Questions and answers on the financial crisis
President/CEO Colorado Bankers Association
These are serious times and people need answers. Here are some honest answers to some key questions. This is the best information we can provide now; major developments may alter some answers. These answers become all the more relevant with the rejection of the financial stabilization bill in the U.S. House last Monday.
What is the crisis?
“Frozen credit markets” is the simple answer but that’s hard for most of us to understand. It means that credit is frozen or very difficult to obtain so consumers and businesses can’t borrow the money they need. When that happens it cascades throughout the economy – impacting Main Street, everyone.
What does this mean for the typical Coloradan?
Consumers need credit for everyday life, and businesses of all sizes rely on short-term credit for daily operations: make payroll, build inventory, and pay suppliers. Big companies go directly to investors and smaller companies and consumers go to the local Main Street bank. Due to recent events, investors are so nervous that they’ve essentially stopped lending to big companies. If they can’t get short-term funding, these companies have trouble paying their suppliers and making payroll. They have to slow production, lay off workers, and order fewer supplies and services.
Then each of the smaller suppliers becomes short on cash. These smaller businesses, in turn, reduce costs by cutting back on staff and services they use. Incomes fall and jobs are lost. Consumer spending falls. People have trouble meeting their debts.
The Main Street community bank that never made a subprime mortgage loan is affected too. Its customers are local citizens and various small businesses. As ailing small businesses and their employees see their bank deposits shrink and have trouble repaying their loans, it is more difficult for banks to renew existing loans and make new ones. As businesses try to expand or as families look to refinance mortgages or borrow for a car or to send their kids to college, money is in short supply. Our economy is driven by small businesses and consumer spending; without having credit available to them, how can our economy recover from the current malaise?
Thus, while global capital markets and short-term funding seem a world away from Main Street, no one is insulated from the impact. The tightening of credit in the wider market is just the beginning.
What is or is not a bank? Why’s that important?
Powerful photojournalism and dramatic headlines influence our views but don’t always mirror reality. The fact is: real banks are strong, solid and vibrant; and generally have the tools, oversight and experience to weather this economic turbulence.
“Real” banks actually are the safe haven to which people move funds during uncertain times. Don’t confuse real banks – insured by FDIC, with “bank” actually in their name – with investment companies, mortgage or insurance companies and other entities that claim they’re “just like a bank.” The term “bank” often is used inaccurately and way too broadly to refer to any business in finance; it really means an FDIC insured institution with “bank” in the name.
Media stories about “bank problems” and “bank bailouts” actually refer in most cases to nonbank entities. Now two major brokerage houses have converted to banks too (even with the required government regulation and examination), recognizing the stability and safety of being a bank.
Bank deposits are safe for three reasons: financial and managerial strength, government regulation and examination to assure safety, and FDIC insurance. Nationally banks have $1.3 trillion in capital, which increased significantly in 2008 despite the troubled economy. Capital is the owners’ investment in the bank. That protects depositors and could be lost by the owner if things go badly for the bank; it motivates owners to operate safely. There is another $129 billion in U.S. banks in reserves for potential loan losses. According to FDIC as of June 30, 2008, 8,385 banks in the U.S. are well capitalized and 91 are adequately capitalized while only 18 banks in the U.S. are undercapitalized. Respectively those categories account for 99.6 percent of all banking assets, .3 percent of assets, and .1 percent of assets.
How safe is my bank?
As of June 30, 2008, Colorado based banks have a strong $5.3 billion in capital (9.86 percent of their assets) which is strong. Loan loss reserves have remained steady at a solid 1.2 percent of loans recently. Noncurrent loans (90 days past due) are a modest .11 percent of total assets. Admittedly loan charge-offs are up slightly but still are low and have been affected very little by the subprime crisis. While banks account for 58 percent of residential mortgage lending, they constitute only 18 percent of foreclosures in Colorado, since banks try to make sure the borrower in fact can repay the loan. Other lenders aren’t so cautious. Banks in general didn’t make subprime loans – and generally don’t own mortgage-backed securities.
In addition to the stability in banks themselves, government examination and regulation provides another layer of protection. FDIC insured banks must meet high standards of financial strength and stability and FDIC and other regulators regularly scrutinize banks’ operations to ensure safeguards are met. Recently Richard Fulkerson, the state banking commissioner, who regulates state-chartered banks said, “The overall Colorado banking industry remains strongly capitalized and well positioned to handle any economic downturns.”
Troubled banks are the rare exception, not the rule. As of June there are 117 banks nationwide that are considered troubled (out of 8,451). On average since 1982, 87 percent of those “troubled” banks never failed – they worked their way back to health with extra attention like a patient gets in a hospital.
While some banks admittedly have some issues to address in this tumultuous environment, in general they are in safe and sound condition. They are the most stable of financial institutions.
How safe is my money? What should I do?
