Indymac Death Watch: Comment from Reader Steve on Regulatory Intervention

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We haven’t been covering the spectacle of Indymac twisting in the wind, since highly-regarded blogs like Calculated Risk and Housing Wire follow the mortgage lenders closely.

However, the panic yesterday about Fannie and Freddie perhaps having to come up as much aswith $75 billion in equity ($75 billion?) diverted attention from what on any other day would likely have been the top story: the grim announcements by Indymac, briefly in possession of the dubious status of being America’s biggest independent mortgage lender.

The Wall Street Journal has a decent story, but its press release was bleak. While the bank is stopping virtually all new mortgage lending and ‘fesses up that it does not expect to be able to raise new capital unless the environment improves, the most serious admission is:

In light of the current environment and related deterioration of our financial position since last quarter, we have been working closely with our federal banking regulators with respect to the actions that they and we must take to meet our mutual goal of keeping Indymac safe and sound through this crisis period. In that respect, based on information we have provided to our regulators, they have advised us that we are no longer “well capitalized”, which we stated on May 12 was a possible scenario. Our regulators have also asked us to submit to them a new business plan for their review and approval, something on which we have been working with them for some time. We have agreed on the basic elements of the plan, and the regulators have directed us to begin executing on it. An important element of our plan is to improve our capital ratios. Without an external capital raise, the traditional way to improve safety and soundness is to sell assets and shrink the balance sheet, which in normal times generally has the effect of improving capital ratios and bolstering liquidity. Yet in this environment, where either there are no bids for most of IMB’s mortgage loans and securities or the bid/ask spreads are abnormally wide, “fire-selling” assets would actually deplete capital further. As a result, the most realistic and cost-effective way to shrink both our balance sheet and our servicing rights asset (which, as discussed in previous communications, is up against the regulatory cap limit), is to curtail most new loan production.

In addition to needing to shrink our assets to improve our capital ratios, we also need to do so to ensure that we maintain prudent operating liquidity. A consequence of falling below well-capitalized is that we are no longer permitted to accept new brokered deposits or renew or roll over existing ones, unless we get a waiver from the FDIC. While we have submitted a waiver application, it is uncertain as to whether such a waiver will be granted.

Reader Steve e-mailed some insightful comments:

For anyone who’s remained in denial, this press release paints a clear picture of the severity of the credit crisis: Indymac can’t raise needed capital, and can only sell off assets at a loss. Part of this story is specific to Indymac, but the problem of capital starvation and deflating assets is a general condition. Evidently the regulators can’t find a buyer for Indymac, and are shrinking it as a prelude to nationalization.

What’s interesting is how they are shrinking it. The prohibition on opening or rolling brokered deposits is an obvious thing to do, but forcing Indymac out of the non-GSE mortgage business is not. The problem for FDIC is that non-GSE mortgages wind up getting pledged to FHLB, and as a secured creditor with an over-collateralized position, FHLB borrowings must be paid off by FDIC if the bank becomes insolvent. This is a large cash flow hit to the insurance fund (over $10B or 1/5 of the Fund in the case of Indymac), but the obligation of FDIC as Receiver to marshall the assets of the estate leaves no discretion for over-collateralized borrowings. The Board of the FDIC made some public comments about this problem a few months ago. FDIC has no access to the Fed to liquify and park a FHLB portfolio. In a bridge bank scenario, the FHLB borrowings remain in place, but FDIC is still obligated to provide a combination of capital and guarantees against loss sufficient to launch a new, well-capitalized institution (perhaps in partnership with private capital)–also a large figure, and the main driver behind Fed/FDIC’s push to modify the bank holding company regulations to allow in more unregulated capital.

My view is that the regulators have adopted a go-slow program in order to kick these problems over to the next administration. The obvious danger to this stratagem is a deposit run requiring intervention. The less obvious danger is that the over-hang of impaired but not written down assets may further depress prices.

When Northern Rock blew up, invidious comparisons were made in the British press between the US system of deposit insurance and the hodge-podge of miniscule deposit guarantees and vague regulatory responsibilities in the UK. We’ll see how the US system holds up in a systemic crisis that has reached large institutions that aren’t `too big to fail’, but have combined liabilities many times larger than the Insurance Fund. FDIC could fall back on Treasury for additional emergency funds, but that’s precisely what the current—and no doubt next—administrations want to avoid at all costs.

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  1. Anonymous

    The shoe hasn’t dropped yet on this one as the bust was only announced last night. I’d expect to see a bit more prominence — and a few more articles — today. By the end of the week it should be clear how it will play out with depositors.

    Basically, Senator Schumer did the depositors a service by blowing the cover off of this one early and his critics should probably be barred from public service,tarred, feathered, and run out of town on a rail.

  2. Anonymous

    Northern Rock is a great example of behind the scenes stupidity and foot—dragging! This drawn out process of non-regulation and denial feeds into a cycle of non-confidence and corruption.

  3. Dan Duncan

    It’s too bad Milberg, Weiss is in the midst of its “difficulties”.
    Recent investors in Fannie Mae and Freddie Mac might just have a case….

