Cost of IndyMac bailout: Worse than the worst-case scenario

When the federal government seized IndyMac in July, it estimated the failure would cost the FDIC's insurance fund somewhere between $4 billion and $8 billion. Yesterday the FDIC said the cost will be even worse than its previous worst-case-scenario estimate: $8.9 billion. 

That's pretty significant -- banks and thrifts are regulated, they are not supposed to be mysterious; and now we learn the IndyMac failure will be even more expensive than the government's most pessimistic estimate, which was made just six weeks ago.

From this morning's L.A. Times: "That figure increased after the agency, which now runs the bank, performed its own valuation of IndyMac's assets and also discovered that more deposits than initially estimated were covered by insurance, said Diane Ellis, the FDIC's associate director of financial-risk management."

The IndyMac news is contained in a larger story, the FDIC's report that "the number of troubled U.S. banks shot up 30% in just three months."

Analysis: The news flow on banks, bad loans, and the availability of mortgages remains very negative. It is hard to cobble together a case for a stabilizing housing market during a time of continued deterioration in the financial industry. In three words, money is tight. True, it is always darkest just before the dawn, but sometimes it is dark because it is the middle of the night. I think Sheila Bair, the head of the FDIC, is correct: "We don't think this credit cycle's bottomed out yet."

-- Peter Viles
Your thoughts? Comments?
Photo credit: Associated Press

Comments

[Cal]

I bet the real reason was that they optimistically looked at the recovery value (like they could improve it) of the loans in portfolio that were in default. I think Sheila got a lesson that lenders are in fact doing all they can to maximize NPV and her magic "No foreclosure" insta-mod solution isn't going to make things better and in fact make things worse.

[anon1137]

Whenever anyone says money is tight, credit is in short supply, my response is, then why are interest rates so low. No one can answer that. Either credit is not tight or something is seriously broken.

[William E. Jones]

anon1137 - Interest rates are low because the Fed has lowered its interest rates a great deal. What the Fed can't influence is risk perception. There is plenty of money available for people and entities who have very good credit and are judged to be good "risks." However, for the average borrower it is much tougher to qualify, and many people can't qualify at all.

We are living through a phenomenon known as "the repricing of risk." It has yet to run its course.

Much economic activity over the last five years was fueled by easy lending. Those days are largely gone. Money is cheap, but only for those with very very good credit.

[Cal]

anon1137 :"Whenever anyone says money is tight, credit is in short supply, my response is, then why are interest rates so low. No one can answer that. Either credit is not tight or something is seriously broken."

Well credit is definitely contracting at almost every level, credit card, auto loans, student loans, and home loans. "Tight" money is a relative term, tight compared to the boom, absolutely, tight compared to the 70's or late 80's, absolutely not.

Why are interest rates low? 2 reasons, 1) The fed keeping the financial system flush with cheap credit because they aren't worried about inflation, they are worried about DEFLATION and 2) Foreigners buying up American debt keeping interest rates low. This is being done to further their own economic agenda (build their economies based on exports for example).

We are still in the midst of a burst credit bubble, many haven't come to terms that we even had a credit bubble yet and the bust is manifesting itself in different ways than busts before it has due to policy response and economic globalization.

But trying telling someone who can't get a HELOC to 90% of their home value or a college kid who can't get a student loan that his peers a couple years before him had no problem getting that credit is still readily available and they'd look at you like you are mad.

[CM]

A married couple with three children and a living trust can have up to $1 million in insured deposits in one bank split in four accounts: $100K in an individual account for the husband, $100K in an induvidual account for the wife, $200K in a joint account, and $600K in a trust account ($100K per child per owner).

I'm sure that the FDIC assumed that each social security number only had $100K in insurance.

[some investor guy]

"Whenever anyone says money is tight, credit is in short supply, my response is, then why are interest rates so low. No one can answer that"

I can answer that.

There are several parts. First, there is the illusion that credit is tight, because it was remarkably loose from about 2003-2007. People who would have been almost uniformly declined for mortgages were actively solicited and approved. Now, we are getting closer to more traditional lending standards.

Second, a year ago interest rates were about the same, but you could get that interest rate with no money down, not so good credit, and a questionable appraisal. The people borrowing today are much more likely to have 10-20% down, have their job and income actually checked, and get a conservative appraisal from the bank.

What that translates to is banks have put a much higher risk premium on anything they view remotely risky. Much of it, they don't want to lend on at all.

For people with poor credit, no down payment, or who want to buy an overpriced house in a bubble area, credit seems really tight. For people with a lot of money to put down, good credit, and a reasonably priced home they would like to buy, it's not much of a problem.

