Banks

U.S. May See 150-200 More Bank Failures

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US May See 150-200 More Bank Failures: Bove

Reuters
| 24 Aug 2009 | 01:07 PM ET

A prominent banking analyst said Sunday that 150 to 200 more U.S. banks will fail in the current banking crisis, and the industry’s payments to keep the Federal Deposit Insurance Corp afloat could eat up 25 percent of pretax income in 2010.

Richard Bove of Rochdale Securities said this will likely force the FDIC, which insures deposits, to turn increasingly to non-U.S. banks and private equity funds to shore up the banking system.

“The difficulty at the moment is finding enough healthy banks to buy the failing banks,” Bove wrote.

The FDIC is expected on August 26 to vote on relaxed guidelines for private equity firms to invest in failed banks, after critics said previously proposed rules were too harsh and would actually dissuade firms from making investments.

Bove said “perhaps another 150 to 200 banks will fail,” on top of 81 so far in 2009, adding stress to the FDIC’s deposit insurance fund.

Three large failures this year — BankUnited Financial in May, and Colonial BancGroup, Guaranty Financial Group in August — collectively cost the fund roughly $10.7 billion.

The fund had $13 billion at the end of March.

Regulators closed Guaranty’s banking unit on Friday and sold assets of the Texas-based lender to Banco Bilbao Vizcaya Argentaria. The FDIC agreed to share in losses with the Spanish bank.

Bove said the FDIC will likely levy special assessments against banks in the fourth quarter of this year and second quarter of 2010.

He said these assessments could total $11 billion in 2010, on top of the same amount of regular assessments. “FDIC premiums could be 25 percent of the industry’s pretax income,” he wrote.

Big U.S. Banks Will Soon Disappear

AMERICAN EXPRESS, American International Group, Bank of america, Banks, Citigroup, Economy, FIFTH THIRD BANCORP, Goldman Sachs, JPMORGAN CHASE, METLIFE, Morgan Stanley, STRESS TESTS, US BANCORP, WELLS FARGO

Big US Banks May Be Headed For Extinction—And Soon

CNBC

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Posted By: Albert Bozzo | Senior Features Editor
CNBC.com
| 08 May 2009 | 02:30 PM ET

In the world of banking, too-big-to-fail may be in the process of morphing into too-big-to-exist.

After hundreds of billions in federal aid and even more in lost investment capital, both the government and investors may be ready for a big sea change.

The only question, for some, is how quickly it will happen.

“In the next few months, we’ll see the tacitly nationalized banks—Bank of America, Citigroup —sold off rapidly into pieces, turned into much smaller banks,” Sanders Morris Harris Group Chairman George Ball predicted on CNBC Thursday, adding the government wants to send a strong message, to “punish too-big-to-fail banks that have blotted their copy and not exonerate their management.”

“Five years from now, these banks will be broken up,” is how FBR Capital Markets bank analyst Paul J Miller sees it.

From Washington to Wall Street to Main Street, a dramatic change in conventional thinking appears to underway.

“Some institutions are too big to exist, because they are too interconnected,” Sen. Richard Shelby (R-Ala.) told CNBC earlier this week. “The regulators can’t regulate them.”

That conclusion became painfully obvious in the two faces of the financial crisis.

On one side, the federal government had to provide billions in aid —and on more than one occasion—to the likes of to Bank of America , Citigroup and the giant insurer AIG , which has its own lending unit, to prop them up.

On the other side, the failure of Lehman Brothers—which might have been averted with federal intervention—reverberated throughout the global economy.

Months later, the Obama administration and Congress now appear keenly focused on the dilemma and are expected to create legislation that will empower regulators to intervene in the affairs of big financial institutions and essentially wind down their operations in an orderly fashion with limited collateral damage to the economy. Such authority would also apply to investment banks tirned bank holding companies, such as Goldman Sachs .

“They need it and they’ll get it,” said Robert Glauber, who was a top Treasury official during the government rescue of the savings and loan industry two decades ago.

Regulatory reform is also likely to include new antitrust authority to block mega-mergers creating financial firms whose problems could adversely affect the overall system. Analysts say, if that’s the case, the government won’t want the too-big-to-fail companies of the past essentially hanging around.

