Most real financial catastrophes play out over a period of years, or they would not be catastrophes at all. The markets are disrupted briefly by an event or two and then go back in the direction in which they were moving, which is, after a disruption short or long, by definition, up.
Long market corrections give experts ample opportunity to make fools of themselves. Some emerge as real champions, people who can make statements so certain and confident that they are later seen as symbolic of the folly of the times. Every real disaster has its own Neville Chamberlain or two.
Sheila Bair, the FDIC chairman, remarked that “In many important respects, financial markets are returning to normal.” The comments were part of her presentation of the agency’s status. The number of “problem banks” being watched by the FDIC rose to 416 at the end of the second quarter from 305 at the end of the first. The assets of the troubled firms rose from $220 billion to $299.8 billion during the same period. Someone who keeps records of odd historical data about the banking system reported that the number of banks on the list was the highest it had been since 1993.
The FDIC has a pressing problem which was also part of the discussion of troubled banks. The agency’s fund has fallen to $10.4 billion from $13 billion in March. A large number of bank failures or the failure of a few big ones would send the FDIC to the Treasury for more funds. That would not instill much confidence in the burgeoning improvement in the credit system, if such an improvement actually exists.
Bair defended her position for the financial world’s improved status by explaining that bank losses are no longer due primarily to the toxic assets that nearly took the credit system down eight months ago. Most of the trouble causing bank write-offs now is from commercial and consumer loans.
Those two parts of the bank debt equation are not as trivial as Bair might make them seem. Total credit card debt was about $1 trillion at the end of last year. That does not include home equity loans which no longer have home values to support them. Credit card defaults are very closely tied to unemployment and home equity default to home values. The idea that the bank write-offs of these loans could total over $100 billion is by no means absurd.
The other specter of losses comes from the commercial real estate sector. According to a Bloomberg article in March, “The country’s 10 biggest banks have $327.6 billion in commercial mortgages, which face a wave of defaults as office vacancies grow and retailers and casinos go bankrupt. A projected tripling in the default rate would result in losses of about 7 percent of total unpaid balances, according to estimates from analysts at research firm Reis Inc.” Those figures do not include all of the medium-sized banks some of which would be included among the firms on Bair’s list of 416 troubled institutions.
The financial and credit crises are not ending. They are just moving to another arena, one in which loans that originally had some collateral are getting into deeper and deeper trouble. The collateral is not of any comfort when its value is decreasing at alarming rates. The government may be in better shape to weather this trouble than it was during the credit crisis of late last year. Banks know that they can turn to the Fed for short term funding. It is unlikely that any of the TARP money will have to be redeployed, but that is not out of the question. The Administration has also seen all of the personal and property default projections and can see them coming.
But, financial markets are not returning to normal, though Bair may argue otherwise.
Douglas A. McIntyre