FDIC protects depositors dollar for dollar including principle and interest up to the insurance limit. It is insurance paid for by the bank that protects the depositor. A troubled bank is usually purchased by another healthy one – like when Chase took over WaMu and Citibank absorbed Wachovia – but if FDIC instead pays off depositors when a bank is closed, it does so within a few days. Since FDIC was created in 1933 no depositor has ever lost a penny of insured deposits. Fourteen banks nationwide have failed in 2008, 3 in 2007, 0 in 2006 and 2005, 5 in 2004, and 3 in 2003 versus the 1,617 banks that failed in the 1980s and early 1990s. That was a difficult era for banks but the industry made necessary adjustments and continues today to provide the public with the safest place for their money. FDIC has $45 billion in reserves and another $5 billion will be added this year alone by banks. Banks have paid tens of billions of dollars in premiums to fund the FDIC (no taxes fund FDIC), and we know we will have higher premiums for years to come. We accept that.
Depositors are insured up to $100,000 per depositor per insured bank. Certain retirement funds such as IRAs are insured up to $250,000. Depending on how deposit accounts are titled in different ownership categories the basic $100,000 protection can be increased to larger amounts. Certain trust accounts are separately insured up to an additional $100,000 if certain conditions are met.
Additional details are available from your local bank or at http://www.myfdicinsurance.gov, and at 1-877-ASK-FDIC (or 1-800-925-4618 for hearing impaired).
Investments involve risk and aren’t insured or guaranteed. Rates from investments like money market mutual funds (MMMF) attracted many people and businesses. But to stop a run on MMMFs the U.S.
Treasury on September 19 guaranteed balances in those funds. That was unprecedented; Treasury did that to keep some of them from collapsing. That guaranty is temporary and only covers amounts in the MMMFs as of that date.
In an era when people are concerned more about the return of their money than return on their money we’re glad to report that real banks provide both the safety of the deposited funds and the earnings on them.
How safe is FDIC?
FDIC is in a strong financial position to weather any significant upsurge in bank failures. The FDIC has all the tools and resources necessary to meet its commitment to insured depositors.
The FDIC insurance fund current balance is $45 billion – but that figure is not static. The fund will continue to incur the cost of protecting insured depositors and it constantly receives premium income from banks. FDIC soon will propose raising premiums paid by banks to ensure that the fund remains strong, and it will propose higher premiums on higher risk activities. The fund is 100 percent industry-backed.
Moreover, if needed, the FDIC has longstanding lines of credit with the Treasury Department, allowing very large sums of working capital, which would be paid back as the FDIC liquidates assets of failed banks. Only once in the FDIC’s history did it borrow from the Treasury – in the early 1990s – and that money was paid back with interest in less than two years.
How does the bank on Main Street feel about the crisis?
We’re as frustrated as the public – even angry. Real banks had little involvement in creating this, but we’re hurt too. These emotions don’t change the reality that action is needed now to assure that credit flows throughout the economy – to benefit all of us. If the economic stabilization package is not adopted, it is only a matter of time before businesses and individuals up and down Main Street feel the negative impact of frozen credit markets. We liken this to bad tasting medicine; we don’t like it but we need it to get healthier. Now it looks like we need to improve the taste of the medicine or let the patient go untreated.
Who/what caused this?
In short, all of us caused this. For decades the U.S. government has promoted home ownership and so has made money cheap and available. Unregulated mortgage brokers and mortgage lenders made poorly underwritten and toxic loans that were taken directly to Wall Street and securitized. Highly leveraged brokerage houses sold slivers of these loan packages to many different buyers. Buyers chased maximum rates as much as desperate homebuyers bought too much house with too little down. Insurance companies, pension plans, money market mutual funds and others bought the mortgage backed securities, ignoring the risk, but pursuing higher rates of return. The financial system is so intermixed that when one entity can’t meet its obligations then it hurts many other entities that trusted it. Most of us are hurt by this one way or another, and many parties contributed to the situation.
For example, your insurance company or pension plan may not directly own any of these bad securities, but they may be invested in companies or institutions that do – so practically everyone is affected.
What is the market doing to solve this?
While banks have issues they need to address, it is the only industry that has the financial strength to help resolve the current crises. A lot has happened recently. It seems long ago that Bank of America took over Countrywide (in March 2008); in September BoA bought Merrill Lynch. Chase purchased Bear Sterns and the S&L WaMu. Lehman Brothers went bankrupt and parts were purchased by an English and Japanese bank. Morgan Stanley and Goldman Sachs converted to banks; and Citi just won the bidding for Wachovia. The U.S. government helped substantially in the rescue of huge insurer AIG.
What is the proposed “bail out”?
Now Congress is considering a controversial $700 Billion Mortgage Stabilization Plan. Although we in banking don’t like doing it, for numerous reasons, we urge Congress to pass legislation to address this crisis in the most expeditious manner possible. It’s that bad tasting medicine. Monday’s rejection by the U.S. House means we all need to anticipate the consequences of no medicine.
