise is expected to close around the end of the year. Citi may have something to say about it too, but that is likely to be little more than bluster to try to persuade the markets that Citi is still financially strong enough to get into this kind of argument.

The combination of Wells Fargo and Wachovia makes good sense geographically and in terms of market position, and there are other reasons to hope the combination could somehow work. The loan losses will not all hit at once, giving Wells Fargo time to raise the capital it needs. The combined bank can look for cost savings, and as both banks have relatively high cost structures, it ought to be able to cut costs in various operational areas. Still, it has to survive the economic turmoil of next year to get any of these benefits, and if things keep going the way they have been, it may have to scramble to stay above water.

The Wall Street Bailout Tog-of-War

Washington’s high-risk Wall Street bailout plan, which some supported in the mistaken hope that it might improve the financial condition of banks and stop the recent run of bank failures, was voted down in the House on Monday amid the largest demonstration of public opposition to a government initiative since the Vietnam War. As one hint at the size of the opposition, the House web site was effectively unavailable during afternoons for the entire week, as it was overwhelmed by inquiries. The Senate, which traditionally has been more sympathetic to the concerns of Wall Street, passed a souped-up version of the bill Wednesday evening. On Friday, the bill returned to the House, where it passed by a narrow margin. President Bush rushed to sign it into law.

For banks, the biggest item in the plan is a temporary increase in FDIC coverage, normally $100,000, to $250,000. The Senate added this provision in the hope that it would slow down any runs on banks that may be coming this winter. Yet the bill did not provide any additional FDIC funding, so it seems unlikely to improve depositors’ confidence in their bank deposits.

The heart of the plan a sort of collection agency in the Treasury Department. This is supposed to improve the liquidity of banks so they will start lending again, yet most of the money will not go directly to banks, but to brokerages, mutual funds, and other financial corporations. If the plan works at getting banks to lend more, the increased lending could lead banks to fail faster, unless the banks can find a way to steer around the loan losses that have piled up at alarming rates for the past two years. Even in the optimistic scenarios of banking industry insiders, it may take two years for the additional liquidity to trickle down to consumer loans.

In the end, the public lost, and Wall Street won. And I have a feeling many of the people on Wall Street will be playing “Take the Money and Run” on their car stereos as they get their bailout money out of the United States and into a more stable foreign currency as fast as they can.

Rescued by a Sinking Lifeboat?

Does a rescue count as a rescue if the lifeboat sinks?

What if the lifeboat does not sink until after Election Day?

Only the atmosphere of political gamesmanship in Washington makes this a complicated question. It should be obvious to all that a short-term “rescue” of a few financial companies does no good in the end if the rescue sinks the whole economy.

I try to imagine the thoughts that go through some of the best minds in Washington. It has to be something like this:

“If I vote no, nothing will happen, but some people might think a crisis was threatening and I didn’t respond.

“If I vote yes, the economy is toast — but that won’t be till after the election, and I’ll deal with it then.”

I have to apologize for the unflattering things I have said about Lou Dobbs in the past, because yesterday morning he had the most insightful description I’ve found of what is going on in Washington now. In an interview, he put it this way: “What we are watching are business ‘leaders’ who won’t surface and put their faces before the American public who are hysterical. Absolutely hysterical. These are not leaders of moment. They are not leaders of great character or vision.” See the whole interview:

Lou Dobbs: Hooray for those who defeated bailout

Michael Moore may be just a filmmaker, but the rescue plan he put together yesterday puts the one that came from Henry Paulson to shame. Step 1: Appoint a special prosecutor. Read the whole plan:

Here’s How to Fix the Wall Street Mess

You don’t have to agree with everything in Mike’s Rescue Plan to see that it is possible to address the problems in the economy without a giveaway program for millionaires so massive that it could sink the whole economy.

The level of cynicism in Washington thinking can be stupefying. Just watching people think that way can make you cynical too.

But wait. You do not want someone in Washington determining how cynical you should be. If you let them control you that way, then they’ve got you where you want you — watching and complaining but not doing anything that might interfere with their grip on power.

And there are simple things you can do. An expanded version of the same disastrous Wall Street bailout package that was voted down on Monday will come up again for a House vote before the week is over, so today would be a good day to telephone or email your Representative, even if you have done so before, to say, “Please vote NO on the Wall Street bailout and save the U.S. dollar.”

