FHLB equity positions – time to lower your exposure?

With all apologies to my friends at FHLB Dallas, what would happen if the FHLB system (or a single FHL Bank) went the way of Fannie and Freddie? Most banks carry FHLB stock on their books to support their FHLB borrowing activity. If you are not using all of your borrowing capacity, does it make sense to sell any excess stock you hold? I’m not proposing that we all rush to sell all of our FHLB stock, but a rational discussion of the investment in a coming ALCO meeting would be appropriate. If banks begin to pare down FHLB borrowings in response to proposed FDIC insurance assessment changes, trimming excess stock holdings may become a larger issue.

My Two Cents

It was a rough weekend to be a Tiger. All five Division I-A football programs with Tiger mascots (can you name them all?) lost. Two other weekend losers: small banks in Northville, Michigan and Eldred, Illinois that were closed Friday by the FDIC. For those counting, there have been 15 failures so far this year.

If the events of the last two weeks have provided any lessons, one near the top of the list should be “Perception IS Reality”. Whether it is an inaccurate statement made forcefully during a debate or an opinion voiced by a talking head, many people hear what they want to hear, accept inaccurate statements as fact and allow fear to snowball into irrational behavior. When you add the lifting of short sale restrictions on financial stocks, margin calls that create 2:00pm market crashes and the “who’s failing next” rumor mill to the mix, should we really be surprised that the turmoil continues? I wonder how much of this mess could have been avoided if we had removed ANY ONE of the following pieces from the equation:

· Mark to Market accounting rules

· The 2008 election cycle

· Hedge funds, short sellers and margin calls

· The FOMC’s excessively easy money stance from 2001 to 2005

Of course, if we had removed sub-prime mortgage paper from the market, perhaps Bear, Lehman, AIG, WaMu, Wachovia, Fannie & Freddie and others would still be healthy and I could spend more time talking about football. In case you were wondering, the five programs with tiger mascots are LSU, Auburn, Missouri, Clemson and Memphis. Taking the “Bad weekend to be a Tiger” theme a bit further, the failed bank in Eldred, IL is a short drive from the University of Missouri, and the failed bank in Northville, MI is not far from Detroit, home of the Detroit Tigers, who also had a dismal year. Good luck to all the Tigers this weekend, and good luck to the banks that are on the FDIC's failures-in-waiting list...

Wachovia / Citi / Wells Fargo

When Wells realized how good a deal Citi had with their $1 per share acquisition of Wachovia’s banking unit, they trumped Citi’s bid by roughly 700% AND did it without FDIC assistance. Wells was the other potential white knight all along, but backed out during the final FDIC-driven negotiations, so they knew enough to make a good offer.

The FDIC really put itself in a bind on this one. By pursuing an “open bank” resolution, the FDIC did not remove Wachovia’s shareholders from the mix, leaving the door open for a better offer that Wachovia’s board had to consider and that the shareholders would likely prefer. While the FDIC would like to get rid of Wachovia without assistance, failing to continue to support Citi’s bid would weaken the FDIC’s ability to resolve other institutions prior to failure. On Friday, Citi seemed to acknowledge that they had been bested by Wells, but the legal and regulatory implications of their rebuffed “rescue” deal may continue for a while.

Liquidity Update

Regions and Chase have begun canceling unsecured fed funds lines with their downstream banks, according to several well-placed sources. While our Primary Liquidity calculations do not include these borrowing lines, the Secondary Liquidity calculations do. As the current credit market mess unfolds, it is becoming clear that regulators and bankers alike should focus more on primary sources of liquidity, as secondary sources become unstable and may be unavailable at the time we need them most. If your Primary Liquidity ratio is below 15%, prepare to justify your risk posture during the next exam. Don’t count on the supposed availability of borrowing lines or the promised purchase of warehoused loans to provide a penny in a pinch.

Acronym of the Week

Richard Fisher, president of the Federal Reserve Bank of Dallas, described current credit market troubles as “a hideous STD -- a securitization transmitted disease”. His remarks before the Money Marketeers of New York University on 9/25 are worth reading in their entirety (http://dallasfed.org/news/speeches/fisher/2008/fs080925.cfm). Two excerpts:

Since the beginning of the year, I have been worried about the efficacy of reducing the fed funds rate given the problems of liquidity and capital constraints afflicting the financial system. As I see it, the seizures and convulsions we have experienced in the debt and equity markets have been the consequences of a sustained orgy of excess and reckless behavior, not a too-tight monetary policy. There is no nice way to say this, so I will be blunt: Our credit markets had contracted a hideous STD — a securitization transmitted disease — for which lowering the funds rate to negative real levels seemed to me to be not only an ineffective treatment, but a palliative and maybe even a stimulus that would only encourage further mischief.

At times like this, it is easy to become melancholy and bitter and cynical. This club, the Money Marketeers, was founded by Marcus Nadler, one of John’s and my predecessors at the Federal Reserve who was there “at the creation.” You will remember that Nadler put forth four simple propositions to counter the intellectual paralysis and down-in-the-mouth pessimism that gripped the financial industry after the Crash of ‘29:

“You’re right if you bet that the United States economy will continue to expand;

“You’re wrong if you bet that it is going to stand still or collapse;

“You’re wrong if you bet that any one element in our society is going to ruin or wreck the country;

You’re right if you bet that men in business, labor, and government are sane, reasonably well informed and decent people who can be counted on to find common ground among all their conflicting interests and work out a compromise solution to the big issues that confront them.”

This became known as “Old Doc Nadler’s Remedy,” and for my part, it is spot on. Every red-blooded American should keep it in mind.

Outlook for Deposit Insurance

Bloomberg News was the target of an open letter from Andrew Gray, the FDIC’s Director of Public Affairs, addressing sloppy journalism in discussing the insurance fund and the potential for a ‘bailout’. The letter, which should make the reporter feel like a child sent to the principal’s office, include the following:

Bloomberg reporter David Evans’ piece (“FDIC May Need $150 Billion Bailout as Local Bank Failures Mount,” Sept. 25) does a serious disservice to your organization and your readers by painting a skewed picture of the FDIC insurance fund. Let me be clear: The insurance fund is in a strong financial position to weather a significant upsurge in bank failures. The FDIC has all the tools and resources necessary to meet our commitment to insured depositors, which we view as sacred. I do not foresee – as Mr. Evans suggests – that taxpayers may have to foot the bill for a ‘bailout.’

...Mr. Evans’ suggestion that the “government” could ever be “on the hook for uninsured deposits” demonstrates a misunderstanding of FDIC insurance. To protect taxpayers, we are required to follow the “least cost” resolution, which means that uninsured depositors are paid in full only if this is the least costly option for the FDIC. This usually occurs when a bidder for the failed bank is willing to pay a higher price for the entire deposit franchise. We are authorized to deviate from the “least cost” resolution only where a so-called “systemic risk” exception is made. This is an extraordinary procedure which we have never invoked. And again, any money we borrow from the Treasury Department must be repaid through industry assessments.

I am confident in the strength of the FDIC’s resources to make good on our sacred pledge to insured depositors. And, remember, no depositor has ever lost a penny of insured deposits, and never will.

Notice the comment about replenishment through industry assessments. If you think back to the years following the S&L crisis, deposit insurance rates were 23 to 31 basis points. With most banks paying around 8 basis points now, the proposal for restoring the fund will probably take us back to the days of 20+ basis point premiums. On October 7, the FDIC Board is scheduled to announce its plans for replenishing the fund.