Debt Rattle, February 10 2008

Updated 3.33 PM

FDIC Begins "Death Watch" of US Banks, Plans to Lower Insurance to $10,000 and Give Vouchers for Hamburgers or Tacos

The Federal Deposit Insurance Corporation (FDIC) has begun a "death watch" on dozens of failing US banks which are drowning in their own debts and piles of worthless subprime, derivative and other investments.

"The FDIC has never supervised a bank failure with more than 175,000 accounts," an FDIC spokesman stated. "So the avalanche of bank failures we anticipate starting this year will challenge us to repay millions upon millions of depositors, making our job pretty well impossible."

The spokesman indicated the only way to pay anyone out of FDIC proceeds is to reduce insured deposits from $100,000 to $10,000 or less which is about all the FDIC fund could afford.

But acting with several American corporations, the FDIC will also give away vouchers entitling those who have lost their life savings to an added bonus of up to 10 free McDonald's hamburgers or up to 20 free Tacos at Taco Bell.

A spokesman at Taco Bell stated that their company is "thrilled to become an integral part of the FDIC program. It is our patriotic duty."

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The story above is a satire or parody. It is entirely fictitious.

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World bourses lost $5.2 trillion in January: S&P’s

World stockmarkets lost 5.2 trillion dollars (3.6 trillion euros) in January thanks to the fallout from the US subprime crisis and fears of a global economic slowdown, Standard & Poor's said Saturday. "If investors thought the market could only go up, January's wake-up call pulled them back into reality," the independent credit ratings' provider said.

Standard & Poor's said the world's equity markets lost a combined 5.2 trillion dollars as emerging markets fell 12.44 percent and developed markets lost 7.83 percent to register one of the worst starts to a new year. "There were few safe havens in January as 50 of the 52 global equity markets ended the month in negative territory, with 25 of them posting double-digit losses," said Howard Silverblatt, senior index analyst at S&Ps. [Another measure of global stocks, MSCI's main world stock index, was down more than $3.6 trillion year-to-date through Thursday.]

All 26 developed equity markets posted negative returns in January, with 16 losing at least 10 percent of their value.
The January declines negated all previous market gains, leaving all of the developed markets in the red for the trailing three month period. In Paris, the stock exchange lost 12.27 percent over the course of January, 15.27 percent over the past three months, more than wiping out its gains over the last 12 months -- down 0.74 percent).

The situation was even worse in London -- down 8.85 percent in January, down 16.54 percent for the past three months and down 2.22 percent over 12 months -- and in the US, which was down 6.07 percent in January, down 10.78 percent over three months and down 2.42 percent over 12 months. The story was similar in Japan, where the market lost 4.47 percent in January, 10.31 percent over three months and down 10.44 percent over the past 12 months. In Germany, in contrast, although the stock exchange lost 13.72 percent in January and 13.84 percent over three months, it was up 13.43 percent over the year.

Equity markets in emerging countries also suffered heavy losses in January, apart from Morocco which gained 10.17 percent and Jordan, which was up by 3.11 percent. Turkey was the most affected with January losses reaching 22.70 percent, followed by China on 21.40 percent, Russia on 16.12 percent and India at 16 percent. But only Argentina and Taiwan slipped into negative territory for the 12-month period.

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Japan is the next sub-prime flashpoint

There is still $300bn of bad debt out there, and Japan could be hiding most of it

Just as battered investors had begun to glimpse signs of recovery in America, the next shoe has dropped with an almighty thud in Japan. Echoes are rumbling across the Far East. The Tokyo bourse has crumbled, suffering the worst start to the year since the Second World War. The Nikkei index is down 17 per cent since Christmas, and the shares of Japanese banks are leading the slide. Mizuho Financial, Mitsubishi UFJ and Sumitomo Mitsui have all been punished as hard or even harder than those US banks at the epicentre of the sub-prime debacle.

The nagging fear is that Japan's lenders - the conduit for the world's greatest stash of savings - have taken on a far bigger chunk of mortgage securities, collateralised loans obligations and other exotica from America's structured credit boom than they have yet revealed.

