Month: October 2009

Sheila Bair’s Big Gamble

The FDIC recently shut down another three banks, bringing total bank failures in the US so far this year to 98. Last year there were 25, and in 2007, there were only three.

The Federal Deposit Insurance Corp. is not just the government entity that insures your cash deposits in the bank; the FDIC also has the unenviable task of unwinding banks that have run up massive debts and have no cash on hand to pay them off or cover their customers’ needs. When too many customers (depositors) learn of the rickety state of their bank and line up to demand their money, it’s called a run on the bank. Runs can drain a bank down to nothing, and the FDIC has to make the call when it’s time to close the doors and sell off the remaining deposits and assets to another, healthier bank, thus avoiding a situation where the FDIC has to make good on all the remaining cash demands of the depositors and creditors of the bank long after all the cash has been drained away by a bank run.

Unfortunately for the FDIC, the pool of healthy banks willing (and able) to buy up the assets of ailing banks has dwindled, leaving the FDIC with a lot of assets on its hands that may in the long term be worth money, but right now can’t be sold for even pennies on the dollar. The FDIC’s own cash pool, which comes from annual fees paid by banks (about 12 to 16 cents for every $100 of deposits) has dwindled.

In 2008, the FDIC spent $20 billion of its cash reserves on 25 bank failures; this year, that figure is more than $30 billion. Around the 1st of October, the FDIC’s cash reserves went into the red–meaning that they need to raise cash fast to cover more expected bank failures. The FDIC estimated earlier this year that they would spend approximately $70 billion total by the end of next year, but raised that estimate recently to $100 billion. The need for cash is hanging over FDIC Chair Sheila Bair like the sword of Damocles.

Big investment banks, like Goldman Sachs and JP Morgan, have been keeping an eye on the situation and trying to figure out how to make money from it all. Last month they proposed loaning money to the FDIC so that Sheila Bair, who’s been a major critic of how Fed Chief Ben Bernanke and Treasury Secretary Timothy Geithner have run the financial industry bailout (without strengthening regulation in the process), can avoid going to her enemies for a loan.

The FDIC has two ways to raise more money. It can borrow money from the US Treasury (with Timothy Geithner’s approval) or it can levy a special assessment on banks. But the FDIC had already issued a special assessment last May, and Bair’s critics wailed that another special assessment, or an increase in the annual assessment, would only drive more ailing banks into the ground. Bair didn’t much like the prospect of borrowing money from Goldman or JP Morgan at usurious rates or, heaven forbid, at adjustable rates (a type of loan that should be illegal, after all the damage it’s done to the economy and to peoples’ personal balance sheets). So Bair came up with a compromise.

The FDIC will ask banks to pre-pay their annual assessments through 2012. In other words, Bair is taking an interest-free loan from banks. In order to avoid harming the banks that are still struggling, she gave them the okay to not report the prepayments on their financial statements, so their cash reserves will look better than they really are.

How is this different from the accounting tricks that banks have been using to hide their debts and overvalue their risky investments to make their cash reserves look good? According to Bair, the difference is in degree. The few pennies that make up the FDIC assessment will be small change compared to the other expenses on banks’ financial statements. But having banks prepay those few pennies will add up to $45 billion that will replenish the FDIC fund.

The other, more important question is this: Will this $45 billion be enough? By the FDIC’s own estimate, they’ll need at least $50 billion to get through the end of 2010. Asking banks to pay their assessments through 2012 right now leaves a gap of two years when the FDIC can expect zero income from its main source but will still have to close down troubled banks. A taxpayer bailout will be inevitable.

The fact that Sheila Bair–the only top regulator in this country who’s been outspoken about the causes of the crash–can’t turn to either the Obama administration or to Congress to replenish the FDIC’s fund is a symptom of just how sick our system is. She’s betting that things will get better between now and next year, that new financial regulation will be in place, that the economy will turn a corner, and that Congress and the American people won’t view a request from her to replenish the FDIC’s fund with taxpayer money as a taxpayer bailout that marks her as the same kind of leach as Kenneth Lewis of Bank of America or Franklin Raines of Fannie Mae.

I hope she’s right–but I don’t think she is. All indications are that banks are in for another round of collapses, this time sparked by commercial real estate loans.

Many banks are using an accounting trick called “interest reserves” to hide the bad commercial loans on their books. When a risky construction loan is made, a bank may choose to calculate the interest on the loan and put that money in a special account called an “interest reserve.” The bank essentially pays the interest on the loan to itself, absolving the debtor from having to make any payments for a certain period of time. These loans are often made to real estate developers who won’t get any income from their new property until they’re done building a new building and leasing it out or selling it. The interest reserve account, however, makes the loan look like a performing loan on the bank’s balance sheet when it’s not; it’s just a risky IOU that will only be paid back if the developer finishes building his project, leases or sells it, and stays in business long enough to pay all his debts.