Exactly how the government does that is unclear, but experts say there are ways without resorting to a heavy-handed approach such as nationalization.

“If once there is some kind of coherent policy toward systemic risk, whomever is managing that policy can start to make life difficult for an entity that is too big to fail,” says former S&L regulator and White House economist Lawrence White, at NYU’s Stern School of Business. “It wouldn’t upset if they were providing subtle nudges.

“The Fed doesn’t want them that big and might make them hold more capital,” suggests Miller.

Some speculate that any further government aid to certain firms might come with such strings attached.

Others say a fresh look at regulation will help the process and unveil the complex, diverse and, at times, incompatible operations of the bank holding companies and their commercial bank subsidiaries.

“They can’t assess the risks of the big banks,” says Frank Sorrentino, Chairman and CEO of North Jersey Community Bank, which recently acquired a failing bank in a transaction assisted by federal regulators at the FDIC.

Risk, or a disregard of risk, may also have factored into the decision-making of big bank executives, who assumed the too-big-to-fail doctrine would catch them if they fell, which the bailouts obviously did.

Small banks clearly have a financial interest in seeing the end of the big bank era, but that alone doesn’t undercut their arguments. In some cases it may be good for business, consumers and the overall marketplace.

“It’s an appealing idea to our clients because it will make them more competitive,” says Robert C. Schwartz, a partner at Smith, Gambrell & Russell, which represents big and small banks in the Southeast. “Changes may leave gaps for the regional banks and the community banks.”

“If the government does the right thing, it will be the private sector that forces these companies to do what they need to do for the benefit of their shareholders,” says Sorrentino, whose bank has $400 million in assets. (By contrasts, the 19 firms involved in the government’s recently completed stress tests have assets of $100-billion or more.)

Investors have clearly been focused on shrinking earnings and stock prices and what some consider diminished prospects for the future, even with a positive resolution to the financial crisis.

“I also think investors are going to realize that they’ll be low-single digit growth rates,” says Miller

Some analysts say recent events highlight a fundamental problem that has been somewhat ignored for years; the financial supermarket structure of the big institutions makes them difficult, if not, impossible to operate with great success.

“Investors will say,That business unit hidden in there; let’s spin that off,” says Sorrentino. “Either the regulators are going to force it or the shareholders are going force it.”

Canadian Banks Avoided Mortgage Meltdown

Banks, Canada, Federal Reserve, Mortgage Backed Securities, Subprime Lending, TD Bank

CBS News

Bankers Eschewed Subprime Loans, Mortgage Securities; The Result — No Bank Failures

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Two more U.S. banks were taken over by the government overnight. And while a number of this country’s biggest banks reported improving conditions this week, some of their accounting methods have been questioned.

One place where none of this banking drama is taking place is Canada, as CBS Evening News weekend anchor Jeff Glor reports.

Ed Clark is a plainspoken, polite and prudent Canadian bank CEO with a few simple rules: “We should never do things for our customers and clients that we don’t actually understand. If you wouldn’t put your mother-in-law in this, don’t put our clients in it.”

You may never have heard of Clark or Toronto Dominion bank (aka TD Bank), but it’s the sixth-largest bank in North America – and, in the middle of a global banking crisis, a profitable one at that.

“We will make more money in this quarter than any bank in North America,” Clark said. “So for a little Canadian bank sitting up here, yeah that feels pretty good.”

How did that come to pass?

“Basically, because we didn’t do the things that blew other banks up,” Clark said.

And neither did TD Banks’s Canadian brethren. In the last quarter of 2008, all of Canada’s major banks were profitable, collectively making $2.5 billion during a period when U.S. banks lost more than $26 billion.

In fact, since the financial crisis began, American taxpayers have provided more than $300 billion dollars to more than 450 companies. During that same period, from their government, Canadian banks have not received one penny.

One reason: Take those infamous subprime mortgages given to risky homebuyers. They crippled banks in the U.S., where at peak, 25 percent of loans were subprime. In Canada? Three percent.

“Our U.S. subsidiaries did not do any subprime lending. Nothing. Zero,” Clark said. “We just said, ‘Stay away from this stuff. We know where this is going.'”

Another villain in the financial crisis were toxic mortgage-backed securities – risky loans that were chopped up and resold in countless different ways. Many banks gobbled up the now virtually worthless investments. Ed Clark got out 4 years ago saying they were just too complex.