Americans and Europeans have so far confessed to $130bn of the estimated $400bn to $500bn of wealth that has vanished into the sub-prime hole. Somebody, somewhere, must be sitting on a vast nexus of undisclosed losses. We may find out soon enough whether the hold-outs are in Japan. The banks have to come clean under the country's strict new audit codes by the end of the tax year in March. "We think this is where the next big problem is going to pop up," said Hans Redeker, currency chief at BNP Paribas.

"We know from Bank of Japan's lending survey that the banks are already tightening hard, so something is brewing. Right now, we are in the lull before the second storm in global markets, and Asia is going to be the source of the nasty surprises," he said. The iTraxx Japan index measuring default risk of 50 Japanese companies saw its biggest one-day jump ever on Thursday to 77.5. Rightly or wrongly, it is flashing a serious distress signal.

What we know is that Japan's economy - still the second biggest in the world by far - has fallen over a cliff since October. It remains joined to America's hip after all. The decoupling theory has failed its first test. Japan's machine orders dropped 2.8 per cent in November and a further 3.2 per cent in December. January housing starts fell to the lowest in 40 years, down 18 per cent on the year. Tokyo property was off 22 per cent. Can this still be blamed purely on a change in building rules?

"Recession is a clear and present danger in Japan," said Tetsufumi Yamakawa, chief Japan economist for Goldman Sachs. "The leading indicators are deteriorating very sharply. Inventory is piling up at a rapid pace. There are clear signs of deceleration in exports of steel and semi-conductors to China," he said. Yes, China. It turns out that the intra-Asia trade that was supposed to immunise the region against a slump is a disguised supply-chain ending up in the US market. American shoppers still make 30 per cent of global demand, just as it did a decade ago. Nothing has really changed. "We think the Bank of Japan may have to start easing by the middle of the year," said Yamakawa.

There is not much monetary ammo left. Interest rates are 0.5 per cent. So it's back to zero, and helicopters of central bank cash ("quantitative easing"), those peculiar hallmarks of Japan's past battle with deflation. The brief attempt to "normalise" Japan Inc has already failed. We tend to forget that Japan remains the world's top creditor nation by far, the shy master of fate. The country's net foreign assets of $3,000bn roughly match the net debts of the US.

The yen "carry trade" - borrowing cheap in Tokyo to chase yields from New Zealand, to Brazil, Iceland, and above all Britain - has juiced the global asset boom this decade by $1,000bn. It is perhaps the biggest liquidity pump of them all, yet it stopped pumping in August. Indeed, it is sucking the money back out again. The yen is soaring. Where have the Japanese recycled the quarter trillion dollars they earn each year from their surplus? Official data shows that their holdings in US Treasury bonds have not risen.

The Swiss offer us a clue, says Redeker. They are Europe's Japanese, champion savers looking for returns abroad. They devoured US sub-prime debt on a much bigger scale per capita than the Americans. Hence the $24bn in write-downs by UBS. So far, Japan's biggest three banks have admitted to just $4.7bn in total losses between them. The figure is rising. Mitsubishi, the biggest, has just raised its tally to 12 times the sum admitted in November. This looks like a replay of the early 1990s when fear of losing face delayed the awful news.

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5 Historical Economic Crises and the U.S.

Earlier this week, I received a copy of a paper co-authored by Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard University, titled Is the 2007 U.S. Sub-Prime Financial Crisis So Different?.
Each of these authors have rather distinguished affiliations. Reinhart is with the NBER, the group whose Business Cycle Dating Committee officially marks the beginning and end of Recessions. And Rogoff is an adviser to the John McCain, who has (almost proudly) professed his economic ignorance.   

Yesterday, in the NYT, Paul Krugman linked this paper to an interesting and perhaps unique factor regarding the 2008 presidential contest. None of the remaining 3 contenders -- McCain, Obama or Clinton -- are economic ideologues. No supply-siders in this group, no one from the Democratic old school. If it turns out that the candidates are pragmatic centrists, more focused on problem solving than ideological belief system, it would be a good thing. This is especially true, if the authors of the paper are correct. Why? If the present situation plays out as they expect, we are going to need all of the problem solving skills available. You see, Reinhart and Rogoff draw parallels between the current U.S. financial woes and five previous financial crises.