Something you can do that is even easier is to register and vote. There is still time to register if you are eligible to vote, and it takes only a few minutes to do. If you are already registered, you can verify that you are still registered, and that too takes just a minute or two. Voting is important because it is the one thing that tells elected representatives that they have to be on their best behavior. When less than half of the eligible voters cast a ballot, politicians figure they can do anything they want. When more than half of the voters vote, politicians sit up and take notice. That is why it is so important for lots of voters to vote on Election Day. Here is a new Hollywood movie, released yesterday, about some of the reasons why you might want to vote:

The Decline of the Political Center

When the Wall Street bailout bill went down to defeat in the House two days ago, it seemed as if almost everyone was surprised by the turn of events. What surprised me was that anyone thought the bill had a chance to pass. I was astonished that House Speaker Nancy Pelosi would bring the bill to a vote so early, not really giving anyone time to study the language of what they were voting on, and without having a legitimate floor debate in which the vast majority of House members who disliked the bill could at least vent their frustrations. I guess she thought she could ambush them. But really, Pelosi and Bush need to get out of their offices a little more and talk to some of the other people in Washington so that they’ll have a better sense of what is politically possible. Pelosi and Bush can sit down at a table with a handful of other so-called leaders and agree to agree among themselves, but if they are agreeing to go in the opposite direction from the direction the rest of the country is going in, all they accomplish is to isolate themselves from the real world.

Those were my thoughts after the carefully negotiated giveaway program Pelosi had shepherded was defeated. But I have talked to many people about this, and I understand now why people were so surprised by the way the vote came out.

The political points of view in America sometimes split out into three blocs, which people call left, center, and right. These blocs differ in their views on the basic idea of responsibility. The left leans toward an idea of social responsibility, or taking care of people. The center sees responsibility as something to be assigned, negotiated, bought and sold in the manner of a business deal. The right sees responsibility as a more private matter, belonging mainly to each individual as a matter of free will.

One of the assumptions deal-makers in Washington have made in the past is that the center bloc can never lose. The center bloc is often the smallest of the three blocs, but it has a pivotal role. Usually the center bloc can get either the left bloc or the right bloc to go along with whatever it decides. Sometimes it is half of the left bloc and half of the right bloc who vote with the center bloc. It scarcely matter how it works out as long as the votes are there. The center bloc can go ahead with its plans, confident of success, without having to bother to check what the left bloc and the right bloc are thinking.

Or so they thought. And that is why Pelosi and other Congressional leaders didn’t bother to count votes to see if their negotiated package made political sense. They were in the center. How could they lose? But lose they did, defeated by a chorus of nos from both sides.

How can the left and right blocs suddenly agree on things and vote down an initiative from the center?

It’s not really so strange when you consider that the left and right blocs both believe in principles — and, to a significant extent, the same principles. For example, left and right agree on a concept of basic fairness and a concept of order and stability. The center likes fairness and stability too, but they won’t let principles stand in the way of their method of businesslike negotiated problem-solving, or deal-making, if you will. But if the center goes too far in abandoning principles to reach a deal, the left and right can stand up together and say, “Hey, wait a minute. This deal you’re offering doesn’t have any principles in it.” And that’s what happened here.

Some observers think there is a sea change going on in politics that will increasingly leave the center out in the cold. David Sirota says it is a popular uprising in his book The Uprising: An Unauthorized Tour of the Populist Revolt Scaring Wall Street and Washington. The book came out in May and seems remarkably prescient when you set it up against the events of the last two weeks.

Yesterday, Sam of Vote Pact argued that the recent trend is toward a historic realignment in American politics. Already, far more voters agree with the positions of Ron Paul, on the right, and Ralph Nader, on the left, than agree with either John McCain or Barack Obama, in the center. Voters may not know about this, of course, because the media does not follow Paul, Nader, or other independent and third-party candidates. But I saw someone comment on Sunday, apparently assuming that the bailout would pass, that if Ralph Nader and Ron Paul agree that the bailout package is a disaster, then we are all in big trouble. The meaning of that comment is that Nader and Paul stand for principles, even as they disagree on priorities. So if Nader and Paul agree that a plan is a terrible mess, it can only be that the plan goes against the basic principles that make things work, regardless of what priorities you want to apply.

