Wednesday, August 26, 2009

What a Difference a Quarter Makes

As promised, I wanted to make sure that we didn’t lose the forest for the trees. With today’s meeting of the FDIC (and the wonderful liquidity conundrum that they face in dealing with the 81st bank closure of the year), we now know that private equity firms seeking to buy troubled banks will need to commit to holding assets for at least 3 years and maintain reserve ratios that are greater than the industry wanted. Ironically, the FDIC is in a Catch-22. On the one hand, they desperately need the market to do their job – namely back the Federal guarantee to banks while maintaining their illusion of control. On the other hand, they realize that traditional capital sources know too many of the dirty secrets about credit quality to pay for catching falling bank stars. However, all this FDIC nonsense is a bit of “deck chairs on the Titanic” for a more significant reason. To race to the punch line, the FDIC failed to consider that the reserve capital they want for market evidence of commitment isn't in the market in a staggering number! Read on.

As promised, I wanted to make sure that you all are tracking the upcoming September release of the Federal Reserve’s Flow of Funds Accounts data (slated for release on September 17, 2009). The reasons are myriad but one of the big reasons is buried on Table B.100, lines 24-30 on page 102. If you’d like to, you can turn there with me. If not, you can trust me – like you’ve trusted the Federal Reserve for so many years…

In one reporting quarter – from the 4th Q of 2008 to the 1st Q of 2009, life insurance reserves lost $10 billion. During the same period, pension fund reserves lost $500 billion. If you look back just five quarters, you realize that the losses are even more consequential (comparing year end 2007 with 1st Q 2009 where the losses are $31.7 billion and $3.47 trillion, respectively). Now some of you still don’t get why these numbers matter but let me connect some dots for you.

Life insurers remain one of the major contributors to credit enhancement leveraging their reserves for credit guarantees at 15-20 times their face value. So, when you lose $31.7 billion in life insurance reserves, you are really losing enhancement value of $475 billion in credit guarantees which in turn erodes the investment grade of credits totaling up to $5.7 trillion in extended credit. Add to that the real loss from pensions of $3.47 trillion and you realize that patient capital in the amount of $9.17 trillion in investment grade (and reserve qualified) money has vanished from the system. Taken together, and concerning ourselves not one iota about other losses in the system, we have an interesting test of true “market recovery” looming on the horizon – namely, will we have investment grade assets for reserves to support debt markets in growing or shrinking numbers on September 17. In short, the FDIC is counting on a theoretical asset reserve that has ceased to exist and is evaporating at a record rate.

Now, please remember, trained propaganda artists still want you to put your money in the NYSE casino so that they can take it before the next “correction” – which is a euphemism for money that you mistakenly thought was “yours” which was really “theirs”. However, if you look at the fundamentals of what it would take to get a healthy system – using the Federal Reserve’s definition of healthy (which you should know I question on many levels) – we would need to see this vector change. For the record, I am making the audacious prediction that the green shoots are poison ivy and we’re going to develop a serious itch on or around the 17th of September when we find out that we’ve been weaving garlands of green with a seriously flawed botanical awareness. Let’s see.



  1. So, if you are the FDIC, how do you prepare for this disaster? Doesn't this have to begin to play out like a Prisoner's Dilemma? Specifically, who will start pointing fingers at whom and when will it all "publically" or "officially" begin?

  2. I think that the "official" response started today when Sheila had the audacity to look at the American people and say that no has or will ever lose any dollar guaranteed by the FDIC. If history has been a teacher at all, we realize that this statement is made just before the collapse. Ironically, letting the FDIC run out of money (which they've already done as I've previously reported) allows for an interesting reversal of the independence they were supposed to have. And, as I've said here before, PBGC will be here as well soon.

  3. I am frustrated by the lack of reportage by the press on these many issues raised here (and elsewhere on other blogs). Several years ago, Lester Thurow wrote in his book THE FUTURE OF CAPITALISM that the press would never be politicized, essentially because financial forces would not allow/permit it (my paraphrase). I emailed him and disagreed. To my surprise he responded but maintained his position. I cannot understand their lack of response now except for politicization. Surely, it cannot be ignorance. What am I missing or overlooking?

  4. I too saw her “official” response and chuckled. It took me back to when Bernanke assured everyone that subprime was “contained.” I eagerly await your next post, David.

  5. Finally, the WSJ:

    David, thanks again for your clear insight...


Thank you for your comment. I look forward to considering this in the expanding dialogue. Dave