All five of these were “associated with major declines in economic performance over an extended period:”

- Japan (1992)
- Spain (1977)
- Norway (1987)
- Finland (1991)
- Sweden (1991)

Of course, none of these are identical to the present 2008 USA, economically, culturally, or politically. However, when one takes a closer look, some of the major parallels are a cause for concern. The Chronicle of Higher Education did just that. In reviewing the Reinhart and Rogoff paper, they focused on the parallels to the Japan crisis.

Like Japan et al., the United States has seen:

• A steep rise in housing prices during the four years preceding the crisis. (The U.S. rise was more than twice as large as the average of the other five.)
  
• A steep rise in equity prices. (Again, the U.S. rise was larger.)
  
• A large increase in its current account deficit.
  
• A decline in per-capita growth in gross domestic product. (In this case, the U.S. situation doesn’t appear as bad as in the five predecessors.)
  
• An increase in public debt. (Here again, the U.S. situation isn’t as bad as in the historical examples – but Reinhart and Rogoff add that “if one were to incorporate the huge buildup in private U.S. debt into these measures, the comparisons would be notably less favorable.”)

The authors' conclusion:
“Given the severity of most crisis indicators in the run-up to its 2007 financial crisis, the United States should consider itself quite fortunate if its downturn ends up being a relatively short and mild one.”

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Ilargi: At the G7 Finance party, we were blessed with a report by the Financial Stability Forum, made up of central bankers and financial regulators from around the world.

And of course we are highly surprised -we are SHOCKED!!- to see that the report blames the current crisis on irresponsible bankers and investors. There is no blame, how ever, for ...yes..... central bankers and financial regulators (governments). They are hereby officially declared innocent as lambs. And you can count on them to do their utmost to serve the public, and get you out of this crisis caused by the evildoers.

Credit crisis 'here to stay,' say top bankers

Darling warns of world 'turbulence' after anxious G7 debate

The world economy faces a 'turbulent time', the Chancellor, Alistair Darling, warned this weekend after meeting finance ministers from the world's main industrialised nations in Tokyo to discuss ways of tackling the credit crunch. Darling and his G7 counterparts were presented with a grim assessment of the damage wrought by reckless lending in the American housing market, which has snowballed into a global financial crisis over the past six months.

'It is likely that we face a prolonged adjustment, which could be difficult,' finance ministers were warned in a report by the Financial Stability Forum, made up of central bankers and financial regulators from around the world. The politicians struck an anxious note after discussions on tightening financial regulation and improving early-warning systems to prevent future crises. 'The current financial turmoil is serious, and persisting,' said Hank Paulson, the US Treasury Secretary. Darling admitted: 'It is undoubtedly the case following the problems that arose in the US housing market last summer that the world is facing a turbulent time.'

The hard-hitting Financial Stability Forum report blamed feckless investors and irresponsible banks for exacerbating the credit crunch, which has pushed America to the brink of recession. Ben Bernanke, chairman of the US Federal Reserve, has already slashed interest rates by 2.25 per cent in the last five months - the fastest cuts for more than 25 years - in a desperate attempt to contain the crisis.

Presenting the first findings from their study of the credit crunch, the central bankers revealed a catalogue of failures that allowed risky 'sub-prime' lending to Americans with shaky credit records to career out of control, through what they called 'the complex network of interdependencies in the financial system'. One culprit was the lavish performance-pay regime on Wall Street and in the City, which, they say, 'encouraged disproportionate risk-taking with insufficient regard to longer-term risks'. The secretive 'off balance sheet' accounting used by many banks to hide their borrowing was also criticised.

But the investors who bought securities backed by the shaky American mortgages did not escape blame either: the report identified 'poor investor practices, including excessive, too often mechanical, reliance on credit rating agencies'.
Darling urged his fellow finance ministers to tackle the role of the ratings agencies - such as Moody's and Standard and Poor's - which gave their imprimatur to the complex financial instruments at the heart of the credit crunch, many of which subsequently turned out to be almost worthless. Since last August the crisis has claimed a crop of high-profile scalps, including the bosses of giant US banks Citigroup and Merrill Lynch, both of which made such huge losses on sub-prime lending that they have been forced to seek cash injections totalling $21bn (£10bn) from foreign backers.

