Fec linked to several stories related to potential bank failures in the US. This bit from the US News & World Report really caught my attention:

“It’s our view that regulators are expecting 100 to 200 banks to fail”
over the next 12 to 24 months, says Jaret Seiberg, a research analyst
for the Stanford Group. Seiberg expects those failures to occur
predominantly in states like Ohio, Michigan, California, and
Georgia—where the construction lending market, which includes
residential real estate, is expected to weaken dramatically…

Washington Mutual lost $1.87 billion in the fourth quarter, hit by
mortgage defaults, write-downs and a substantial increase in the amount
it set aside for bad loans.

That got me to thinking about the FDIC.  My understanding is that it insures checking and savings accounts up to $100,000 per depositor and up to $250,000 per IRA account, so if these banks fail won’t it be on the hook to insure all those accounts?  How much moolah are we talking here?

When I set my fingers to typing this post I was going to ask "How much of the taxpayers money is at risk here?" but upon doing a little reading I discovered that the FDIC is funded by insurance payments from the banking institutions themselves.  So unless something catastrophic happens then taxpayer dollars shouldn’t be at risk right?  Something about this sounds spookily familiar.

Oh, yeah.  Right when I was getting out of college and beginning my life in the working world (that would be 1989) there was this little thing called the savings and loan crisis that I didn’t really understand, but seemed to have all the real adults spooked.  It happened to coincide with a real estate bust and a fairly decent recession, and it resulted in the birth of this new institution called Resolution Trust CorporationFrom the Wikipedia entry on RTC comes this: that ended up employing lots of people in DC to do something really important: bailing out the S&Ls and the morons who broke them on the shoals of a booming-busting real estate market.

According to Joseph E. Stiglitz in his book, Towards a New Paradigm in Monetary Economics, page 243, the real reason behind the need of this company was to allow the United States government to subsidize the banking
sector in a way that wasn’t very transparent and therefore avoid the
possible resistance. This is supported by the fact that the banks had
better information related to the loans than the RTC.

So pardon me if I don’t swallow whole the idea that taxpayer dollars may not come to the rescue of the current crop of morons who are breaking their banks on the shoals of the latest booming-busting real estate market.  Somehow the pinstripes always find a way to dump their problems on the denim crowd.

Update: Ed Cone links to an article about the feds getting ready to help out. From the article: The Federal Reserve, struggling to
contain a crisis of confidence in credit markets, plans to lend
up to $200 billion in exchange for mortgage-backed securities…it will hold
auctions of Treasuries in exchange for debt including AAA rated
mortgage securities sold by Fannie Mae, Freddie Mac and by
banks.  Ed then says, "I’ve made some rotten investments in my lifetime, it
would be nice if someone would swap me some Treasuries for them. "

That didn’t take long.
 

Well I guess we can call the tanking of the US mortgage and real estate industries a real problem now that 60 Minutes has done a story about it.  One part of the story features an interview with a family who signed on the dotted line for an adjustable rate mortgage without consulting an attorney.  The reporter, Steve Kroft, asks them why they didn’t view this as a big, risky investment and get professional advice and the reply from the husband was that he was just looking at it as a way to get his family out of an undesirable neighborhood into a good neighborhood.  His wife pointed out that they’d told the lending agent they were dealing with that they could only afford a certain amount per month (around $2,400) and the agent went ahead and sold them the ARM anyway.  Now they’re trying mightily to keep up but since their house is now worth less than they paid which means there’s about 0% chance to refinance and their monthly payments are more than they can swing they’re in deep doo-doo.

The response that many people often have to stories like this, including myself, is caveat emptor…buyer beware.  The problem with this attitude is that modern American society is a very complex place to live, and although real estate is regulated to a certain degree there is still plenty of room for people to unwittingly get screwed.  You need look no further than the other end of the mortgage industry to see how the market is almost incomprehensible to even the most sophisticated minds.  According to this article in the New York Times the chief executive of credit rating agency Moody’s said that "his agency had made significant mistakes in the rating of structured
finance products, but added that the agency had been deceived by people
who put together the products."  Here’s an excerpt:

“In hindsight, it is pretty clear that there was a failure in some
key assumptions that were supporting our analytics and our models,” the
executive, Raymond W. McDaniel Jr., told a panel at the World Economic Forum, where he heard complaints about conflicts of interest and suggestions that large fees had influenced the ratings.

He
said that one reason for the failure was that the “information quality”
given to Moody’s, “both the completeness and veracity, was
deteriorating” as the subprime mortgage market grew.

In a brief interview later, Mr. McDaniel did not provide any specifics about who had misled the rating agency.

Rating
agencies are paid by the companies they rate, a fact that has been
harshly criticized here and elsewhere. “The issue is the reliability of
the system that generates the ratings,” Jacob A. Frenkel, a former
central banker who is now vice chairman of the American International Group,
said in an interview Friday. If investors are to rely on the ratings
agencies, he said, they “must be compensated by investors.”

My point is that the problem with caveat emptor is that if we rely solely on that kind of "every man for himself" mentality then the free market is much less free.  Look at it this way; while many people in the mortgage industry were enriched in the short term many, many more people have been harmed.  Thousands of people have lost their jobs, companies have gone out of business and literally millions of homes are going into foreclosure which means that just as many families have lost their piece of the American dream.  Who knows how long it will take these industries to recover, and how long it will be before many of these families will be able to buy their own homes.

As with most modern American stories this one has lots of gray areas.  In another part of the 60 Minutes story Kroft interviews a young couple who say that they’ve been advised to just walk away from their house and let their credit take the hit now that their monthly mortgage payments are moving up and the value of their house is plummeting.  The couple readily admits that they knew exactly what they were doing when they signed on for their ARM.  The woman says something like "How does it make any sense to pay $3,200 a month for a 3-bedroom house?" to which Kroft replies with something like "Well you agreed to the terms of the contract."  The couple doesn’t want to take the hit to their credit, but they just don’t see the value in overpaying for their house and they don’t think they can refinance now that the house is worth less than the note.  Basically these folks gambled and lost, much like the mortgage companies and financiers who created the vehicles that enabled this behavior.  Still, basic ethics say that if these folks knowingly took this gamble and can still afford the payments on their house they should pay it. 

The thrust of Kroft’s story is that this is essentially a case of good old fashioned greed on all sides of the equation.  Really that’s overly simple.  I’m sure that there are many people who sold these mortgages that truly felt they were enabling the American dream, and that if things got tight for the borrowers they could always re-finance.  I’m also sure that many people took the ARMs because they wanted a better life for themselves and their children and thought that if worse came to worse they could re-finance.  Of course there were also lenders who didn’t care about the American dream and just wanted the commission on the sales, no matter who they hurt to get it and there were borrowers who saw a way to game the system and did it. 

The result we have to deal with, beyond the short term financial pain we’re currently grappling with, is that there is very little trust left.  Investors and borrowers no longer trust the financiers, which means that there’s now sand in the gears of our markets.  Without trust on all sides of the equation we’ll have an adversarial marketplace that will inhibit its growth, and that’s bad for everyone.  I know that support of government regulation is antithetical for most in the business community, but the reality is that government regulation can enable markets by giving all of the players a sense that they are playing on an even field.  Sure there is such a thing as over regulation, but there’s also such a thing as under regulation and we’re seeing the results now.  Let’s hope our esteemed leaders find a healthy balance in the near future.