Clark: “As soon as you see that complexity, you say, ‘How can I possibly think I actually can guess whether this will work or not?’ And as soon as I hear that, I say, ‘Get out of it.'”

Sherry Cooper spent years at the Fed overseeing Wall Street, before moving to Bay Street, the Canadian equivalent.

“It didn’t take long for me to discover that this is an entirely different culture,” said Cooper, chief economist at the Bank of Montreal. “Canadian banks were up to their ankles in the toxic muck whereas American banks were over there heads.”

“A lot of this is about saying, ‘Here are old banking rules, and we’re prepared to give up short term profit in order to make sure we have a balance sheet that doesn’t blow up on us,'” Clark said.

One reason why Canada is the only industrialized nation in the world without a single bank failure in the current economic downturn.

Government Bailout Hits $8.5 trillion

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Kathleen Pender

The San Francisco Chronicle

November 26, 2008

The federal government committed an additional $800 billion to two new loan programs on Tuesday, bringing its cumulative commitment to financial rescue initiatives to a staggering $8.5 trillion, according to Bloomberg News.

That sum represents almost 60 percent of the nation’s estimated gross domestic product.

Given the unprecedented size and complexity of these programs and the fact that many have never been tried before, it’s impossible to predict how much they will cost taxpayers. The final cost won’t be known for many years.

The money has been committed to a wide array of programs, including loans and loan guarantees, asset purchases, equity investments in financial companies, tax breaks for banks, help for struggling homeowners and a currency stabilization fund.

Most of the money, about $5.5 trillion, comes from the Federal Reserve, which as an independent entity does not need congressional approval to lend money to banks or, in “unusual and exigent circumstances,” to other financial institutions.

To stimulate lending, the Fed said on Tuesday it will purchase up to $600 billion in mortgage debt issued or backed by Fannie Mae, Freddie Mac and government housing agencies. It also will lend up to $200 billion to holders of securities backed by consumer and small-business loans. All but $20 billion of that $800 billion represents new commitments, a Fed spokeswoman said.

About $1.1 trillion of the $8.5 trillion is coming from the Treasury Department, including $700 billion approved by Congress in dramatic fashion under the Troubled Asset Relief Program.

The rest of the commitments are coming from the Federal Deposit Insurance Corp. and the Federal Housing Administration.

Only about $3.2 trillion of the $8.5 trillion has been tapped so far, according to Bloomberg. Some of it might never be.

Relatively little of the money represents direct outlays of cash with no strings attached, such as the $168 billion in stimulus checks mailed last spring.

Where it’s going

Most of the money is going into loans or loan guarantees, asset purchases or stock investments on which the government could see some return.

“If the economy were to miraculously recover, the taxpayer could make money. That’s not my best guess or even a likely scenario,” but it’s not inconceivable, says Anil Kashyap, a professor at the University of Chicago’s Booth School of Business.

The risk/reward ratio for taxpayers varies greatly from program to program.

For example, the first deal the government made when it bailed out insurance giant AIG had little risk and a lot of potential upside for taxpayers, Kashyap said. “Then it turned out the situation (at AIG) was worse than realized, and the terms were so brutal (to AIG) that we had to renegotiate. Now we have given them a lot more credit on more generous terms.”

Kashyap says the worst deal for taxpayers could be the Citigroup deal announced late Sunday. The government agreed to buy an additional $20 billion in preferred stock and absorb up to $249 billion in losses on troubled assets owned by Citi.

Given that Citigroup’s entire market value on Friday was $20.5 billion, “instead of taking that $20 billion in preferred shares we could have bought the company,” he says.

It’s hard to say how much the overall rescue attempt will add to the annual deficit or the national debt because the government accounts for each program differently.

If the Treasury borrows money to finance a program, that money adds to the federal debt and must eventually be paid off, with interest, says Diane Lim Rogers, chief economist with the Concord Coalition, a nonpartisan group that aims to eliminate federal deficits.

The federal debt held by the public has risen to $6.4 trillion from $5.5 trillion at the end of August. (Total debt, including that owed to Social Security and other government agencies, stands at more than $10 trillion.)

However, a $1 billion increase in the federal debt does not necessarily increase the annual budget deficit by $1 billion because it is expected to be repaid over time, Rogers said.

