Bank Buyers Wait For FDIC Subsidy
A Wall Street Journal commentary authored by Dan Katz and Stephen Miren screamed “The FDIC Guarantees Instability” as if it were posted on Mises.org. The punchline is given away in the subtitle: “The ‘system-wide’ deposit backing only kicks in once a bank fails, so potential buyers wait for the subsidy.”
So, JP Morgan head and FDIC friend Jamie Dimon waited until First Republic fell into the arms of the deposit insurer rather than go make a deal directly with First Republic. This way, as Katz and Miren write, “By the FDIC’s estimate, the takeover comes with a taxpayer-funded subsidy of $13 billion, including a loss-sharing agreement in which the FDIC will absorb 80% of First Republic's losses on residential and commercial loans.”
As we possibly head into, or are already in, a recession, the above mentioned FDIC loss-sharing deal will become very important. Based on experience from the Great Financial Crisis, any ex-First Republic borrower who gets into trouble can expect Dimon’s lieutenants in the field to say, “no, we’re not working anything out. Pay now or we'll put you in default.” Say the borrower comes back and says, “Listen, can I give you 80 or 90 cents on the dollar for my loan, or I’ll give you more collateral, or….” Again, since JPM is already covered for the first 80%, they know they will get a 100% recovery by dropping the hammer and will do so.
Meanwhile the next bank in the line of fire, PacWest “pledged an additional $5.1 billion of its loans to the central bank on Wednesday, which the lender said resulted in an additional borrowing capacity of $3.9 billion,” reports Reuters.
So, the Federal Reserve is slowing PacWest’s roll toward insolvency. Of course PacWest is not lending anyone any money, the money from the Fed is explained as follows, "We pledged additional assets as collateral for borrowings to increase our liquidity position for potential deposit outflows," PacWest said in a filing.
There are rumors that Western Alliance has stopped funding at least some construction projects it has committed to.
Rohit Chopra foresaw this mess last October writing, “Here’s the pickle that we’re in. The United States now has a substantial number of massive banks with over $100 billion in assets. These aren’t the very biggest banks that are deeply integrated into the global financial system, like JPMorgan Chase and Citigroup. These are domestic systemically important banks that are heavily focused on retail and commercial banking. They have grown much larger over time given that the Justice Department and the bank regulators have been relatively strict when reviewing small bank mergers and quite lax when evaluating big bank buyouts.”
The May 11th Almost Daily Grant’s wrapped up a piece entitled “Shift Key” about the current state of credit spreads with a quote from New York University Finance Professor and financial historian Edward Altman,
My current assessment is that the benign credit cycle we have enjoyed since 2010, with the exception of a few months in early 2020, is over. We recently reached an inflection point to an average credit risk scenario.
If we continue to incur unexpected shock catalysts, similar to the recent Crypto and Silicon Valley Bank and other banking meltdowns, combined with a “hard-landing” economic recession, we could witness another financial-credit crisis, with non-financial corporate risky debt default rates rising to perhaps 10%, or more, over one or two years.
Meanwhile, a rose-colored glasses wearing Jamie Dimon said on May 11th as paraphrased by CNBC, “Regional banks are “quite strong” and will have good financial results, but managers are worried because of the bank runs that have taken down three firms, he said.”
Depositors are not listening to Mr. Dimon and neither are regional bank shareholders.
