Look Who's Upside Down Now

On Thursday night, we learned Washington Mutual (WM) with $307.2 billion in assets became the largest bank failure in U.S. history (see MarketWatch). In July, Indymac with assets of $32 billion failed. WaMu is the 14th bank or thrift to fail this year.

How bad is it? On June 30, the FDIC had just $45.2 billion to insure deposits. Bloomberg reports the final FDIC bill could top $150 billion and that is separate from the $700 billion bailout currently under debate on Capitol Hill.

To put some numbers to this banking crisis I went to the federal reserve data. The decline in the solvency of U.S. banks over the past ten months has been breathtaking.

Much like borrowing a down payment, banks borrowed $3.5 billion in January in order to meet their reserve requirements. By August, banks had borrowed $123.5 billion to meet their aggregate reserve requirement of $42.6 billion. By Sept 24, the borrowing had swelled to $158.3 billion! Not once in the 59 years before 2008, had borrowed reserves exceeded internal reserves.

The aggregate balance sheet of the U.S. banking system now resembles that of an upside-down interest-only subprime mortgage customer. Fittingly, Hank Paulson called it a "house of cards".

What now? The numbers, and their accelerating deterioration, clearly suggest the banking system is on a precipice.

The fear trade takes on new twists.

The Treasury had to pledge to protect money market funds after $133.3 billion was withdrawn over just 2 days last week. (Bloomberg)

On Thursday the US mint temporarily suspended sales of 1-ounce American Buffalo gold coins after demand exceeded supply. (FT.com)

Rapid money supply growth, and the government's need for new funds puts upside pressure on interest rates, inflation and taxes.

When the bailout is cobbled together, any market bounce is likely to be short-lived. Investors will once again focus on the U.S. economy, which is cascading into a recession. Falling durable goods orders, weak housing data, a spike in unemployment claims and GE's (GE) profit warning represent just one day's worth of red flags.

In this environment, just like in 1990, that bailout money will be used to repair bank balance sheets via Treasury bond investments. It will not be put at risk where it could help the economy. Already the money multiplier effect has disappeared. In the 13-wk period ended Sept 15, the seasonally adjusted annualized growth in M1 was much stimulated 6.9%, but M2 barely grew at a 1.6% pace.

Investors should expect a multi-year bear market. Recession into at least mid-2009 seems to be a foregone conclusion. Asset deflation could transform into inflation if the feds tinker with the economy long enough.

Cash rich firms that can self-finance their acquisitions, like Berkshire Hathaway (BRK.A), stand to clean up in the years ahead.

Stock position: None.

Comments

[Lawrence York:]

The Reserve data tell it all. This bailout is for the banks to meet their reserve requirements, for the Fed to recapitalize, and for the FDIC. I agree with you that money supply tells it all and that we can expect further contraction of the US economy. Given the unfortunate circumstance we must pay the price to save the financial system but must also include the yet mentioned cost of bailing out GNMA. Since this aggregate number is a couple trillion dollars the question to debate is if while they're at it everyone shouldn't also be issued a VISA card by the government to pay their debt on time.

2008 Sep 26 09:54 AM

[FWG:]

I don't like it.. There is something wrong with the entire scenario. Days away from a bailout, WM with 21 billion in bad lawns is given to JP Morgan.. Why, because JP Morgan didn't want to pay a fair value, so there friends in Wash gave it to them for 2 billion. Many Americans were hurt in a ploy to force the hand of the politicians that don't want the bailout. The shareholders (hardworking American taxpayers) should have been considered. all week we are reading info about how the federal gov't was trying to find a buyer for WM. to bad the investors didn't have the inside information.

2008 Sep 26 11:36 AM

[BlackyBlack:]

They gave Wamu to JPMorgan because JPMorgan already fudges its books under a national security exemption. It's already set up to be a black hole/tarp to hide everything in. They are in crisis mode, so don't expect them to be fair. They are just trying to stall while any evidence of fraud is destroyed.

2008 Sep 26 12:25 PM

[Urbane Gori...:]

They sold it cheap to JP because nobody wanted to buy it. And they had to do it before there was a run on deposits. That's all.... No big conspiracy. jegan ;-)


** VOTE REPUBLICAN AGAIN IN 2209
NOVOCAIN/PAIN - THAT'S THE TICKET!!!***

2008 Sep 26 01:47 PM

[Al-USA:]

For Mr Egan:

If you believe that, then you also believe the $700,000,000,000 is in the best interests of the average American taxpayer and that the multitude of lobbyists involved in the crafting of the bailout are there merely to secured the best interests of the average folk. Right...

Also, I think you meant 2009 since by 2209 nobody alive today will be around. Heck, the way the rich are manipulating the US government, the US might not be around either. Read up on the history of the Western Roman Empire to put my comments into proper context.

2008 Sep 26 06:22 PM

[Urbane Gori...:]

You're right... Typo.. Did mean 2009... And I have read all three volumes of 'The Rise and Fall of the Roman Empire' ... What a dozer.... personally, I'm more inclined towards 1984, which I am re-reading, with great enthusiasm.

As to the Bailout... Yup... Don't like it either, but like chemo, it is necessary. And you are right about lobbyists... I agree that they are the devil perched on the shoulders of our politicians, constantly whispering in their ears, promising untold dirty little pleasures, chuckling as they succumb like 14 year old boys viewing their first porno... It's times like these that make you question the old adage about Democracy not being perfect, but the best system there is... Seems like an excuse to keep rowing the boat towards the precipice.

Sorry about the litany.... Anyway:

I do believe the the American public does not deserve the cost of this bailout.

I do not think this is the end of the costs.

I do not think this bailout and any other efforts will stop a worldwide downturn.

I do think that lobbyists, bankers, politicians, brokers, Greenspan, and to a large degree the greed of the public, have put us in this unholy spot. Gotta do it and soon!\

jegan ;-)

2008 Sep 27 01:06 PM

[notsosmart:]

fwg-the bad lawn given to jp morgan-not enough fertilizer or water?

2008 Sep 27 02:04 PM