Annual deficit

A deficit arises when the government’s expenditures exceed its revenues in a particular year. Some estimate that the federal deficit will exceed $1 trillion this fiscal year as a result of the economic slowdown and efforts to revive it.

The Fed’s activities to shore up the financial system do not show up directly on the federal budget, although they can have an impact. The Fed lends money from its own balance sheet or by essentially creating new money. It has been doing both this year.

The problem is, “if you print money all the time, the money becomes worth less,” Rogers says. This usually leads to higher inflation and higher interest rates. The value of the dollar also falls because foreign investors become less willing to invest in the United States.

Today, interest rates are relatively low and the dollar has been mostly strengthening this year because U.S. Treasury securities “are still for the moment a very safe thing to be investing in because the financial market is so unstable,” Rogers said. “Once we stabilize the stock market, people will not be so enamored of clutching onto Treasurys.”

At that point, interest rates and inflation will rise. Increased borrowing by the Treasury will also put upward pressure on interest rates.

Deflation a big concern

Today, however, the Fed is more worried about deflation than inflation and is willing to flood the market with money if necessary to prevent an economic collapse.

Federal Reserve Chairman Ben Bernanke “has ordered the helicopters to get ready,” said Axel Merk, president of Merk Investments. “The helicopters are hovering and the first cash is making it through the seams. Soon, a door may be opened.”

Rogers says her biggest fear is not hyperinflation and the social unrest it could unleash. “I’m more worried about a lot of federal dollars being committed and not having much to show for it. My worst fear is we are leaving our children with a huge debt burden and not much left to pay it back.”

Economic rescue

Key dates in the federal government’s campaign to alleviate the economic crisis.

March 11: The Federal Reserve announces a rescue package to provide up to $200 billion in loans to banks and investment houses and let them put up risky mortgage-backed securities as collateral.

March 16: The Fed provides a $29 billion loan to JPMorgan Chase & Co. as part of its purchase of investment bank Bear Stearns.

July 30: President Bush signs a housing bill including $300 billion in new loan authority for the government to back cheaper mortgages for troubled homeowners.

Sept. 7: The Treasury takes over mortgage giants Fannie Mae and Freddie Mac, putting them into a conservatorship and pledging up to $200 billion to back their assets.

Sept. 16: The Fed injects $85 billion into the failing American International Group, one of the world’s largest insurance companies.

Sept. 16: The Fed pumps $70 billion more into the nation’s financial system to help ease credit stresses.

Sept. 19: The Treasury temporarily guarantees money market funds against losses up to $50 billion.

Oct. 3: President Bush signs the $700 billion economic bailout package. Treasury Secretary Henry Paulson says the money will be used to buy distressed mortgage-related securities from banks.

Oct. 6: The Fed increases a short-term loan program, saying it is boosting short-term lending to banks to $150 billion.

Oct. 7: The Fed says it will start buying unsecured short-term debt from companies, and says that up to $1.3 trillion of the debt may qualify for the program.

Oct. 8: The Fed agrees to lend AIG $37.8 billion more, bringing total to about $123 billion.

Oct. 14: The Treasury says it will use $250 billion of the $700 billion bailout to inject capital into the banks, with $125 billion provided to nine of the largest.

Oct. 14: The FDIC says it will temporarily guarantee up to a total of $1.4 trillion in loans between banks.

Oct. 21: The Fed says it will provide up to $540 billion in financing to provide liquidity for money market mutual funds.

Nov. 10: The Treasury and Fed replace the two loans provided to AIG with a $150 billion aid package that includes an infusion of $40 billion from the government’s bailout fund.

Nov. 12: Paulson says the government will not buy distressed mortgage-related assets, but instead will concentrate on injecting capital into banks.

Nov. 17: Treasury says it has provided $33.6 billion in capital to another 21 banks. So far, the government has invested $158.6 billion in 30 banks.

Sunday: The Treasury says it will invest $20 billion in Citigroup Inc., on top of $25 billion provided Oct. 14. The Treasury, Fed and FDIC also pledge to backstop large losses Citigroup might absorb on $306 billion in real estate-related assets.

Tuesday: The Fed says it will purchase up to $600 billion more in mortgage-related assets and will lend up to $200 billion to the holders of securities backed by various types of consumer loans.

