More banks on the brink?

IN THE two weeks after Rep. Charles Schumer (D-N.Y.) demanded an investigation of its financial health, panicked depositors withdrew $1.3 billion from IndyMac Bank, causing the first run on a U.S. bank since the 1980s savings-and-loan crisis. With its government takeover on July 11, IndyMac became the largest bank failure in decades.

Despite the quick rescue of most depositors, analysts from across the political spectrum agree that the U.S. financial system remains on wobbly legs almost a year after the sub-prime mortgage fiasco blew up.

Middle-aged folks may remember when bank closures were routine during the savings-and-loan crisis, when over 1,600 FDIC-insured banks were closed or received bailouts from 1980 to 1994. The evidence is still visible in the form of large buildings that housed "trustworthy" bank--now converted into stores, offices and even restaurants like "The Vault" in Berkeley, Calif.

As the second-biggest U.S. bank failure ever, IndyMac's $32 billion in assets dwarfs all 31 previous banks that failed since 2000. Treasury Secretary Henry Paulson spoke reassuringly about the 75-year safety record of FDIC-insured bank deposits. But the former Goldman Sachs CEO also said he expected the number of "problem" banks to grow.

At the reconstituted IndyMac Federal Bank, people waited for hours in long lines to withdraw their funds, insured by the FDIC for accounts up to $100,000. As of March 31, IndyMac had $19 billion in deposits, all but about $1 billion of which was insured.

The FDIC also paid an additional 50 percent advance it wasn't required to on higher deposits to the bank's estimated 10,000 affected customers, probably to prevent panic nationwide. However, FDIC spokesperson David Barr said it may take several years for the FDIC to completely settle all customer claims.

THIS LATEST blow-up is another result of the shaky state of the U.S. financial system in the wake of the mortgage crisis.

In the deregulated 1990s, major U.S. banks created new mortgage-based bonds and related securities that were traded worldwide--and when the mortgage payments slowed or stopped, these securities lost their value.

Today, many banks are technically solvent by counting their mortgage-backed securities as valuable, but no one really knows how valuable they are. And all the banks owe each other money in a tangled web of securities transactions--far more than the actual mortgages they were all betting on.

As a result, bank earnings in the first quarter of 2008 were half the level of a year earlier, and the average return on assets (profit rate) was the second lowest since 1991. While almost two-thirds of large banks (with over $10 billion in assets) saw their net income fall in the first quarter of 2008, four large institutions accounted for more than half of the $16.3 billion decline industry-wide. These banks have already received massive bailouts from the Federal Reserve since their housing-related securities were revealed to be bad and became non-tradable.

Because these banks are so big, the government is under pressure to bail them out whatever the cost. Analysts agree that these gigantic institutions, with their interlaced investments, are essential to the capitalist economy, and therefore "too big to fail." The government must rescue wealthy investors and lenders from their own bad judgment, encouraging ever more risky investments, a situation that economists call "moral hazard."

While IndyMac was the first U.S. bank run in the current financial crisis, a major run at the Northern Rock Bank shocked people across England last September, and bailouts were needed for banks holding U.S. mortgage-backed securities in Germany, France, the Netherlands and Australia.

IndyMac was a prime candidate for collapse. It was a leader in "Alt-A" mortgages, supposedly safer than sub-prime mortgages because they were given to borrowers with good credit, without verification of their income or assets.

IndyMac's assets also included "pay-option" adjustable-rate mortgages that allowed borrowers to temporarily make lower payments, shifting part of their interest payment onto the total loan balance (the principal). These lower starting payments also let lower-income borrowers qualify for larger loans, setting them up to lose their homes.

By March 2008, IndyMac's delinquent loans had ballooned to 8.86 percent of their total outstanding, six times higher than the level a year previously. Stockholders had already lost faith in IndyMac's viability before Schumer's warning letter, reducing its stock price from a 2006 high of $50 a share to less than $1.

In fact, IndyMac was a spin-off from notorious sub-prime mortgage lender Countrywide Financial, which has been sued by three states for fraudulent lending practices. Law enforcement sources told the Associated Press last week that the FBI was now also investigating possible home loan fraud at IndyMac.

More small and mid-size banks are expected to close branches, merge or fail in the months to come, as the weakening economy leaves working people and small businesses unable to repay loans. William Poole, the former president of the St. Louis Federal Reserve Bank, told Foreign Policy magazine this week:

We are going to have failures of large numbers of firms, financial firms in particular. A traditional important piece of business for community banks and regional banks are loans to real estate developers and builders. And now that some of those are going into default, it's leading to failures of smaller commercial banks, and the ones that were the most heavily involved in real estate are the ones at the greatest risk. It looks like there's more of that to come, because there is no sign of a revival in home-building.

While the FDIC officially listed 90 "problem" banks at the end of March, analysts say up to 150 small and midsize banks could fail in the next 12 to 18 months.

No wonder ordinary customers are nervous. After liquidating a certificate of deposit at IndyMac, 56-year-old Anne Martin planned to do the same at possibly troubled Downey Savings and Loan, told the Los Angeles Times, "I know they did a lot of loans, and I'm afraid they're going to be caught up in the same situation."

IF MANY more banks fail, taxpayers might end up bailing out the system again, as happened with the 1980s savings and loan crisis.

The FDIC has $53 billion set aside to cover $4.2 trillion in insured deposits, and IndyMac's bailout alone will cost between $4 billion and $8 billion. If it starts running short of funds to cover deposits at failed banks, the FDIC could raise fees for insured banks. But these costs are likely to be passed along to bank customers in higher fees, and the federal government must spend tax revenues to cover any remaining shortfall.

This is already raising hackles, as both Congress and the Fed have deferred providing real help to the millions of families losing their homes. New York Times business reporter Gretchen Morgenson points out that "asking Main Street to bail out Wall Street leads to this inevitable question: Weren't the financial folks the ones who helped create the mess we're in?"

As inflation and falling home prices eat away at people's savings, calls for increased regulation of financial institutions are intensifying, and the neoliberal dogmas that dominated for several decades have been thrown into question.

"If the pendulum swung away from government toward much greater confidence in markets during the last generation, the pendulum is clearly swinging back again now," Daniel Yergin, author of the pro-free market book and PBS series "The Commanding Heights," told the Los Angeles Times.

In a remarkable statement of liberal outrage from within the financial investment community, Rex Nutting, Washington bureau chief of the MarketWatch Web site, called on the Democratic presidential candidate Barack Obama to "push back" against the banking lobbyists and restructure the entire regulatory system. Because "the myths of laissez-faire capitalism die hard," Nutting said, Obama must "stir up the kind of populist anger that could send him to the White House with a real mandate for changing the way the economy works."

On the other hand, other top capitalists are hoping to use the crisis to make a quick buck--by buying up troubled banks on the cheap.

Billionaire financier Wilbur Ross Jr., owner of the infamous Sago coal mine where 12 miners died after an explosion in 2006, plans to put up about $2 billion and get another $4 billion from investors, including Arab sovereign funds, to buy up U.S. banks, according to Bloomberg.com. Meanwhile, foreign government funds have already invested billions in major banks like CitiBank.

As the real estate information Web site Doctorhousingbubble.com commented, "Although the housing crisis and credit debacle have been going on for sometime, seeing large banks in trouble and people scrambling for their money will hopefully light a fire with our politicians. All we get is corporate welfare for those on Wall Street, while middle class Americans struggle to keep enough money for a dignified retirement."

In the months to come, we'll see a battle among politicians and Wall Street about how much U.S. financial institutions need to be restructured. But only strong voices from unions and other working-class organizations will win changes that help the people on Main Street.