Another 6 US banks fail

This week I am going to discuss the failure of yet another batch of US banks.

Jim Sinclair is a precious metals expert who has authored numerous magazine articles and three books dealing with a variety of investment subjects, including precious metals, trading strategies and geopolitical events, and their relationship to world economics and the markets. He is a frequent and enormously popular speaker at gold investment conferences and his commentary on gold and other financial issues garners extensive media coverage at home and abroad.and a very generous, knowledgeable and person, has a wonderful website www.jsmineset.com that is literally a mine of accurate and essential information about gold. Having followed it for over two years now, I would like to quote from CIGA (Comrade in Golden Arms) Richard in today's posting about six US banks that have just failed:

Earlier this year, the Financial Accounting Standards Board (FASB) capitulated to pressure from banks and financial institutions and allowed financial institutions to value worthless assets at values that the financial institution had concluded were correct, not values that were market-related.

Six more banks were closed this week. Collectively, they had assets of $13.425 billion and deposits of $9.368 billion. The total estimated cost to the FDIC’s Deposit Insurance Fund (“DIF”) is $2.384 billion.

Consistent with recent trends, by the time these banks were finally closed their condition had deteriorated to a point far worse than banks were allowed to in the years before this crisis. As a result, the FDIC continues to incur much higher rescue costs than it would if it were able to close them at a stage more like they have been historically. The total cost to the DIF of closing this week’s failed banks exceeds 25% of their total deposits. By contrast, the FDIC was only required to make up about 5.7% of insured deposits in connection with the three banks it closed in 2007, at the beginning of this crisis.

The details of this week’s closings also point out some troublesome discrepancies between the value of assets stated on the banks’ balance sheets and their perceived market value. Five of the six acquiring banks this week required the FDIC to enter loss-share agreements as a condition of their purchasing the assets of the failed institutions.

Insisting upon a loss-share agreement indicates the prospective buyer is so worried about the value of the assets it is purchasing, it is unwilling to alone bear the risk that their value will turn out to be lower than anticipated. In the case of the three banks closed in 2007, none of the acquiring banks required that the FDIC enter into a loss-share agreement.

The largest of this week’s bank failures was AmTrust Bank of Cleveland, Ohio. On paper, AmTrust appeared to be very well capitalised. It claimed to have assets of $12 billion against deposits of $8 billion, a ratio of 1.5:1.

However, closing AmTrust cost the FDIC an estimated $2.0 billion, 25% of the value of its deposits. Furthermore, the purchasing bank, New York Community Bank (“NYCB”), was only willing to purchase about $9.0 billion (75%) of AmTrust’s assets, and did so only on the condition that the FDIC agree to share the risk of loss with respect to $6.0 billion of that amount. In the final analysis, it appears that NYCB had confidence in the value of only $3 billion of the $12 billion in assets on AmTrust’s balance sheet.

Furthermore, the parties appear to have concluded that the $12 billion in assets listed on AmTrust’s balance sheet were only worth about $6 billion. Otherwise, the FDIC would not have allowed for a $2 billion charge to the DIR to make good on AmTrust’s $8 billion in deposits.

There is not enough information available at this point to determine the causes of this huge discrepancy between the claimed and actual values of AmTrust’s assets. However, in the absence of an allegation of criminal fraud it stands to reason that the failure to require fair value accounting contributed substantially to this discrepancy.

The facts surrounding the closings of the remaining five banks this week raise similar concerns.

This week’s bank closings continue to warn of U.S. banks’ deteriorating balance sheets and of the FDIC’s inability to resolve troubled banks before they cause extraordinary losses. Nationwide, banks are going broke much faster than the FDIC can close them. This creates a domino effect whereby the FDIC loses the ability to mitigate losses at the same time it exhausts its capacity to pay claims.

As of November 12, 2009, the DIF had fallen into deficit and in order to replenish it, the FDIC ordered banks to pre-pay three years’ worth of deposit insurance premiums, amounting to about $45 billion. In the three weeks since then, the FDIC has been forced to acknowledge another $3.394 billion in liabilities – more than 7.5% of the new revenue it is attempting to raise by way of the pre-payments. Very soon the entire $45 billion will be wiped out and the U.S. Treasury will become the FDIC’s sole source of funding for years to come.

Given this dire situation with the banks in the US, the case for holding physical gold strengthens. If you have not yet added gold into your portfolio, I strongly suggest that you investigate your options and consider putting at least 10% of your assets into the yellow metal.