Source: Associated Press

Net Worth runs Tuesdays, Thursdays and Sundays. E-mail Kathleen Pender at kpender@sfchronicle.com.


Merrill Lynch Made 700 People Millionaires in 3.6 Billion Dollar Bonus Spree

AIG, Banks, Merrill, Stimulus Bill, Wall Street Bonuses

Merrill bonuses made 696 millionaires: probe

02/12/2009 @ 8:28 am

Agence France-Presse

via RAW STORY

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WASHINGTON (AFP) – Merrill Lynch quietly paid out at least one million dollars bonus each to about 700 top executive even when the investment house was bleeding with losses last year, a probe has revealed.

They were part of 3.6 billion dollars in the firm’s bonus payments in December before the announcement of its fourth quarterly losses and takeover by Bank of America, the investigation by the New York state Attorney General’s office showed.

“696 individuals received bonuses of one million dollars or more,” New York Attorney General Andrew Cuomo said of the Merrill scandal in a letter to a lawmaker heading the House of Representatives financial services committee.

Cuomo said “these payments and their curious timing raise serious questions as to whether the Merrill Lynch and Bank of America boards of directors were derelict in their duties and violated their fiduciary obligations,” according to a copy of the letter.

Bank of America said recently it was aware of the amounts and timing of the bonuses even though previous reports had suggested the top bank was surprised by the payout.

Cuomo said in his letter to Democratic lawmaker Barney Frank that his office was also examining whether senior officials at both companies “violated their own fiduciary obligations to shareholders.

“If they did, this raises additional serious issues with regard to the inappropriate use of taxpayer funds,” he said.

“Merrill Lynch’s decision to secretly and prematurely award approximately 3.6 billion dollars in bonuses, and Bank of America’s apparent complicity in it, raise serious and disturbing questions,” he said.

Shareholders and experts had expressed concern over Merrill’s 15.3 billion fourth-quarter loss, which caused Bank of America to request a second round of government bailout on January 16.

Bank of America’s shareholders voted to approve Merrill’s takeover on December 5.

Former Merrill Lynch chief executive John Thain, Bank of America chief administrative officer J. Steele Alphin and other top executives have been summoned to provide testimony in the probe.

“One disturbing question that must be answered is whether Merrill Lynch and Bank of America timed the bonuses in such a way as to force taxpayers to pay for them through the deal funding,” Cuomo said.

Cuomo said the Merrill Lynch bonus payment was “nothing short of staggering.”

While more than 39,000 Merrill employees received bonuses from the pool, the vast majority of these funds were “disproportionately distributed to a small number of individuals.”

“Indeed, Merrill chose to make millionaires out of a select group of 700 employees.”

Experts Are Bewitched, Bewildered and Befuddled By The Economy

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Economy in Turmoil and Bailout Plans Adrift

THE SAN FRANCISCO CHRONICLE

Carolyn Lochhead, Chronicle Washington Bureau

Sunday, December 7, 2008

Washington —

Detroit automakers are in line behind governors who are in line behind banks, seeking emergency aid from Washington. Nearly $8 trillion in federal commitments is already out the door, and half of the $700 billion October rescue package has been spent. The economic downturn is accelerating. And nobody is really in charge.

Among a lame-duck Bush administration, a lame-duck Congress, and a president-elect, Barack Obama, who has no legal authority to act and is reluctant to get entangled with the Bush team, Washington’s political vacuum has left policy adrift at the most critical economic period in a generation.

12lobby550Three of the most storied companies in U.S. economic history – General Motors, Chrysler and Ford – face possible bankruptcy. With GM threatening to topple by the end of this month, House Speaker Nancy Pelosi reached a compromise with the Bush administration on a temporary loan for less than half the $34 billion the automakers wanted. It is aimed at keeping GM and Chrysler alive until the Obama administration takes office. Ford said it could survive without loans so long as the other car makers avoid bankruptcies that would disrupt shared supply chains.

Horrendous job losses in November – 533,000, not including 422,000 who left the workforce – exceeded the gloomiest forecasts. Economists warn that failures in Detroit will intensify the contraction, but at the same time say $34 billion in emergency loans may not save the automakers anyway.