And as banks battle to shore up their finances after losing billions of pounds, there are fears that the supply of credit to ordinary consumers and businesses is drying up, sending the world economy into a downturn - and potentially causing even more losses for the banks. Darling has insisted that the UK has 'good reasons to be confident' about its ability to withstand a slowdown in the global economy; but the government rescue of Northern Rock illustrates that the banking sector, at least, is not immune. The Bank of England has already cut interest rates twice to cushion the impact of the credit squeeze, but the British Chambers of Commerce (BCC) warned today that the economy was set to slow down rapidly in 2008.

'Our problems are not that different from those of the US: we have very large personal debt, a housing market which has been overblown and is now weakening, and a huge trade deficit,' said David Kern, the BCC's economic adviser. The Institute of Directors will add to the pessimistic mood tomorrow, when it reveals that business investment plans have 'fallen off a cliff' in the past three months.

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Britain ‘facing huge job losses’

TWO in every five employers plan redundancies over the next three months, according to an influential survey to be published tomorrow. It comes as two leading business groups warn of weak business confidence and a sharp slowdown in growth.

British Retail Consortium (BRC) figures will show, however, that consumers remain resilient in spite of economic worries. The BRC retail sales monitor, in conjunction with KPMG, is set to show total sales last month almost 5% up on a year earlier. Like-for-like sales – adjusted for new floorspace – have risen more than 2%. Retailers had been very downbeat about prospects for January following a poor December, with like-for-like sales rising only 0.3%. This week’s figures will come as a relief, but the BRC is likely to warn that any strength is likely to be temporary.

This will be the big fear if the warning of many redundancies from the Chartered Institute of Personnel and Development comes true. Its winter labour market outlook, also in conjunction with KPMG, is set to show that 38% of the more than 1,500 employers surveyed plan redundancies over the next three months, with a quarter intending to let go at least 10 employees. Although it is normal for a proportion of employers to be planning redundancies, the latest figure is sharply up on the 17% number three months ago.

“Employers’ initial reaction to talk of an economic slowdown was to hold fire and take stock of the situation,” said John Philpott, the institute’s chief economist. “But a substantial number now expect to trim their workforces.
“With net recruitment activity still positive, signs of mounting employer pessimism shouldn’t be read as evidence of a jobs market meltdown. But it does suggest the UK is entering a period of slower employment growth and somewhat greater job insecurity than in recent years.”

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UK: Increasing home repossessions to hit 12-year high

House repossessions are expected to hit a 12-year high this year, with 45,000 owners seeing their homes taken away, experts warned yesterday.

The prediction came despite figures showing that last year's 21 per cent rise in repossessions was smaller than expected. More than 27,000 homes were taken back by banks and building societies in 2007, fewer than the 30,000 that most experts had predicted. However, it still equates to one in every 400 home owners, figures published by the Council of Mortgage Lenders, show. The CML forecasts that this will climb as the full impact of the credit crunch starts to hit people's monthly budgets.

With a growing number of lenders refusing to offer mortgages to those with a poor credit history, many people in financial trouble are expected to find their finances even more stretched. The CML is predicting that 45,000 homes will be repossessed this year. This would still be some way off the crash in 1991, when 75,500 were repossessed. Separate figures showed that 15,600 households had not been able to pay their mortgage for a year or more, a rise of six per cent in six months.

Data from the Ministry of Justice showed that repossession orders, the first stage in the process, had climbed seven per cent in the final three months of last year, compared with the same period in 2006.
Howard Archer, a leading economist, said: "The financial pressure on many home owners is increasing, and it seems certain that repossessions will trend up significantly during 2008, particularly if the economy suffers an extended marked slowdown and unemployment starts rising."

