As we work ourselves through this Great Recession, one has to wonder about the state of affairs in the two primary financial institutions, the Federal Reserve and the Department of the Treasury, that supposedly try to manage our economy. Based upon the evidence, these esteemed institutions do not understand fundamental financial accounting rules (e.g., Assets = Liabilities + Equity) that are taught in the first week of Accounting 101.
And that is a big mistake that the entire world has had to pay for.
For example, let’s take the bad loan bank problem that has been at the heart of the Great Recession. Remember, TARP? Remember, how in the fall of 2008 our financial leaders (Paulsen, Bernanke, Geithner) told us how the banks “too big to fail” were going to go down without a major influx of Governmental funds? Remember, the panic attack after TARP, when the stock markets of the world dropped by more than 40% (on top of the 25% that the markets had already dropped before TARP)?
Well, it’s time that we take a look at the true reality of the situation—this time keeping the fundamentals in mind. Exhibit 1 provides an accounting for the banks that the Federal Deposit Insurance Corporation (FDIC) has actually shutdown since the beginning of our Great Recession.
FDIC Bank Shutdowns by Quarter
(excluding two outliers: Washington Mutual and IndyMac)
Year & Qtr
% of Assts
*NPA = Nonperforming assets = loans delinquent in payment, in foreclosure, etc.
**DPO’d = Depositors Paid Off in lieu of being merged into an active bank
There are several things that the reader should understand immediately from Exhibit 1, including:
• It took a while for the FDIC to build up their staffing so that they could begin correcting the “bad bank” situation in the United States at the rate of approximately 45 banks per quarter;
• Most banks (96%) that are shutdown are quickly merged into a healthier active bank with the FDIC’s assistance. In the case where the assets of a “bad bank” are not merged with a healthier bank, the FDIC instead pays the insured depositors off immediately;
• The estimated losses on the above shutdowns are in the range of about 13% of assets;
• Most banks (96%) that are shutdown show an amount of Non-performing assets (i.e., loans delinquent in payment, foreclosure, etc.) greater than the remaining Equity in the bank. The 4% that don’t meet this condition are close to meeting this condition; and
• Most banks that are shutdown are typically smaller banks.
So, what is the point? The point is this. A non-performing asset (NPA) is reflected on the books of the banks as an asset. If that asset is non-performing then that asset is substantially reduced in value. And to get the non-performing asset off the books, there is only one way to do it, and that is to use up Equity. Remember, Assets = Liabilities + Equity. If you reduce the value of Assets, then you either have to reduce Liability or Equity on the other side of the equation. In the case of non-performing assets, no liability is lessened, so it has to come from Equity.
OK. So again I ask, what is your point?
My point is this. The panic of 2008 should never have happened. Oil (TARP) was thrown onto a fire that was already burning well on its own. If you look at the banking industry books, this Great Recession never should have been compared to the Great Depression. And that was a very, very big mistake. The result was unnecessary panic that actually drove us closer to a Great Depression than it did to help the situation. In truth, the current Great Recession is only about 2-3 times worse than the S&L crisis in the early 1990s and a far cry from the Great Depression of the 1930s.
But what about the banks “too big to fail”? Trust me, the banks “too big to fail” were never going to fail—the accounting figures never even came close to showing them as failing. The big banks have always had plenty of Equity to cover their portfolio of Non-performing assets—both yesterday and today—in fact, nearly 5 times the Equity to Non-performing assets.
Besides, the big banks are where the “big players” keep a substantial amount of their cash deposits—most of which exceed the FDIC insurance limits and thus are uninsured. Now do you really think the big boys would let the big banks go down when there was still quite a bit of Equity left in them even after accounting for their bad loans? I hardly think so.
Hindsight? Baloney. The above analysis is the same analysis that was used during the resolution of the S&L crisis, and is the same analysis that the FDIC is using today to solve the Great Recession crisis. Look again at Exhibit 1. There is only one way to interpret that.
In effect, while the FDIC has been going about doing its job, the financial leaders from its sister institutions (i.e., the Fed and the Treasury) stumble around over-complicating things.
What I am telling you, folks, is this: the worst of this Great Recession is over. If you go into the banking industry database, you will find that there are still 373 active banks with non-performing assets greater than equity on the books. Although this number may seem large, the total amount of the assets of these 373 banks is approximately $200 billion (less than 1.5% of total industry assets), and the estimated losses associated with those 373 banks is in the range of 6% of assets, or $11 billion.
In other words, what assets remain to be cleaned up by the FDIC is about one-third the amount of assets for all the previous FDIC shutdowns (including those of Washington Mutual and IndyMac) and the amount of losses on those assets are likely to be half of what they were for the earlier shutdowns on a per dollar asset basis.
Yes, it may take another two years or eight quarters to clean up the remaining so-called “bad banks”, but for the most part, the worst is over. And it is time to get back to business and believing in our country again. We should all be thankful that the FDIC has once again done its job. If only we could say the same for the boys and girls over at the Fed and Treasury.
In case you are interested, Exhibit 2 provides you a good perspective for the future of FDIC bank shutdowns, assuming that the FDIC shutdowns banks at a rate of 47 per quarter and goes after the banks with the greatest difference between non-performing assets and equity first.
Projected FDIC Bank Shutdowns by Quarter
Year & Qtr
% of Assts
But what about the Big Four banks (i.e., JP Morgan/Chase; Bank of America, Citigroup, and Wells Fargo) and all of their foreclosures? Today, as of 06/30/2010, these same Big Four banks are reporting Equity in the range $655 billion with $130 billion in unaccounted for non-performing assets (which includes all those problem foreclosures). It’s hard to see a problem there.
And in case you are interested, these same four banks were showing Equity in the range of $555 billion with unaccounted for non-performing assets in the range of $107 billion in the fall of 2008 when our esteemed leaders came up with TARP.
So let me reiterate one last time for our esteemed Economists. It’s time to get with the game. It’s time for you to smart yourselves up a bit and begin talking to some of your “lesser” colleagues over at the FDIC or some of us “old-fogies” that worked through the S&L problem during the early 1990s. Assets = Liabilities + Equity. It’s hard to make it any simpler than that for you.