Nobody in Washington wants the automakers to fail, fearing the fallout on the rest of the economy, which is now in the kind of decline that no one under 30 has ever experienced.

“The economy is now locked in a vicious downward spiral,” wrote Nigel Gault, chief economist of economic forecaster IHS Global Insight. The problems have spread globally, greatly magnifying the danger of a long and painful downturn.

What to do?

A big part of the problem is that no one really knows what to do.

“The world is dealing with an unprecedented series of economic events,” said Joseph Grundfest, a professor of law and business at Stanford University and co-director of the Rock Center on Corporate Governance. “Anybody who stands up and says, ‘Look, this is what you should be doing,’ not only lacks humility, but also lacks a real appreciation of the intellectual difficulty of these circumstances. Because if the answer was so clearly obvious, everybody would have it.”

Pelosi backed off her insistence that the Bush administration bail out the automakers from the $700 billion bank rescue fund, agreeing to tap $25 billion already allocated to the automakers to build green cars. The first $350 billion of the bank fund is almost gone. Congress would have to vote to release the second half, and both parties are so furious with the way the administration has handled the bank rescue that they have warned Treasury Secretary Henry Paulson not to bother asking for more.

“I am through with giving this crowd money to play with,” Senate Banking Committee chairman Chris Dodd, D-Conn., said Thursday, a sentiment echoed by House Republican leader John Boehner.

President Bush, engaged mainly in a series of retrospective speeches and interviews on his legacy, nonetheless forced Pelosi to back off the bank fund Friday. After years of fighting Detroit on fuel-economy standards, Pelosi had resisted using money intended to retool the automakers. Bush said he was worried about giving tax dollars to “companies that may not survive.” Commerce Secretary Carlos Gutierrez warned that allowing Detroit to tap the bank rescue fund would only invite other industries to do the same.

As Congress plunged through two days of inconclusive hearings on Detroit, Obama remained noncommittal. His “one-president-at-a-time” line so irked House Financial Services chairman Barney Frank, D-Mass., that he let loose one of his signature retorts: “I’m afraid that overstates the number of presidents we have,” Frank said. Obama has “got to remedy that situation.”

Obama’s radio address

Obama responded with a presidential-style radio address Saturday, promising the biggest public investment in infrastructure since the federal interstate highways were built in the 1950s, along with all-out efforts to retrofit public buildings for energy efficiency, modernize school buildings, and expand broadband networks, including helping doctors and hospitals switch to electronic medical records. All are part of a huge fiscal stimulus program, with more to come, that he promised would create 2.5 million jobs and save money over the long haul.

“We won’t just throw money at the problem,” Obama said. “We’ll measure progress by the reforms we make and the results we achieve – by the jobs we create, by the energy we save, by whether America is more competitive in the world.”

The colossal bank bailouts, and the way Paulson has managed them, have rendered Paulson effectively powerless. Both parties, under his dire urgings and at great political peril, passed the unpopular $700 billion bank rescue a month before the election. Paulson told them he had a plan. Now they feel betrayed.

Paulson has run through $350 billion veering from one strategy to another. The money may indeed have prevented a banking collapse, but it has not unglued credit markets as much as expected. His rescue of banking giant Citigroup came under fire for its lack of transparency, generous terms and taxpayer assumption of close to $300 billion in debt.

“The value of these measures thus far has been to stave off a total meltdown, which we flirted with,” said Robert Shapiro, former undersecretary of commerce for economic affairs in the Clinton administration and now head of Democratic think tank and advocacy group NDN’s globalization initiative. Shapiro argued, however, as do many Democrats, that Paulson has failed to tackle the underlying problem of housing foreclosures that is causing banks to rein in lending.

Nor has the administration explained to the public the difference between bailing out banks and bailing out automakers, said Bruce Bartlett, a former Treasury official in the George H.W. Bush administration. That has led to confusion about why anyone is getting bailed out.

In addition, “the theory underlying the bailout has changed over time,” Bartlett said. “The $700 billion number appears to have been picked out of thin air. I never saw a rationale for it.”

Fed actions

The Fed has taken further radical steps to inject liquidity into the banking system and guarantee loans, $8 trillion worth by some estimates. Presumably not all the assets it has backed will sour.

