Tuesday, September 29, 2009

FDIC Seeks Buffer for Deposit Insurance

The Federal Deposit Insurance Corp. will require banks to prepay premiums that support insurance on depositors’ funds, due to staff projections that bank failure provisions have forced the insurance fund’s reserve ratio into a deficit as of today.

FDIC Chairman Sheila Bair is pictured at right.

But consumer deposits are still protected by cash and marketable securities that can be sold off and those assets "remain positive," FDIC staff reported Tuesday in a Board of Directors meeting.

No banks have failed in Connecticut at this point in the calendar year, according to FDIC records, but slightly under half of the 95 failures that have occurred were spread across California, Illinois and Georgia.

The FDIC insures up to $250,000 per account, but Tuesday was the first time in the organization’s 75-year history that it decided to collect fees early from banks. As of December 30, institutions would have to pay the assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012.

That is the time banks normally would pay insurance premiums only for the third quarter of 2009.

The FDIC projected that the fund will need $100 billion through 2013, an increase from the staff’s May 2009 estimate of $70 billion over the same period. "Projected failures have increased due to further deterioration in the condition of insured institutions, as reflected in the increasing number of problem institutions. Asset quality problems among insured institutions are not expected to abate in the near-term," Arthur Murton, director of the FDIC’s Division of Insurance and Research reported, to the board.

Approximately $25 billion of the $100 billion in projected failure costs already has been incurred this year and the FDIC anticipates that the majority of costs are likely to occur in 2009 and 2010.

The prepaid assessments are expected to bring in about $45 billion from affected institutions.

"We haven’t analyzed it fully yet, and at this point, it is still a proposal. But we understand it is in our interest and the industry’s interest to support the FDIC, and this looks like the best option," said Ed Steadham, vice president of public affairs for Webster Bank in Waterbury.

The FDIC imposed an emergency insurance fee on banks earlier this year which brought in about $5.6 billion. The industry opposed any additional assessments, saying that would likely do more harm than good. Such a move would directly reduce bank income, hinder capital growth, and make lending much more difficult, the American Bankers Association said in a statement.

"The pre-paid assessments represent money that the FDIC expects to receive from banks anyway over the next several years, but having the cash on hand sooner rather than later provides more flexibility for dealing with any contingencies over the foreseeable future. The bottom line is that customer deposits remain safe in banks and the FDIC has the resources needed to meet its responsibilities," ABA Chief Economist James Chessen said.

Matthew Breese, a research associate with the firm Sterne, Agee & Leach, Inc., said that from a liquidity standpoint, institutions will lose a lot of cash and cash equivalents, but on the upside, they will know what to expect, rather than the uncertainty of repeated special assessments going forward.

"We believe it was the FDIC’s best option," Breese said. "During a time when profitability is important to banks and to the economy, you can’t have this big question mark hanging over the industry."

John Carusone, president of the Bank Analysis Center, said banks will have to set up prepaid asset accounts and put capital against them for the next three years. A pay-as-you-go system would be more prudent, he said.

"There’s no assurance for the banks that paying the money upfront is going to relieve them a later burden," Carusone said. "There’s no consensus from Congress on what the new regulatory landscape will look like and we still don’t know the magnitude of future bank losses."

FDIC Chairman Sheila Bair did not rule out another option of tapping into the agency’s $500 billion line of credit with the Treasury Department, if circumstances worsen. "But today is not that day," Bair said.

There will be a 30-day comment period before the policy goes into effect.

Friday, September 25, 2009

We’re in a recession… so why hasn’t the stock market listened?

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

It’s no secret that the U.S. and most of the world has been in a recession since late 2007, although so many people have felt the pain long before it “officially” began. The National Bureau of Economic Research (NBER), a non profit group from Cambridge MA, is the official scorekeeper of recessions and expansions and use various objective and subjective methods to declare the start and finish.

Most analysts keep it simple and use two consecutive quarters of negative gross domestic product (GDP) growth as the line in the sand for recession. The problem here has been that by the time a recession has been triggered, it’s usually close to being over. That was until the tsunami of 2008, which will go down as one of longest economic downturns in history!

So enough with the textbook info, most people want to know why the stock market has rallied so hard in the face of horrific employment numbers and an economy that keeps shrinking. I can give you the easy one line answer and then offer some details.

The simplest reason is that the stock market is one of the greatest discounting mechanisms in the entire financial system. By discounting, I am not talking about something in a retail store that’s offered at 20% off. Rather, the behavior of the stock market today is signaling economic activity three to nine months down the road. In this case, although the reports remained dire in March and April, the stock market rallied because it was snuffing out that things were about to become a lot less worse than they have been. And that would eventually lead to some kind of recovery.

Let me give you some more examples.

In October 2007, the market made its all-time high above 14,000 and then promptly collapsed 16.50% to 11,700 by mid January 2008. During that three month stretch, corporate earnings and economic numbers continued to show good growth, coming in as or better than expected. A significant rally began again in March 2008, following the Bear Stearns rescue and the economic effects of that rally showed up in the June/July period.

Following Lehman’s vaporization in September 2008, the stock market fell off the cliff, losing more than 20% in one week, yet the economic numbers did not severely worsen for three to four months.

My all time favorite example of why you should watch the stock market’s behavior over what news is actually being reported takes us all the way back to 1990 when Iraq invaded Kuwait.

The economy was already showing very early signs of weakening with inflation ticking up and the S&L Crisis becoming front and center. Saddam Hussein was the catalyst that actually pushed it over the edge. Oil spiked to over $40, which at that time was viewed as deeply recessionary. Another $20, it was thought, would throw us into another depression! I guess those analysts wouldn’t still be employed today with that mentality.

Anyway, stocks sold off very hard, losing more than 20%, from July to October 1990, while the economic reports just began to weaken. From that historic bottom in October 1990 with the recession deepening, banks going out of business on a weekly basis and the U.S. about to begin its first war since Vietnam, the stock market took off like a rocket ship, soaring more than 30% by the time the recession was officially declared over in April 1991.

The stock market almost always looks ahead at economic activity three to nine months down the road. If you are basing your investing decisions on the economic or earnings news of the day, you will usually find yourself chasing your tail. Remember, what’s being reported today is already in our rear view mirror. It’s where we’ve been. Imagine driving your car to the supermarket and only looking in that rear view mirror. Not a pretty outcome, right?

The stock market hammered out that historic bottom this past March, not because the landscape was getting better at that time, but because it saw a light at the end of the tunnel three to nine months down the road. Stocks typically begin to rally around the time where the recession is at its worst and the fewest people expect it. It does its best to confound the masses, so as investors, we should always expect the unexpected and look ahead.

If your philosophy has been to wait until the economic reports signal a recession or expansion, you may be making investment decisions at precisely the wrong time. The reasons for the beginning of a bull or bear market are irrelevant. If you must have rational explanations for things, the stock market is a tough place to make money unless you have the unique ability to invest with hindsight.

To quote John Maynard Keyes, “The stock market can stay irrational longer than you can stay solvent”.

Tuesday, September 1, 2009