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No more rate cuts: there'll be no UK recession

Against a deteriorating global outlook, the Bank of England lowered rates again last week - to 5.25 per cent. UK borrowing costs have now been cut in two of the Monetary Policy Committee's last three monthly meetings. Compared with the US Federal Reserve, which has slashed rates 225 basis points since the sub-prime crisis broke last summer, the MPC's combined 50-point reduction looks cautious. No matter, say the stockbrokers and investment bankers who so desperately want UK rates to fall. Having talked up the ridiculous prospect of a 50-point drop last week, they now predict at least three more cuts over the coming months - with base rates reaching 4.5 per cent by Christmas.

Such forecasts are useful when trying to breathe life back into an ailing stock market or rein in estimates of future sub-prime losses. They are also analyticallly flawed. I accept that cash-strapped mortgage holders want much lower rates. But I reckon the MPC - having already taken big risks with its inflation-fighting credibility - won't follow the Fed's example. When in a hole, I sincerely hope the Bank knows when to stop digging.

Yes - those arguing that rates will drop to 4.5 per cent are in the majority. And the weight of money in the market thinks the Bank will go further still - with the June 2009 futures curve now close to 4.25 per cent. I'd say such bets are wrong. By overstating the extent to which the UK economy will suffer over the next year they, in turn, overdo the amount of MPC "first aid" required. Those expecting deep rate cuts also fail, in my view, to understand crucial differences between the UK and US economies.

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Ilargi: The EU is known to be far more aggressive towards business practices it doesn’t agree with than US regulators (see Microsoft). This may yet wreak havoc on bond insurers and potential buy-out and bail-out plans coming from Wall Street.

EU's McCreevy warns ratings agencies on structured finance

European Union Internal Market Commissioner, Charlie McCreevy, warned on Wednesday that if credit ratings agencies did not correct the lack of distinctive ratings for structured finance products, he would take action. "If the proposals are not forthcoming in coming months, I would not hesitate to move forward to have it addressed with regulatory action," McCreevy told the Society of Business Economists in London.

On Tuesday, credit rating agency, Moody's Investors Service, said it may change how it rates mortgage backed securities and other structured finance products, after criticism that its rating contributed to the global credit squeeze of the past six months when banks suffered losses as defaults rose on U.S. subprime mortgages. Moody's issued a "request for comment" on five options after regulators and investors said it was too slow to recognize credit deterioration in mortgage-backed and asset-backed securities, including collateralized debt obligations. Rivals such as Standard & Poor's and Fitch Ratings have faced similar criticism.

"I am not going to be prescriptive today but I will say this: strong independent professional oversight of the credit professionals within the rating agencies...and of the operation of the ratings function is absolutely essential if market and regulator confidence is to be restored with respect to the effective management of the conflict of interest inherent in the rating agencies' business models," McCreevy told the audience in London.

In the wake of the near collapse of U.K. mortgage lender, Northern Rock, during last summer's credit and liquidity squeeze in world markets, McCreevy also expressed concern about the lack of regulatory framework in Europe for dealing with bank failure. McCreevy noted there were 44 institutions doing cross border banking in Europe, but it was not clear who the lender of last resort would be should any of them be hit by trouble.

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Debt fears heighten in US and Europe

Fears about corporate and commercial property debt reached new heights in the US and Europe on Friday as investors liquidated holdings in a sign of spreading credit turmoil. The markets were gripped by worries that economic weakness would affect corporate profits, leveraged buy-outs and commercial property. This represents an escalation of the crisis that began with concerns about US subprime mortgages.

The trading was particularly heavy in leveraged loans – used by private equity firms to finance deals. Mutual funds that invest in these loans have been hit with redemptions, forcing them to dump some of their holdings. Hedge funds that bet on the likelihood of buy-out deals happening have been among the casualties. The turmoil has also put pressure on banks and other investors who are holding $200bn (£103bn) of leveraged loans that they had been hoping to sell. Kevin Cronin, portfolio manager at Putnam Investments, said: “The overhang of bank debt from last year’s leveraged buy-out activity is becoming more problematic.

“Loans are being liquidated at distressed prices and banks are looking to reduce risk.” Loans used to finance two of last year’s biggest buy-outs, utility TXU and credit card processor First Data, were among those hit, Mr Cronin said. Closely followed measures of credit risk in the US and Europe peaked as investors unwound complex trades that lose money when credit deteriorates.

