Monday, June 1, 2009

300 or 2,000? How can we change destiny?

At the end of every nightmare, a new day dawns. - D. Santiago

This observation about bank stress trends from the IRA Newsletter garnered some attention.

"At the current rate of deterioration, that could put the Stress Score for the entire industry over 10 by Q4 2009 or a full order of magnitude above the 1995 baseline. Such a worst case scenario suggests that we could see one in four US banks merged or resolved through the cycle. In the event, that suggests that over 2,000 institutions, large and small, will be resolved. Put that into context with the FDIC's "official" dead pool of 300 or so institutions and that gives you a tangible measure for how much "spin" might live within the official version of the problems facing the US banking industry."

One email from a respected reporter asked,

"Is this the same thing as saying one in four banks may fail? How realistic is it to assume what the data suggests? What specificially would drive so many banks out of existence? In other words, what's their Achilles heel in your judgment?"

When a bank fails it is resolved, that is, merged by government edict into another "healthier" institution. Yes it is possible that we will see a good portion of now weakened banks become the subject of a merger feeding frenzy later this year. This could indeed lead to the emergence of a smaller industry populated by larger more economically resilient and politically powerful companies. Some people believe that it's a good thing to concentrate banking power into a more consolidated industry. Me? I just see fewer banks charging higher fees for basic services.

What the IRA analyis of 1Q2009 FDIC data is saying is that lacking any improvement in the infrastructure that supports banking, our analysis indicates that the deterioration of the industry will continue to spread potentially affecting a larger population of institutions as the year progresses.

As has been stated in previous observations, banks have been migrating down the path towards weaker net incomes as a result of stalled lending engines and ballooning anticipated losses on existing loans. The pursuit of good lending begins to look more like balance transferrals instead of true blue new loans that expand the U.S. economy. Anything riskier carries the stigma of being just another balance sheet item eventually headed for the REO pile. It's not easy to make a living under such conditions and the biological sustainment capacity answer is that the population must shrink to equilibrate with the environment.

Dude I don't like that answer either. There's no reason why a country like the United States of America should "equilibrate" to a lower quality of life at this stage in our history. It just does not make sense to me that we'd let something like this happen when we have it in our power to create a different destiny.

The Achilles heel in this equation is the bastard cousin of banking ... finance. Finance is the leverage we create to make our money do more for us. It is a powerful and dangerous tool that can both create and be driven by good and evil. Behind banking's ailments is the fact that securitization, a central element in leveraging the operational processes of main street banking, is now dormant. Driven by greed and excess, it's caretakers have been driven into discredit and trust in it has evaporated. Entire industries that enabled it have ceased to exist in the last 24 months. What's left of it is stored in Federal financial toxic meat lockers. We've done all this at the very peril of our quality of life.

The fact of the matter is that unless we get the financial engines supporting our banking product inventory restarted in some rational fashion banking will continue to de-leverage. Does that mean giving the greedy back their licenses to steal candy from babies? Of course not. What I think it does mean is making a national effort to construct the apparatus to deliver a new range of financial vehicles to enable banking to do it's job again. And do it at a quality of life target design point at oh say "the pursuit of happiness" once more.

And so begins the search for a new dawn.

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