I was surprised to learn that five Presidential candidates have “agreed with a set of principles around foreign policy, privacy, the national debt and the Federal Reserve.” They could agree on these principles because they are common-sense principles that most of the voters in the country would agree with. Yet these are principles that the two center bloc candidates, Barack Obama and John McCain, are running against, inviting voters to hold their noses and vote for one of the two.

Just as it is assumed that the center always wins in Washington, McCain and Obama are running on the assumption that the closer they come to parroting a center position, the better their chances of winning. Yet principles are important too. Obama’s idealism and energy accomplish nothing if there are no principles behind them. McCain’s maverick approach, or his willingness to compromise on anything, provides no direction unless there are principles that guide him in which compromises to make. Of course, both candidates do believe in principles, but they are doing their best to hide them so that they will appear more centrist. The theory is that the one that is closest to the center will win. My prediction is that the opposite will hold true in this election: that a candidate who appears to stand for something, a candidate with a spine, will be the winner.

One reason I am sure something is changing is that I have heard from voters who have spent their entire adult lives voting in just one party, up until now. Something happened in September to make them say they are now going to start voting on issues. Combine these brand-new issues voters with the voters, angry at being effectively disenfranchised, who are ready to vote against any incumbent, and things could really change in this election. Of course, these voters are not numerous enough to turn everything upside down, at least not at this point, but they could provide the margin that decides hundreds of races across the country. A popular uprising? It might, at least, be enough of a change to persuade politicians that not standing for anything is no longer the safe way to run for office, or the safe way to vote once elected.

Go to College, Pay Higher Interest Rates

A friend who is just starting graduate studies got a note yesterday from Discover Card. Discover is raising her interest rate to prime plus 15 percent for all prior purchases, and prime plus 10 percent for all purchases going forward.

It was a curious notice to read, as the account holder in question pays her card off in full every month, and has no prior purchase balance.

But I have heard so many stories like this — people paid for tuition using their credit cards, then the bank raised their credit card interest rates in a big way — that I have to believe that there is now an unwritten rule among banks against paying for tuition with a credit card. It seems that banks automatically and immediately raise interest rates for any account holder who pays any college tuition, regardless of anything else in the account holder’s history.

The theory, apparently, is that you will be in college for the next four months and won’t be earning much money to pay off your tuition during that time, so the banks may as well soak you for as much interest as they can get during that period.

This may make a few extra bucks for the banks in the short run, but it is a terrible idea. The account holders often feel insulted, cheated, and suspicious, and rightly so, and that can only damage the banks’ chances of future revenue.

My friend in graduate school won’t be paying any interest on her credit card, since she pays the full balance every month, but she is responding to the interest rate hike by cutting back anyway. “I have to stop using my card,” she told me. “When I use my card, I use it too much. I need to save my money — I might really need it someday.” And that’s an approach most of us may have to take.

Even if there is nothing at all wrong with your credit card history, you might suddenly find one day that banks are raising your card interest rates, perhaps even doubling them, or cutting your credit limit, even cutting it below your current balance so that your new purchases are declined, and the bank may do this with no warning and for no reason that you can figure out. Banks are doing this far more often as they try to guess which borrowers are solvent and which are not. There is really no way to guard against this except by not relying on your credit cards.

In a panel discussion last winter, a banker was asked how close to your credit limit you can go before it raises a red flag back at the bank. He may have surprised everyone in the audience when he said that if you want to be safe, you should not spend more than 30 percent of your credit limit. For example, if your credit limit is $13,000, and you don’t want your bank to worry about how much you are spending, keep your balance below $3,899. Years ago, you could spend right up to your credit limit, and often 15 percent more, before the banks would rein you in. Now the credit limit is mostly an illusion. Try spending half your credit limit, and you shouldn’t be surprised if your bank cuts your credit limit by half.

In case it isn’t obvious, this is a part of the “credit freeze” that Federal Reserve chairman Bernanke and Treasury Secretary Paulson have been talking about. It also illustrates why the Wall Street bailout bill that failed yesterday in the House would not have succeeded in addressing the problem. We know it would not have prevented bank failures, but it also would not have made the banks start lending loosely again. If a bank is worried about a consumer borrowing $3,900, it is not because the bank does not have the money to lend. Rather, it is because the bank is worried that the consumer may not pay the money back. That is a worry that will not go away no matter how much money the bank has in its safe.

