Year end funding pressures may accelerate bank failures.

September 1, 2008

 

According to this article at the Wall Street Journal, the FDIC has been urging the Office of Thrift Supervision, which is a division of the Treasury Department, to be more active and stringent in urging banks to strengthen their balance sheets. According to the same article, the OTS isnt very fond of the idea of pressing on banks. This is hardly surprising – it is the FDIC that will have to pay the depositors, and eventually reorganise these banks somehow, which is going to drain its reserves. There are more than 8400 banks in the United States, and a sustained streak of failures could put in jeopardy the strength of any insurer, however well-prepared it may be.

 

Sheila Bair has so far been relatively open about the risks to the banking system, given the secretive nature of her profession. She has given the public repeated warnings about the prospect of banks failures, while at the same time trying to inspire some sort of confidence by insisting that the government is in control of the situation.

 

But it is not enough that this serious matter is being dealt with by relatively lower ranking members of the government. There’s no reason to wait until the problem reaches catastrophic proportions. The credibility of Mr. Paulson’s intervention in the GSE issue has suffered for the reason that also made his sponsorship of last year’s SIV deal a failure – too little, too late. He and Mr. Bernanke seem to be unable to grasp the need for preemptive, far-sighted solutions, choosing instead to focus on saving the day. To see that the economic situation is not going to get any better any time soon requires only a brief glance at two pieces of data: FED’s lending survey, and mortgage defaults. And under these conditions, if the government is to have any credibility, it must act preemptively and with clear goals. Otherwise the patchwork of impromptu solutions is likely to be torn apart in the whirlpool of financial turmoil.  

 

As year end approaches, funding pressures are likely to intensify, along with bank failures. There’s even a possibility that some large bank will also default on its obligations.  The last two months of last year were nightmarish for interbank funding, and now, with the ECB actually discussing reducing or closing the window of lending for certain types of collateral, we’re likely to see an even worse year end scenario. Arguably the worst will hit British and Spanish banks, as they have been increasingly turning to the ECB to deal with problematic paper, but the general air of insecurity should permeate all sectors of the financial market, from bonds and currencies, to credit default swaps.

 

Banks failures are accelerating. It is certainly possible that they will reach levels of the savings and loans crisis. As demonstrated by the OIS spread, institutional actors already have little confidence in each other, what is not needed now is panic by the public. The FED and the Treasury already have considerable difficulty managing the relatively sophisticated players of the financial system, and a generalization of the problems is the last development that we need.  

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