Restructuring, Tightened Credit, and Betting the Bank

Now that banks are buying back auction rate securities after having done the same thing with structured investment vehicles last fall, the question becomes where they will be obtaining funds to do so. Is it a coincidence that Federal Reserve facilities borrowing for their new 84-day loans is strong last week, when banks are moving to repurchase auction rate securities and thereby avoid lengthy and costly litigation? Probably not. But a sizeable proportion of banks must be running out of collateral for even those subsidized credits, a hypothesis supported by other bank moves in recent weeks.

For instance, UBS announced a significant restructuring recently and then reached their ARS settlement a few weeks later. Wachovia announced it was beginning to restructure by liquidating its BluePoint Re Ltd. Bermuda insurance unit that sold insurance against defaults on mortgage-backed securities the same day they announced their own settlement on ARS. These and other examples suggest that, for many banks, asset sales will be necessary to generate sufficient capital for settlements as well as daily operations.

Where banks can’t sell assets, they are tightening credit. According to the Fed’s latest survey, 77.7% of banks are tightening standards on subprime mortgage loans … 75.6% are making it tougher to get mid-grade Alt-A and “nontraditional” mortgages … and 62.3% are tightening standards on prime loans – the most since the Fed started its quarterly survey 18 years ago.

This week, Morgan Stanley (another ARS settlement target) began cutting off its home equity line of credit (HELOC) customers, preventing borrowers from drawing any more money against their lines and slashing the size of the lines that others have outstanding. JPMorgan Chase made changes to HELOCs for some 150,000 customers since March, according to Bloomberg. Bank of America-Countrywide, Chase, Citibank, SunTrust, USAA, Wachovia, Washington Mutual and Wells Fargo are some of the other institutions doing the same thing.

And where banks can’t tighten credit or sell assets, they undertake the Thrift Crisis-era strategy of offering sky-high interest rates on insured deposits. Downey Financial, the California thrift company said it had recovered about 45% of the net outflow that occurred last month in part because it has resumed advertising for CDs. While Downey did not reveal the rates they are paying on those CDs, the Wall Street Journal noted that weak banks are already offering rates as high as Wachovia’s 4.25% one-year and Countrywide’s 5% five-year CD rates. Compared with national averages of 3.6% and 4.16%, respectively, according to, and Treasury note rates of the same durations of about 2.3% and 3.3%, respectively, high-rate insured CDs are great deals for investors. Indeed, investors are responding just as in the Thrift Crisis. CDARS products, which split up large investment balances into pieces below $100,000 so as to be covered by deposit insurance, are again flowing into the industry, creating a classic Thrift-crisis hot-money signal indicating which banks are next to fail.

This summer, banks are scrambling for cash. By being slow to resolve weak institutions and dabbling in “creative” endeavors to forestall losses, policymakers and regulators are setting up the same forbearance environment as in the Thrift Crisis. The result in the Thrift Crisis was a roughly fifteen times increase in deposit insurance losses and one fewer deposit insurance agency, as well as a rough recessionary period and decades of litigation. Must we make the exact same mistakes over again?

One Response to "Restructuring, Tightened Credit, and Betting the Bank"

  1. London Banker   August 27, 2008 at 1:15 pm

    Another Bush in the White House, another widespread banking crisis in the country that traces back to regulator forbearance. To quote you, “Must we make the exact same mistakes over again?” I guess so, only this time the whole world will feel the effects of massive deleveraging as US real estate falls back to earth.The observation about rising competition for deposits is interesting. I can remember a friend at the US Treasury in the 1980s bragging about how he arbitraged CD rates among troubled thrifts – always within the FSLIC guarantee. It’s a game that can be played again today up to the FDIC guarantee.