    Wasn’t it just a few weeks ago that we had a massive rally on the basis Fannie and Freddie would be freed from their loan caps? I remember this rally vividly…15 minutes after the close, and Maria’s on CNBC in one of her post-coital rally recaps. Her hair has a reconstituted look, as if Maria’s make-up artist had to play humpty dumpty and “put it back together again”. She looks into the camera, and her eyes twinkle with blissful satisfaction, and she says, “Fannie and Freddie lead the charge on Wall Street today. Their shares surge 20%!”
    I swear, she couldn’t even wait for the camera to cut away before she takes a contented drag from a cigarette.

    So let’s see….

    The government has a real interest in Fan and Fred.

    Fan and Fred have had questionable books for years.

    In the midst of this conflagration, Fan and Fred, with their sketchy books aren’t held in check as part of the problem. Rather, they are given a firehose connected to The Petroleum Reserve in the form of “No Loan Caps!”. This development is cheered with an unprecedented rally in their share prices.

    A few weeks later, in a state of befuddled confusion, a major investment bank states that the housing crisis “continues”. This “continuation”—something so patently obvious—is met with surprise…because…”housing troubles are bad for Fan and Fred”.

    Shares plummet.

    I realize much of the initial rally was short covering. I realize that it was foolish to buy Fan and Fred on the basis of the No Caps announcement.

    Nevertheless, this stinks. The WSJ, etc., who are confused about the disconnect between debt and equity markets need only look to the price action of these companies. Equity holders, aka Main Street, are in Denial…until they’re not…and then they get slaughtered.

    It just isn’t right….

    Of course, in this twisted environment, if Milberg Weiss was to get involved, it would bribe the governemnt to hire Milberg as the government attorney in a major tort action against investors who were foolish enough to pump up Fan and Freds’ stock and the “gall” not hold onto it in the face of 100% dilution.

  4. Richard Kline

    Sheol, that press release by Indymac plays like the first four bars of “Nearer My God to Thee.” We knew they were dead men talking, but still. I do not doubt for a second that regulators are trying desperately to spackle and paste until after the November elections, not least because the Treasury is most certainly going to have to stand behind FDIC in the course of this all and the present zero value added Administration just isn’t up to it.

    I read that number on Fannie and Freddie in the NYT, and my reaction was exactly the same: _$75M_?? Where is that coming from, and more to the point are there that many fools with sufficient doug left in the Oblong Enclosure? Again, Big Gubmint is going to have to pay for the wedding, here. Which is all the more reason why harebrained and futile financial pity parties for mortgage holders just aren’t affordable: we need what scratch we’ve got to save the institutions which make mortgage lending and depository banking work for the country as a whole.

    Equity holders have been in denial for a YEAR. If they _weren’t_ in denial, they wouldn’t still be equity holders, so their standing is diagnostic of their thinking. And they are going to stay in denial until something other than H2O comes out of the showerheads. Along about the back end of November . . . . It is indeed a pity that the probable next President of the USA ‘believes in markets’ so he’ll waste his first two years in office doing more of all the wrong things, most likely. Leaders: Where are they when you really need them?

  5. Anonymous

    So indymac is too big to fail. It would cause too much of a drain on the FDIC at the moment. So the government has to “prune” Indymac down to a size it can handle. In the mean time indymac shares at 40 cents? Beats the heck out of shooting craps in Vegas, because with the momentary reprieve, you never know what may happen.

  6. Anonymous

    “[Paying off FHLB borrowings would be] a large cash flow hit to the insurance fund (over $10B or 1/5 of the Fund in the case of Indymac).” — Reader Steve

    So, obviously, the FDIC itself is undercapitalized.

    Since 1994, when Magoo essentially abolished reserve requirements by allowing overnight sweeps, the overall thrust of policy has been to centralize risk in government institutions.

    Centralizing risk is bad enough. But having inadequate capital levels at the central guarantors (FDIC, Federal Reserve; not to mention Fannie and Freddie) is inexcusable.

    The gods are not insane; but they throw dice like fools. Oh, no — NIGHTMARE ROLL!

  7. Anonymous

    because of the inability of the fdic to fund the cash flow hit; they will have to bridge it. thus, the fhlb advance will stay in place (as additional guarantees will be provided to the FHLLB of SF. btw, this will be the largest failure since continental illinois.

    there are few potential buyers for this dump. the fdic will have to write a large check to plug the hole after the asset mark when a transfer is made to a buyer. also, they will look to keep as many assets in the hands of the buyer, but the fdic will retain a very large first loss position. the buyer will receive incentives to maximize value during the workout (think of the ncnb deal with the fdic for first republic).

    while the fdic will try to limit the cash flow hit; there still is a signifcant accounting issue with the loss estimate. the loss estimate will have to be deducted from the $52b fund. as reader steve says, this loss estimate could take out 20% or more of the fund.

    there are other similar thrifts that are next in the cue — bankunited, downey, and first federal. combine these with indymac and there goes more than half of the fund. then there will be all kind of games to keep wamu standing as they would exhaust anything left in the insurance fund. just think, this is without a major commercial bank failure (up to $100b in assets — anybody above is TBTF).

    the insurance fund already stands at $1.19 for every $100 of deposits. the minimum is $1.15; so the industry is going to have pony up some major dollars to recapitalize the fund.

    the games on indymac are interesting. notice how the ots issued the less than well capitalized letter after quarter-end. hence, indymac will not be in the problem bank statistics for 2008q2 and the higher deposit insurance assessment is delayed. seriously, what did the ots learn in teh past week that it did not already know at the end of the second quarter? also, all of senator schumer haters, especially teh director of the ots, need to crawl back in their holes.

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