The current financial crisis has been blamed on a real estate bubble and a derivatives bubble, but the real culprit is the lending bubble. The Wall Street bailout idea can never work because it just feeds a collapsing bubble. A bubble, when it collapses, will continue to collapse no matter how much money you pour into it.

It is a bizarre concept for most of us to imagine an economy that is not primarily built on borrowed money, yet borrowing was not the key to any economy in any century before the 20th century, and we can keep our current economy going even as the lending bubble goes away.

For most of us, this starts with our credit cards. We’ve been hearing for years that paying off credit cards is the surest way to improve financial strength. Now it may be the key to your financial stability too. Now is not the time to lean on any of your credit cards. If you have credit card balances, pay them off quickly, with a sense of urgency about it. Skip dessert or don’t buy any more clothes for a couple of years if that helps you pay off your cards faster.

In the past, many of us have relied on credit cards to get us through tight times financially. That may not be possible in the next few years. If banks learn you are suddenly in a difficult financial position, that is exactly when they would like to cancel your credit cards — something banks are doing far more often these days. In a pinch, you might borrow a little from friends, but for the most part, you are going to have to save money to cover the next little downturn in your personal economy. As bizarre as this sounds, it is the way people did it up until about 1975. Yes, that is a very long time ago, but it still proves it can be done. How much should you save? A good rule of thumb is to save enough to cover most of a year of living expenses.

After you do that, it is important to pay off all your loans — even your home mortgage. Traditionally, we have thought of a home mortgage as a binding contract, which the bank can’t squeeze you out of unless you are ever late with a payment, but banks may be able to find a way out of this too, so a mortgage is not an arrangement you want to entirely rely on either. You may have no choice — you have to live somewhere — but do what you can to get your mortgage balance below what you can earn in one year, and then pay it off completely.

Businesses need to do the same kind of thing. Wall Street lobbyists yesterday morning were going around with a soundbite, probably fictional, of an employer who worried that if the credit freeze continued, he wouldn’t be able to borrow money to meet the payroll. That is a real concern, but the solution is not to encourage banks to lend money to businesses that are living so close to the edge. Those are the loans that go bad. Businesses need to stop depending on loans for their day-to-day operations. I know this must sound bizarre in an age when financiers debate whether a debt-to-equity ratio of 5 or 10 is better. Yet 40 years ago, a banker would laugh you out of the office if you were running a business and asked for a payday loan. If you operated your business that way, bankers wouldn’t even consider it a business. That was a long time ago, but it proves that a business can be operated without relying on multiple lines of credit.

Again, the reason not to lean on credit is for your own financial stability. When the whole credit market is unstable, you cannot add much stability to your own life by employing credit. And as you free yourself from all the entanglements of credit, you also help get the economy going again.

I am not really suggesting that people should never borrow or lend money, just that we may need to bring our use of credit back into balance. In my opinion, that means we should be in debt no more than about half of the time. The way things work now, many of us are in debt from the day we sign up for college until the day we die. That is not a good balance, and the lack of balance is what has caused the credit bubble and the current recession. The faster we can individually stop leaning on credit as a way of life, the sooner the recession can end.

The JPMorgan Chase Clause

I took a look at the new legislative text of the proposed Wall Street bailout overnight, and while the plan is no longer structured as a slush fund, it still offers Treasury Secretary Henry Paulson tremendous flexibility — enough to:

• Spend all $700 billion before November 2
• Pay large banks as much money as he wants to

You might hear from someone in Washington that this second point has been addressed. The bill has a provision requiring the Secretary to pay fair prices for some assets it purchases. This is the first sentence of subsection 101(c), which is titled “Preventing Unjust Enrichment.” Sounds good. Yet the second sentence of this subsection offers a loophole big enough to drive a nuclear bomb through. “Unjust enrichment” is permitted for “troubled assets acquired in a merger or acquisition.” Virtually all of the assets of a bank like JPMorgan Chase went through their big merger, so I am calling this provision the JPMorgan Chase clause. Do you think it will bother anyone that the Wall Street bailout bill gives JPMorgan Chase an advantage over your reliable hometown bank that hasn’t been through a merger?

The House of Representatives is planning to vote today on this deeply flawed and dangerous legislation, a bill that, even if implemented correctly by the Treasury Secretary, would do far more harm than good. Now would be an excellent time to email or telephone your Representative to say, “The Wall Street bailout bill is deeply flawed and dangerous. Please save the U.S. dollar by voting no on the bailout bill.”