A Second Casualty

Back on March 17th, 2008, I reported in this blog about the first casualty of the Great Depression of this century. That report was about the imminent collapse and subsequent bailout of Bear Stearns, one of America's longest tenured investment banks. At that time, I mentioned that this would only be the first of many bank failures. Today, we will look at the second casualty - IndyMac, a California based bank that closed its doors on Friday.

The following are excerpts from an article by James Turk, founder of www.GoldMoney.com.

America's Second Biggest Bank Failure

Late Friday afternoon (July 11th) federal regulators swooped in on California-based IndyMac Bank and closed its doors. With $32 billion in assets, it is according to The Los Angeles Times the second largest bank failure in US history. IndyMac will re-open its doors on Monday morning as a ward of the FDIC.

Some background will be helpful to put this bank failure into perspective. IndyMac is ground-zero of the sub-prime crisis and the poster-child of imprudent lending. Founded in 1985 by Countrywide Bank, whose own recent failure was masked by its acquisition by Bank of America, IndyMac pioneered the issuance of so-called Alt-A mortgages to borrowers who do not fully document their income or assets, which typically means borrowers with blemished credit histories or real estate speculators looking to 'flip' houses during the bubble years. Alt-A mortgages were considered to be less risky than the subprime loans which started the current financial crisis last year, so IndyMac's plight may cause everyone to re-think that credit quality fairy tale.

IndyMac sold most of the loans it originated, but it also drank its own poison by holding some of these loans on its books, which is the important point. The liquidation value of IndyMac's assets may be instructive to help us understand what lies ahead for the unfolding financial crisis. By applying IndyMac's experience to the value of the questionable mortgage assets still within the global banking system, we can begin to understand the scope and magnitude of the problem.

IndyMac's $32 billion in assets are funded by $19 billion of deposits, with funding for the $13 billion balance having been provided primarily by debt and a little equity. About $1 billion of deposits are above the insured limit, so the FDIC is insuring about $18 billion of deposits, but here is the interesting - and scary - stuff. The FDIC press release states: "Based on preliminary analysis, the estimated cost of the resolution to the Deposit Insurance Fund is between $4 and $8 billion."

Think about this statement for a moment. After liquidating the bank's assets, not only will IndyMac shareholders and holders of IndyMac debt be wiped out, the FDIC's insurance fund will still take a "$4 and $8 billion" hit so that the $18 billion of insured deposits in IndyMac are made whole. So let's do a little math here.

After liquidating $32 billion in assets, the FDIC still has to add some $4 billion to $8 billion more to make sure $18 billion of deposits are made whole. So in the worst case scenario, the liquidation value of IndyMac's $32 billion of assets is $10 billion, or in other words, the true market value of IndyMac's assets is only 31% of their stated book value. In the FDIC's best case scenario, the liquidation value of IndyMac's $32 billion of assets is $14 billion, which is still only 44% of their stated book value.

So here is the all-important question. Can we infer from this liquidation analysis of IndyMac that the true value of sub-prime and Alt-A mortgage debt still in the banking system is something less than 50% of stated book value?

Tomorrow, we will continue with James Turk's article and look into the question as to why the liquidation value is less than 50% of the stated book value.

This may come as a shock to some people, but I have been reporting for many months about the dangers and irresponsible repercussions of fractional reserve banking. (Check out the History of Money series beginning January 28th, 2008 in this blog.) You can not continue to create money from nothing and have it last forever. There will be consequences, sooner or later. As far as the government is concerned, as long as they are not the ones picking up the check when the bill comes, everything is 'business as usual'.

By the way, the FDIC is another one of those quasi governmental corporations that is really not part of the government (like the IRS and the Federal Reserve Bank). There will be more about this as well later this week.

It will be a very interesting week. Stay tuned ...

Hear this, you who trample the needy
and do away with the poor of the land,

saying,
"When will the New Moon be over
that we may sell grain,
and the Sabbath be ended
that we may market wheat?"—
skimping the measure,
boosting the price
and cheating with dishonest scales,

buying the poor with silver
and the needy for a pair of sandals,
selling even the sweepings with the wheat.

The LORD has sworn by the Pride of Jacob: "I will never forget anything they have done. Amos 8:4-7 (NIV)

If you have comments or questions, please feel free to contact me at the address below.
Email: DeltaInspire@panama-vo.com