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Stimulus Package Will Hasten Collapse of Fannie and Freddie

Some folks may have noticed that the stimulus package raises the limit on the size of the mortgages that can be insured by Fannie Mae and Freddie Mac, the two huge government created mortgage agencies, from $417,000 to $730,000. This is supposed to help the housing market in high priced markets, where the current limit may not even be sufficient to purchase the median priced house. There has been very little analysis of the impact of this measure in the media and all of the commentary has come from economists who somehow managed to miss the housing bubble. If the media had relied on a broader array of sources, they would have told the public that the move is likely to hasten the collapse of Fannie and Freddie.

With house prices dropping at a 16 percent annual rate nationwide, millions of homeowners with prime conformable mortgages (the type that are in Fannie and Freddie's mortgage pools), owe more than the value of their homes. For example, in San Diego, many homeowners may owe $400,000 on a house now worth $300,000. A high percentage of these homeowners will opt to walk away from such homes, in effect making themselves $100,000 and leading to huge losses for the mortgage holders. This process is already occurring, as the foreclosure rate on prime mortgages is rising rapidly and reaching levels seen in the subprime market just a few years ago.

The capital base of both Fannie and Freddie is very limited compared to the amount of debt that they insure. As the foreclosure rate continues to rise, they will both be forced to take large write-offs and will soon be pressing up against the limit of their capital base. Raising the cap on conformable mortgages will hasten the date when this will occur. Look for analysis in the media from surprised economists when Congress debates the bailouts of Fannie and Freddie.

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Ilargi: In yesterday’s Debt Rattle, I posted three separate articles on the banks’ non-borrowed reserves issue. Now Mish chimes in with a comment on one of those articles, by Bloomberg’s Caroline Baum. He agrees that her conclusions are faulty.

However, I have to disagree with Mish on two points:

First, he kind of claims that she is not the one to blame for the silly quotes by the senior U.S. economist at JPMorgan in her article. That of course is nonsense. A journalist is always responsible for what (s)he writes. No matter that Mish likes her writing and advertises her book on his site. I like Baum too, but as I said yesterday, her article "tastes" like she's trying too hard. Perhaps she was under pressure.

Second, Mish reiterates the “very strict” requirements for collateral deposited at the Fed when banks borrow from it. Once again, I point to my article What the FED accepts as collateral these days. While it may not provide conclusive proof, it does provide conclusive doubt, so to speak, more than enough to hold back for now on claims for collateral requirements based on what the Fed itself publicly states. Let’s put it like this: the situation is by no means black and white, and should not be painted like it.

Borrowed Reserves And Tin-Foil Hats

There is indeed such a thing as a banking system being short of reserves. In addition, the Fed does not have absolute control over supply of reserves. Let's start with a discussion of how the TAF works and work our way to the correct conclusions.

Banks participating in the Term Auction Facility (TAF) have to put up collateral for the amounts they borrow.

Term Auction Facility
• Under the term auction facility (TAF), the Federal Reserve will auction term funds to depository institutions. All depository institutions that are eligible to borrow under the primary credit program will be eligible to participate in TAF auctions. All advances must be fully collateralized.

Discount Window Collateral
• The Federal Reserve Banks accept a broad range of assets as discount window collateral. Discount window loans must be collateralized to the satisfaction of the local Reserve Bank.

The Reserve Banks will consider accepting as discount window collateral any assets that meet regulatory standards for sound asset quality. Depository institutions should direct questions regarding specific assets to local Reserve Bank staff. Clearly, the Fed does not hand out reserves willy-nilly. It lends them, but only if banks have sufficient collateral. Furthermore lending is not "printing". Thus Glassman, the senior U.S. economist at JPMorgan Chase & Co. really needs an education here.

Still more education is required. The Fed does not have "control" over supply of reserves because it does not have control over assets held and loans made by member banks. If Glassman's thinking is representative of bank thinking in general, it's no wonder banks balance sheets are so $#@%'d up.