The markets have judged some steps effective, Grundfest said. These include buying mortgage debt from Fannie Mae and Freddie Mac, which lowered mortgage interest rates; injecting capital into banks, which prevented them from imploding; and backstopping federal money market funds to stop a panic.

“But the reality is the effects are not large enough,” said Grundfest. “There is a massive global repricing of certain assets. It’s real estate values coming down not just in the United States but around the world, and a massive de-leveraging, not just in the United States but around the world.”

The consequences include widening recession, unemployment and foreclosures.

“Part of the unfortunate reality is that if real estate prices are going to re-equilibrate to a lower level that is significantly lower than the peak, it is mathematically impossible to have that happen without having homeowners and lenders lose a lot of wealth,” Grundfest said. “To the extent that people think government policy can prevent that from happening, the only way you can do that is by having the government say, ‘OK, you lenders and homeowners, you won’t lose the wealth, we the government will lose the wealth.’ And that means that all the rest of us will lose the wealth. But the wealth will be lost.”

Why banks are different from automakers

There is little disagreement that the failure of the Detroit automakers would pose a heavy burden on the economy as autoworkers lose their jobs and suppliers, auto dealerships and other businesses supported by the automakers fail. But these are different from the systemic effects of a widespread banking panic on the whole economy.

House of cards

Banks loan out far more money than they keep in deposits, roughly $9 in loans for every $1 in deposits. This is what some describe as an intentional house of cards. The system works fine in normal times to expand credit to consumers and businesses.

But if confidence in a bank collapses, and all the depositors demand their money at the same time, even a healthy bank will inevitably fail. This is known as a bank run, made famous in the Jimmy Stewart movie “It’s a Wonderful Life,” often shown at Christmas.

Panic mode

When there is a general collapse in confidence, and depositors rush to draw their money out of many banks at the same time, the entire financial system can fail. As depositors demand their money, banks call in their loans and sell their assets, and yet still cannot pay all their depositors.

Asset values are driven to fire-sale prices. Credit shrinks dramatically. The contraction is every bit as powerful as the expansion of credit that occurred when the bank initially leveraged its deposits into a much larger 9-to-1 portfolio of loans. This reverse process is known as “de-leveraging.”

When this happens to many banks at the same time, as happened in the Great Depression, the credit contraction can bring down the rest of the economy.

Tight credit

The U.S. financial system came quite close to a 1929 abyss in mid-September, which led Congress to pass a $700 billion rescue plan. Even so, bank credit remains sharply constricted and asset prices depressed.

After the Great Depression, the federal government put in place the Federal Deposit Insurance Corp. to protect depositors in a bank run and prevent panic from developing in the first place. (In the current crisis, the FDIC raised its protection level from $100,000 to $250,000 in deposits.)

– Carolyn Lochhead

E-mail Carolyn Lochhead at clochhead@sfchronicle.com.

General Barry McCaffrey Exposed For The Ultimate Spineless Shill That He Is

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THE NEW YORK TIMES

November 30, 2008

One Man’s Military-Industrial-Media Complex

By DAVID BARSTOW

In the spring of 2007 a tiny military contractor with a slender track record went shopping for a precious Beltway commodity.

The company, Defense Solutions, sought the services of a retired general with national stature, someone who could open doors at the highest levels of government and help it win a huge prize: the right to supply Iraq with thousands of armored vehicles.

Access like this does not come cheap, but it was an opportunity potentially worth billions in sales, and Defense Solutions soon found its man. The company signed Barry R. McCaffrey, a retired four-star Army general and military analyst for NBC News, to a consulting contract starting June 15, 2007.

Four days later the general swung into action. He sent a personal note and 15-page briefing packet to David H. Petraeus, the commanding general in Iraq, strongly recommending Defense Solutions and its offer to supply Iraq with 5,000 armored vehicles from Eastern Europe. “No other proposal is quicker, less costly, or more certain to succeed,” he said.

Thus, within days of hiring General McCaffrey, the Defense Solutions sales pitch was in the hands of the American commander with the greatest influence over Iraq’s expanding military.

“That’s what I pay him for,” Timothy D. Ringgold, chief executive of Defense Solutions, said in an interview.

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President-Elect Barack Obama's Press Conference | Dec 1 2008

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Part Two

Circular Firing Squad With Cavuto and Stein

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