Thursday, August 27, 2009

I can fly, I can fly. Oh Crap there's the ground

The FDIC has increased the number of banks on its official watch list of dodgey banks from 300 to 420 not counting the 81 closed so far this year. They admit they are unsure what to do about even more banks that are holding at least one trillion in toxic assets on their books. Technically the banks have until next year to reconcile these losses against their capital requirements. How many institutions are involved is unknown but one trillion dollars in losses would wipeout the entire equity of an awful lot of banks. Waiting for the deadline would crash all these banks at once and that could cause an old fashioned bank panic.

The FDIC’s favorite method for dealing with an insolvent bank is to sell it to another solvent bank. The problem is that they are running out of solvent banks to be the new owners. To deal with this, they have sharply reduced the capital requirements to own a bank in order to attract private equity firms as buyers. Private equity groups are shadowy investment companies that are not required to file reports to the SEC like publicly traded firms do. Much of the mess we are in was driven by their risky practices, most of which used to be illegal. A lot of it still is, except nobody has enforced the law in 30 years. When Foxes with flame-throwers are guarding the hen house, there’s fried chicken for everybody.

This ongoing crisis is no where near peaking as a huge number of adjustable rate loans are yet to reset to interest rates the borrowers will not be able to pay. Then you have millions of unemployed mortgage holders whose middle class jobs are gone for good and are drifting toward default. With half of home loans underwater nobody can sell to avoid foreclosure and as the default rate picks up this will drive prices still lower, putting still more into potential default. You also have a fantastic amount of commercial paper that will soon be determined to be of no value.

This all will continue to drive the cycle of layoffs, bankruptcies, business failures, foreclosures and bank failures. Then repeat the cycle faster and faster. It’s as if everybody is in a decaying orbit, enjoy the view while it lasts. The ground is rushing up to greet us.

Watching the shooting stars at www.prairie2.com

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