The collapse of the real estate market has brought bankruptcy to many real estate developers, and banks are ending up owning semi-developed properties that they can’t sell or manage. The use of interest reserve accounts is widespread in the banking industry, but bank regulators are complaining that many banks are resisting the need to write off these bad loans and do away with their interest reserve accounts. Banks are hoping that the real estate market will pick up and they can sell those properties. But with most companies downsizing and commercial vacancies high, the future doesn’t look so good for US banks.

Fiddling While the World Burns

The UN Summit on Climate Change came and went last week, with very little change in nations’ attitudes toward capping carbon emissions. In spite of the Obama administration rhetoric that the meeting was a successful step forward, no deal was reached-no consensus on targets, no caps on emissions, and no specific goals to reduce global warming gases.

Certainly, the leaders of individual nations stood up, one-by-one, and gave self-congratulatory speeches about the small steps they were taking to regulate carbon emissions in their respective countries. Chinese president Hu Jintao expressed a willingness to set specific goals, but gave no indication what those goals would be. Each country had the same attitude: “we’re willing to do something, we just don’t want to be the first to commit to a specific goal.” Even Japan, which has committed to specific targets, will only enact their plan if the rest of the global community follows suit. In other words: “you go first.”

It’s hard to argue that the country to go first should be anyone other than the US. We’ve been responsible for most of the carbon emissions spewed into the atmosphere up till now. If China now produces more than we do, it’s only been in the past year or two that they’ve surpassed us. We are still the global leader, at least in perception, and if we want to kid ourselves that our actions inspire other nations to follow our lead, then we need to act with the responsibility that leadership requires.

President Obama, however, has pushed the climate crisis further down on his agenda, below the wars in Iraq and Afghanistan (which should be ending by now, but aren’t), the healthcare reform debate (which has been slowly simmering for years and could have waited awhile longer), and the economic crisis (which he’s used as a convenient excuse to put off instituting carbon caps). Sure, switching from a carbon based energy system to cleaner energy is going to have an economic impact, but it has to begin as soon as possible or the economic impact in the future will be even more dire than the current recession.

Take, for example, the UN Environment Program’s latest report, released shortly after last week’s climate summit. It predicts that, if all the countries in the world institute the strictest carbon limits that they’ve committed to so far, the planet will warm by 6.3 degrees Fahrenheit by the end of this century. That’s approximately double the previous estimate done by the Intergovernmental Panel on Climate Change in 2007. In addition, the new report predicts that sea levels will rise by as much as 6 feet by 2100, instead of the 1-1/2 feet predicted by the IPCC. Such a change would be catastrophic in terms of population dislocation, salination of low-lying farmlands, and would seriously disrupt the world’s climate system, bring food scarcity, and, yes, negatively impact the global economy.

So there’s no excuse to stall, even for another year. The Copenhagen Summit in December is fast approaching, and world leaders are no closer to agreeing on an agenda, much less a new treaty to replace the expiring Kyoto Protocol. The Obama administration should be looking at the Democratic majorities in the House and Senate and telling themselves: “we will never have a better chance than this to pass binding legislation to regulate carbon emissions. Let’s do it now.”

Instead, in the absence of any action in Congress, state governments are taking action in court to force limits on carbon emissions. Much of the carbon emitted in industrialized countries is caused not so much by vehicle exhaust, but by the burning of coal to generate electricity. Coal is still the cheapest and easiest way for many nations, from China to the US, to power our computers and turn on our lights.

So eight states, along with New York City and three public land trusts, sued in court for the right to prosecute five power companies for creating a “public nuisance” by not reducing their carbon emissions. Last week, a two-judge panel of the US Court of Appeals for the Second Circuit in New York ruled in favor of the states’ right to sue the power companies. Notably, the two judges were not “liberal judicial activists”; one was appointed by George H.W. Bush in 1990 and the other was nominated by George W. Bush in 2003. If conservative justices can rule in favor of carbon limits, then Congress no longer has any excuse to punt on this issue.

But it’s up to the Obama administration to roll up their sleeves and get started on an international treaty while simultaneously pushing for legislation in Congress. It’s not enough for us to take a wait-and-see approach, or to argue that individual nation’s goals are good enough to bring carbon emissions down, because those individual limits are clearly not strong enough.

If the US can propose that G-20 nations submit to an international economic plan for “more balanced growth” to be monitored by the IMF and a peer review process, then we can at least propose an international framework for balanced carbon reductions. Such a framework would not rely on a cap-and-trade scheme that allows the biggest polluters to continue their destructive ways, but would institute a global carbon tax that makes businesses pay the real costs of using dirty forms of energy. The proceeds from the carbon tax would be used to develop and implement cleaner forms of energy production.

The solution is within reach. Someone-in this case, President Obama-needs to step forward and announce a plan. Obama missed his cue when he engaged in hand-shaking and back-slapping at the UN summit instead of laying a serious proposal on the table and asking the rest of the world to make firm commitments to steep reductions. There’s not much time left before the Copenhagen summit, he needs to get busy.

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