Wednesday, September 17, 2008

Your last nightmare was brought to you by....

The words you want to be repeating to yourself are... Washington Mutual. WaMu is the sixth largest bank and the largest savings and loan in the United States. Rumours abound that it is up for sale having lost 85% of its share value in one year. Shares closed today at $2.01 and its rating has been reduced to "junk" by Standards and Poors. In fact, shares dropped even further after the markets closed to somewhere around $1.80.

The problem with Washington Mutual is that it is not only extremely exposed in the high-risk mortgage market, (yes, subprime and adjustable-rate mortgages), it has a huge customer base with (by their own recently released 3rd quarter outook) $143 billion on deposit.

Let's toss in another little number. Washington Mutual borrowed from the Federal Home Loan Bank of San Francisco to the tune of $58 billion to finance all those high profile mortgages. What the hell is the FHLB of SF? Glad you asked.

The Federal Home Loan Bank (anywhere it's based) is a US government corporation established by former US president Herbert Hoover in 1932, in the depths of the Great Depression, to provide low-cost credit to residential home lenders. This was a government owned corporation which was intended to provide regional banks, thrifts (savings and loans), etc. with low-cost money and enough capital to keep the home construction market alive and financing for middle income Americans with enough stable income to buy a modest house.

In the Bush 41 era, in the throes of deregulation, the FHLB ended up with an expanded role and less government control. Under Clinton, a Republican-controlled congress took the leash off FHLB and it behaved more like a private investment bank than a government operation. In short, in order to survive, it had to behave more like a private investment firm and, instead of reporting to the US Federal Housing Administration, reports to the Security and Exchanges Commission.

Means nothing? That's what I figured.

The FHLB was never supposed to be able to lose money. The money loaned to small banks and thrifts was supposed to be low risk. In short, the borrowers (credit unions and the like) had to have a strict lending criteria. That meant the retail borrower, (home buyers), had to provide some assurity that they could repay the mortgage and that they had a proven record of saving a little more than the amount of the monthly mortgage payment. Under the older regulations Washington Mutual would never have been able to borrow wholesale mortgage funds from the FHLB if they were signing subprime mortgages.

Now, the FHLB is losing money. After years of constant growth it is showing losses. And who underwrites those losses? The US government. The taxpayers.

This (20th Century) Depression Era, government established lending institution, with a mandate to lend only for residential housing became a player, however unwittingly, in a Ponzi scheme. Instead of dictating mortgage rules to lenders, they took a "hands off" approach because of several deregulation moves. But none was more important than the Financial Institutions Reform, Recovery and Enforcement Act of 1989 enacted by George Bush the Elder. It removed the FHLB from a supervisory and regulatory role on the lending practices of regional banks and thrifts. The smaller lending banks were closer to the consumer and they would assess risk - locally.

So, Washington Mutual actually has a liability of over $201 billion. If WaMu fails the taxpayer is on the hook for the $58 billion borrowed from FHLB San Fran. Money on deposit with WaMu is averaged at $5,200 per depositor. The Federal Deposit Insurance Corporation (FDIC) guarantees depositors insurance on their funds up to $100,000.

It gets ugly now. The FDIC has been depleted and has funds on hand of about $45 billion. It cannot cover WaMu depositors if WaMu fails. That said, FDIC has stated that the US Treasury, (yeah, the taxpayer again) will inject money into FDIC to cover its insurance liability.

Got that? Good. Sounds great... until you figure out that the US Treasury is in a huge deficit balance. It gets its money from taxes and by issuing bonds which are bought up by foreigners. That's where you need to listen to Paul Craig Roberts, former assistant Secretary of the Treasury under Reagan.
Most Americans, including the presidential candidates and the media, are unaware that the US Government today, now at this minute, is unable to finance its day-to-day operations and must rely on foreigners to purchase its bonds. The Government pays the interest to foreigners by selling more bonds, and when the bonds come due, the Government redeems the bonds by selling new bonds. The day the foreigners do not buy is the day the American people and their government are brought to reality. This is not the financial position of a superpower … Will what happened to Lehman Brothers today be America's fate tomorrow?
In short, the US government is borrowing money to finance the bailouts of of failing banks because they borrowed money to finance a risky scheme which failed.

Now WaMu has been making a lot of noise that they have the capital to cover their losses and manage their debt. Except for one small thing. Money on deposit to a bank is actually a liability - not an asset. A bank's assets are the shares they issue and the loans they've made (but now, we have to wonder how good they are), and in the case of WaMu, their shares have lost most of their value and a huge chunk of their loans are not recoverable. That means they have little or no collateral to put up to borrow their way out this mess.

WaMu, despite its size, owes a lot, isn't worth much and is losing money - lots of money. If it was a horse you'd shoot it. Yes, there are all kinds of news stories hinting that there is a buyer for WaMu. Except that that doesn't solve much and WaMu would be an extreme risk for any buyer.

So, no bank is going to buy WaMu without a guarantee.... and guess who that's coming from. (File your tax return early and often.)

If no other bank buys WaMu then the US Government will be forced to place it in conservatorship.

By the weekend, the cost of the subprime mortgage scheme will be passed from the grandchildren of Americans to the great-grandchildren.

And if you're some poor shmuck in Iraq or Afghanistan, you're wondering what you're coming home to.

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