Tight credit = fewer stupid loans. It doesn't mean higher interest rates for the best risks.

[anonymous]

Those jumbo mortgages are due to reset this spring. The federal governement knows this, too. It's going to be far worse than $8.9 billion. But by then the current administration will be out.

[BC]

"Whenever anyone says money is tight, credit is in short supply, my response is, then why are interest rates so low."

Credit being tight and credit being expensive are two entirely different things.

If rates are 12%, credit is expensive.

If rates are 6%, but there are enormous hurdles to get the loan, credit is tight.

[Nelcisco]

And Jim Cramer sees signs of a turnaround in housing huh!
Deteriorating mortgage industry means deteriorating housing, but we all know that, or do we!

[Laker]

anon1137,
You are correct my friend.
The side effect from the low interest rates is a crazy inflation that is going on now.
We are experiencing an inflation of about 10%. Usually the FED will fight it, but now it has all the reason not to.
1) They need to keep rates low so that most of the resets do not rise.
2) Keep low so that over leveraged loan owners can keep charging on their credit cards.

The problem is that US is not Europe, our unions are not that strong or big and can't shutdown the economy. That is why there is a crazy price inflation but at the same time flat wages or in fact deflation in income as people are losing their jobs...

[tew]

The valuation adjustments are understandable, even if the magnitude is large. However the "...discovered that more deposits than initially estimated were covered by insurance..." part is really disturbing.

That stuff should be available in real time down to the penny. It should flow directly from bank records with little ambiguity.

However, it seems like the FDIC only has estimates of aggregate deposits rather than actual amounts insured. Aweful. And you can bet that banks with outdated IT systems lobbied to keep it this way, so they wouldn't need to implement some simple systems.

[Laker]

CM,
go to FDIC website.
If you have individual account at WAMU with $100,000, and same thing for your wife.
Now if you both have a joint account with $200,000 in it and WAMU fails....(probably in the next 4-6 months)
You will lose $100,000.
Why? Coz according to FDIC, you can have a total of $100,000 per depositor, so both you guys are insured for $200,000. The rest will be paid to you maybe $0.50 on the dollar....As you see FDIC is running low on reserves, i doubt that they would pay more than a $0.01 on the dollar above the insurance limits...
Watch out...

Plus, as Cal said, the crazy fast efforts by sheila to freeze and modify all Indymac loans are very bad. Problem is that when she decides to modify the loan down to what the borrower can pay, she adds the cost that FDIC will need to bring to the table to make indymac whole and sell-able...
If she removes 50% of the principal of a loan of a $1,000,000. That $500,000 will come from the FDIC reserves to fill up the gap.
I can't believe that such simply math is foreign to "experts" like sheila bair....
What a moron is running the FDIC???
I would put shock to run FDIC, and we would be 10 times better.

[Valley Renter]

These losses can only mount as more and more IndyMac customers are encouraged to miss payments so that their loans are reset to 3%. I do not have a very high level of confidence on the competence of FDIC management and in the end it will unfortunately be taxpayers like us bailing out the FDIC.

[Nick]

If only we could send Sheila the bill for the extra $900 million she's cost the taxpayers so far with her personal crusade to give taxpayer money to speculators and crooks. There aren't enough punishments in our legal system to adequately address her actions against the people of the country, but I'd settle for the one for treason.

[Cal]

I wonder if Indymac is taking any additional losses because they chose to give back 50 cents on the dollar to the uninsured depositers.

[larry]

I think the fed can offer IOU checks if they can't pay.
Meanwhile, they can sue Greenspan to recover some money because Greenspan's exuberant jerking actions with interest rates put the housing market into this mess.

[eckalectic]

Another reason why are rates so low? How about a massive flight to safety by big money investors piling into treasuries?

IndyMac will not be the last nor the largest bank to fail. WaMu and Downey depositors take note.

[Tom Eliason]

There is both inflation and deflation in this economy, occurring simultaneously. That tends to obscure the gravity of the situation becaus ethe numbers just get averaged.

Simply put, all staples, raw materials and energy are experiencing a very high rate of inflation. These product/service categories are owned by massive corporate concerns, meaning the big guys are getting richer faster than ever.

Every other category in the economy is actually deflating and rapidly. This includes literally all value-added products and services where most of the middle class finds itself employed. IOW, the areas where we, the people, make a living are rapidly contracting in both volume and price... the areas where fat cats reap their rewards are growing like crazy.

I call it the War on the Middle Class.