As announced by Congressional negotiators September 28 the package includes:
Asset Purchase – The Emergency Economic Stabilization Act of 2008 (EESA) provides up to $700 billion to the Secretary of the Treasury to buy mortgages and other assets that are clogging the balance sheets of financial institutions, pension plans, and local governments
Taxpayer Protection – standards to prevent excessive or inappropriate executive compensation for participating companies, minimal risk to taxpayers by requiring that any transaction include equity sharing, requirement that most profits be used to reduce the national debt, fees on entities benefiting from the program if there’s a taxpayer loss after five years (many believe the program actually can make money from asset appreciation and equity stakes in assisted companies.)
Oversight and Transparency – prohibition of arbitrary or capricious actions, strong oversight board with cease and desist authority, transparency and public accountability through regular and detailed reports to Congress, independent Inspector General monitoring use of the Treasury Secretary’s authority, GAO audits to ensure proper use of funds and appropriate internal controls to prevent waste and fraud
Homeownership Preservation – maximum efforts to modify purchased mortgages for homeowners at risk of foreclosure, percentage of future profits to meet America’s housing needs
Funding Authority – $700 billion authorized with $250 billion available immediately and an additional $100 billion released upon certification that funds are needed, final $350 billion subject to a Congressional disapproval
Why do it?
Because real banks are in pretty good shape there is little direct impact on banks, but the crisis will have a dramatic indirect effect on our economy in Colorado as well as elsewhere and on every Colorado consumer and business if not addressed quickly.
It is very clear that we are in a severe credit crunch, where loans for consumers and businesses of all sizes are becoming less available and loan interest rates are higher than should be the case. In this atmosphere, expanded lending by banks is needed more than ever to make up the gaps caused by the retreat of other financial services firms. However, expanded lending must be backed by increased capital. One significant negative aspect of the financial markets crisis is that strong banks that wish to expand lending are finding it very difficult to raise capital to back that expanded lending.
The crisis on Wall Street and in financial centers around the world reached a point last week where extraordinary action is now required. In many ways, credit markets stopped functioning. The flow of credit and capital is the lifeblood of our economy, and without that flow the economy will be severely undermined. Furthermore, the value of investments and pensions will be negatively impacted.
While the focus has been primarily on mortgage lending, many other types of loans pass through the financial markets. Examples include automobile, credit card, student, and business loans. If the financial markets are not functioning, the demand for these loans cannot be funded. Potential borrowers simply will have to be turned away, with a cascading impact on our economy.
Much of FDIC-insured banks’ lending is based on deposits. However, banks of all sizes obtain some of their funding through the financial markets. For example, many banks use advances from the Federal Home Loan Banks (FHLBs) to provide liquidity, and the use of those advances has increased in response to the financial crisis. However, funding for the FHLBs is obtained through the financial markets and even these AAA-rated FHLB securities can be affected by the seizing up of those markets.
A primary reason that the financial markets have frozen is that there is no confidence in the value of certain types of assets. Financial institutions in fact own billions of dollars of assets that the dysfunctional markets are pricing well below their true worth.
The banking industry entered this crisis in very strong shape, having built record levels of capital. In fact, the vast majority of banks remain well capitalized, and banks have about $1.3 trillion in capital. The FDIC fund is sound and the industry is committed to paying the insurance premiums needed to keep it sound.
This is not action we sought in any way, but it is action that, most unfortunately, is necessary to address the financial crisis on Wall Street and to ensure that credit is available for consumers and businesses on Main Street. This crisis was largely created by unregulated mortgage brokers making toxic loans that were taken directly to Wall Street and securitized. Then the problem was exacerbated by Wall Street firms that had leverage levels well beyond those allowed for the banking industry.
Members of Congress and Secretary Paulson and Chairman Bernanke have pointed out consistently that the regulated banking industry is not the cause of this crisis and, in fact, that our regulation should serve as the model for tighter regulation of mortgage brokers, Wall Street firms, hedge funds, etc.
What should I do in the meantime?
Talk to your bank. Learn about the amount of capital it has, and about its reserves for loan losses. Understand FDIC coverage; go to http://www.myfdicinsurance.gov. If you still have concerns and your deposits exceed the insured amount, generally $100,000, consider spreading them out among several banks.
COLORADO BANKING STATS
Colorado stats including only Colorado-chartered banks 6/30/08:
– 156 Banks
– $53.9 Billion in Assets
– $34.5 Billion in Loans
– $42.9 Billion in Deposits
– $5.3 Billion in Equity Capital
Colorado stats including all banks doing business in the state as of 12/31/07:
– 197 Banks with over 1,600 offices across the State.
– Banking produces 24,000 jobs
– $97 Billion in Assets
– $57 Billion in Loans
– $81 Billion in Deposits
The Colorado Bankers Association brings together banks of all sizes and charters. Our members – the majority of which are smaller banks – represent 90 percent of the Colorado industry’s $100 billion in assets and 24,000 employees.
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From June through September, John Etchart spends most of the day driving a tractor through hayfields below the mountains near Meeker in northwestern Colorado.