Kicking the Housing Can Down a 1-Way Street and Over a Cliff

by: Richard Suttmeier
Housing stocks, community banks and regional banks have led the downside and lag the upside. The Housing Sector Index (HGX) is down 21.3% year to date and 6.2% below its post-FOMC low. The America’s Community Bankers Index (ABAQ) is down 16.7% year to date and up just 2.0% since its post-FOMC low. The Regional Banking Index (BKX) is down 27.8% year to date and up just 3.2% since its Post-FOMC low. Compare this to the S&P 500 at 6.3% lower year to date and up 7.0% since last Tuesday’s post-FOMC low.
The FDIC kicked bank failures down the road. The FDIC's closed 64 community banks so far on "Bank Failure Fridays" in 2011, and almost all had significant overexposures to commercial real estate loans, including construction and development loans. Based upon the regulatory guidelines, the FDIC should have begun to close overexposed banks in 2007, but it ignored the guidelines and only began to seize failed banks in 2008 with just 25 failures. 140 banks failed in 2009 with a peak of 50 in the third quarter. 157 banks failed in 2010. We now have 64 bank failures in 2011, and 386 since the end of 2007. I still predict 500 to 800 bank failures in total by the end of 2012 into 2013. There are still 759 of the 7,574 FDIC-insured financial institutions overexposed to construction and development loans. Another 1,466 community banks are overexposed to non-farm, non-residential real estate loans.
Looking at pipeline risk, which is the ratio of CRE loans to CRE loan commitments, 3,810 community banks have a pipeline of 80% or higher of their real estate loans funded, which is 50.3% of all FDIC- insured financial institutions. C&D loans still total $295.5 billion and including non-farm, non-residential real estate loans, CRE loans total $1.06 trillion; thus a total of $1.356 trillion in legacy problem loans remain on bank balance sheets. There is talk that community banks may be allowed to amortize loses on CRE loans over a seven-year period, when most who need help should be liquidated.
Dodd-Frank kicks the can for the FDIC Deposit Insurance Fund (DIF). The FDIC DIF is in arrears by an estimated $4.5 billion, and insured deposits have increased by 48.9% since the end of 2007 to $6.389 trillion. Under old rules, DIF would have to be 1.15% of insured deposits by the end of June 2012. Dodd-Frank pegs the requirement at 1.35% by June 2020. Individuals are adding to bank deposits to take advantage of the $250,000 deposit guarantee among each bank. If deposits are $10 trillion, the fund would require a balance of $135 billion, with banks with more than $10 billion in assets paying larger percentages. This is a big tax on the “too big to fail” giants.
Toxic assets are off-balance sheet at the “too big to fail” banks. These assets must eventually be accounted for just as regional banks pare back on reserve for losses to doctor up recent earnings reports. There are 24 banks in the BKX and 14 were rated a sell according to ValuEngine as of August 10.
Deleveraging of derivatives remains a concern. Instead of deleveraging exposures to notional amounts of derivative contracts, this time bomb of potential banking problems has grown by 49.3% since the end of 2007 to $246 trillion.
The TARP still covers the banking playing field. There are still 567 institutions that have TARP money and 161 of these are delinquent on at least one TARP dividend payment.
The mortgage market remains a problem for homeowners. Let’s help homeowners who are current on their mortgages instead of those in default or foreclosure. The housing market depression is the most important cause of a double-dip recession. Here’s a plan to help the economy of Main Street by helping the healthy homeowners.
  • Offer a Ginnie Mae-backed 30-year fixed rate mortgage at 100 basis points over the 10-year US treasury yield. With the 10-Year yield at 2.10, the Ginnie Mae government-backed mortgage rate would be just 3.10 percent.
  • Ginnie Mae borrows from the US Treasury to create the funding pool. It keeps 50 basis points to cover costs and the servicing bank gets 50 basis points. This alone will put money in consumers’ pockets that they do not have today.
  • Another feature of this program would allow any homeowner to reduce a mortgage by taking funds from a retirement account without penalty and without paying taxes on these funds.
  • If a homeowner sells a home at a loss, the capital loss is allowed to be a tax deduction amortized over 10 years.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.