A shortage of reserves comes into play when banks no longer have sufficient collateral to exchange for temporary reserves. Banks that do not have sufficient collateral, do not get loans from the discount window or the TAF. Period. End of Story. The Fed does NOT simply "print money" and hand it out to capital impaired banks. Bankruptcies result. If Citigroup could have borrowed reserves from the Fed at 3-4% wouldn't it had done so instead of raising $7.5 billion from Abu Dhabi at an interest rates of 11%?

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Ilargi: In the same article above, Mish also reverts to a statement by John Dugan, Comptroller of the Currency, which remained a bit hidden here realier this week, and he is right to put emphasis on what Mr. Dugan factually says, since it’s eye-opening. The potential losses to US community banks (hello, Potterville) are staggering. many will fail, and drag entire communities down with them. So says the Comptroller of the Currency.

Remarks by Dugan

Remarks by John C. Dugan Comptroller of the Currency January 31, 2008 (PDF)

Over a third of the nation’s community banks have commercial real estate concentrations exceeding 300 percent of their capital, and almost 30 percent have construction and development loans exceeding 100 percent of capital. Here in Florida, as in other states where housing is so important to local economic growth, the concentration levels are more pronounced. Over 60 percent of Florida banks have CRE loans exceeding 300 percent of capital, and more than half have C&D loans exceeding 100 percent of capital.

We’re now entering a stage of the CRE credit cycle where problems have started to surface and losses have started to increase – which is the second inescapable fact I mentioned at the outset. In terms of asset quality, our horizontal reviews have indeed confirmed a significant increase in the number of problem residential construction and development loans in community banks across the country.

Given these circumstances, what do we see as the consequences in the coming months? Not surprisingly, there will be more frequent interaction between supervisors and banks with concentrations in CRE loans that are declining in quality. There will be more criticized assets; increases to loan loss reserves; and more problem banks. And yes, there will be an increase in bank failures.

I want to emphasize today, as we see the clear signs of CRE credit quality declining, that we will expect banks with CRE concentrations to make realistic assessments of their portfolio based on current, changed market conditions. That may require you to obtain new appraisals. For those of you in stressed markets, it will almost certainly require you to downgrade more of your assets, increase loan loss provisions, and reassess the adequacy of bank capital.

Read this again and again until it sinks in:

Over a third of the nation’s community banks have commercial real estate concentrations exceeding 300 percent of their capital, and almost 30 percent have construction and development loans exceeding 100 percent of capital.

There will be more criticized assets; increases to loan loss reserves; and more problem banks. And yes, there will be an increase in bank failures.

Why Will Banks Fail?

• Banks will fail because they do not have sufficient reserves.
  
• Banks cannot borrow those reserves because they do not have sufficient collateral.
  
• The Fed's collateral requirements do not permit printing money and handing that money over to failing banks.
  
• The Fed will not change those requirements and start printing money because of the "checkmate" scenario discussed below.

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British Land writes off £1.4bn from value of commercial property as market ebbs

Britain's second-largest property developer was forced to cut £1.4bn from the value of its offices and out-of-town retail parks yesterday in response to the credit crunch and failing investor confidence. The continued impact of the downturn in commercial property is also expected to curtail the frenetic pace of building in the City. This comes as banks and other financial institutions are assessing the impact of the deteriorating economy and whether they need less office space, British Land said after reporting its third-quarter results. The developer, which counts Broadgate in the City and Meadowhall shopping centre near Sheffield among its portfolio of sites, said a "pause" in building was likely until confidence was restored.

The credit crunch has made it harder for property groups to raise funds, causing confidence to plummet in recent months. Investors have reacted by pulling their money from individual firms and then withdrawing millions of pounds from commercial property funds. Investors' nervousness most recently forced the insurer Axa to shut the doors of its life and pensions property fund to withdrawals. Similar moves by Friends Provident, Scottish Equitable and Scottish Widows have locked in thousands of investors for six months or more.

British Land said the decline in investor sentiment meant its quarterly net asset value fell by 16.7% to £14 a share, as portfolio values dropped 8.9%. Stephen Hester, chief executive of British Land, who oversaw the firm's switch to a tax-efficient real estate investment trust (Reit) last year, said that in the short term confidence remained low. "People are asking 'will financial institutions fire people in large numbers?' They haven't yet, but until the world economy plays out a little longer we won't know for certain. If they do let lots of people go then they won't need as much office space," he said.

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British banks set for bumper profits

Britain's banks are forecast to report bumper profits of more than £42bn for 2007 despite being forced to stomach losses caused by the credit crunch. Bradford & Bingley kicks off the reporting season on Wednesday and will be followed by all the major players, culminating in HSBC on March 3. Stricken lender Northern Rock has yet to set a date to report its figures. But with a backdrop of worsening economic conditions, there are suggestions that 2007 could be the last record year and that the profitability of the banking system is facing its greatest risk in a decade.

Since the financial markets began to dry up in the summer, the way banks finance their lending has shot to the forefront of investors' minds and concerns about the balance sheets of banks are expected to dominate the coming weeks. John-Paul Crutchley, banks analyst at Merrill Lynch, said: "The reporting season will be about balance sheet issues. It will be about what balance sheets look like, what the funding issues will do for growth and the outlook for 2008."

Any additional write-downs caused by investments in exotic trading instruments linked to the sub-prime mortgage crisis could also unnerve investors. Royal Bank of Scotland and Barclays are of concern and RBS in particular remains mired in speculation that it will need to raise as much as £12.5bn to shore up its capital base after the acquisition of parts of ABN Amro last year. The Barclays Capital investment banking arm may also need to admit to greater losses. James Hutson, analyst at Keefe Bruyette & Woods, believes "the biggest short-term risk to the sector remains the magnitude of investment write-downs".

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Who will pay the mortgage when the homeowner walks? You

In California, lenders are generally barred from getting money from a defaulting borrower. The lender gets the house and that's it, even if the borrower has $1 million in the bank. Only judicial foreclosure allows the lender to get the borrower's other assets, but it's slow, expensive and encourages a defense of loan origination fraud. Buying a house with little down is like having your cake and eating it, too. If the house appreciates, you keep the riches; if it doesn't, you walk and lose only what you put down, often nothing. It's wrong to insure such losses with taxpayer money.

Laws limiting investor liability are everywhere. If you own stock in a company that goes bankrupt, you don't feel a moral obligation to pay the company's creditors, because the law limits your liability. But the government doesn't guarantee those creditors' losses - and it shouldn't do so in the housing market, either. Visit www.uwalkaway.com, a company that sells kits explaining a homeowner's right to walk if the house isn't a good deal anymore. And "60 Minutes" recently featured a couple who explained they could afford their mortgage payments, but the house was "worth less," so why pay?

Who loses if the trend grows? The biggest loser will be mortgage bond investors, and next is originating banks and investment banks (because investors will try to sue for fraud and misrepresentation). Homeowners who put zero or 5 percent down lose little more than outsized hopes of future riches. And as uwalkaway.com notes, eight months of "free rent" will help them feel better. Now that Congress has passed higher loan limits for Fannie Mae, Freddie Mac and the Federal Housing Administration, Americans will lose because investors facing losses can get paid by Fannie, Freddie and FHA.

In the future, Congress should require California to allow lenders to garnish wages of affluent borrowers who walk away from their homes. It's dishonest to have it both ways: (1) federal tax money backstops investor and bank losses when homeowners walk away from homes, and (2) California law allows homeowners to walk away without liability - even if they have money to pay. It's not that the California statute is bad alone; it's that it's wrong for federal taxes to guarantee huge loans without homeowners guaranteeing those loans too.

Gov. Arnold Schwarzenegger wrote last Monday, "Unfortunately, the California families most hurt (by inability to get affordable mortgage credit) are in lower- and moderate-income brackets." Then, he magically ties this to raising the loan caps to $729,750. But 2006 California median family income was $64,563. This isn't an anti-poverty plan.

Even Marin, California's top 2006 county for median family income, was $99,713 - too low to benefit from the higher caps. I see how politicians could confuse median family income, because they don't hang out at places where they'd meet a median income earner. The new increase in the loan caps is nothing more than a handout. It's welfare for the wealthy - a group that tirelessly touts free market principles. Raising the caps is morally wrong, and it's also bad policy.

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