Troubled Assets Revisited

Congressional Oversight Panel (August 2009) on the current stability of the United States financial system “In the run-up to the financial crisis, banks and other lenders made millions of loans to homeowners across America, expecting that their money would eventually be paid back. ... “They are no longer expected to be paid off in full, and they are very difficult to sell. There is no doubt that the banks holding these assets expect substantial losses, but the scale of those losses is far from clear. … “If the economy worsens, especially if unemployment remains elevated or if the commercial real estate market collapses, then defaults will rise and the troubled assets will continue to deteriorate in value. Banks will incur further losses on their troubled assets. The financial system will remain vulnerable to the crisis conditions that TARP [the Troubled Asset Relief Program] was meant to fix.”1

SINCE THE FINANCIAL SYSTEM REMAINS “VULNERABLE” IF ANYTHING GOES WRONG WITH THE ECONOMY (SUCH AS A DOUBLE-DIP RECESSION), IT IS VITAL TO UNDERSTAND WHAT WERE “THE CRISIS CONDITIONS THAT TARP WAS MEANT TO FIX.” THAT VULNERABILITY, ACCORDING TO THE AUTHORITIES QUOTED BELOW, IS “LITERALLY A MELTDOWN OF THE FINANCIAL SYSTEM”. Sen. Chris Dodd (D) of Connecticut interviewed by Mike Barnicle (September 2008) "I can‘t even begin to describe to you adequately the mood last evening with the leadership of the House, the Senate, Democrats and Republicans, in a meeting with Ben Bernanke, the chairman of the Federal Reserve, and Hank Paulson, the secretary of the Treasury, [SEC Chairman] Chris Cox, when they described what situation we‘re in not only here but globally. And if we fail to act in the coming days, the consequences for us here at home, as well as around the world — pension funds, 401(k)s, mutual funds, jobs, literally a meltdown of the financial system. … "I think — they said, Look, I mean, this is — we‘re at a moment here, not a matter of weeks away or months away or years away, we‘re a matter of hours or days away from the largest collapse of the financial markets in the history of this country, and the effect would be a global effect. And this was a very sobering moment. I‘ve listened to a lot of very important moments

in a quarter of a century here, but I can‘t recall another moment as sobering as that one. "And I will tell you, Michael, what happened immediately thereafter was this five or ten seconds where the oxygen went out of the room. That‘s how dramatic it was. And obviously, these men don‘t use hyperbole. There was no press in the room. There was no one trying to score points politically. It took the breath away of everyone in that room."2

Rep. Paul Kanjorski (D) of Pennsylvania, chairman of the House Capital Markets Subcommittee, speaking on C-Span "Look. I was there when the Secretary [of the Treasury] and the Chairman of Federal Reserve came those days and talked with members of Congress about what was going on. It was about Sept. 15th. [note: The closed door meeting described in the message below was in fact on Thurs. Sept. 18, 2008.] Here's the facts: and we don't even talk about these things. On Thursday, at about 11 o'clock in the morning, the Federal Reserve noticed a tremendous drawdown of money-market accounts in the United States to the tune of $550 billion was being drawn out in a matter of an hour or two. The Treasury opened up its window to help. They pumped $105 billion in the system and quickly realized that they could not stem the tide. We were having an electronic run on the banks. They decided to close the operation, close down the money accounts, and announce a guarantee of $250,000 per account so there wouldn't be further panic out there. And that's what actually happened. If they had not done that, their estimation was that by 2 o'clock that afternoon $5 1/2 trillion would have been drawn out of the money market system of the United States; [it] would have collapsed the entire economy of the United States and within 24 hours, the world economy would have collapsed. Now we talked at that time about what would happen if that happened. It would have been the end of our economic system and our political system as we know it. And that's why, when they made the point we've got to act and do things quickly, we did."3

Investor Warren Buffett, interviewed by Becky Quick (March 2009) "BECKY: ... you told us this was an economic Pearl Harbor about six months ago, but did this happen more quickly or more severely than even you expected? "BUFFETT: It certainly happened clofse to the worst case. I mean, you never know what's going to happen, but I would not have--I would not have thought there could've been a much worse case than what has happened. Although, I will say this, the Fed did some things in September when it happened... "BECKY: Mm-hmm. "BUFFETT: ...that were vital in keeping the place going. I mean, when the--if they hadn't have insured money market accounts and, in effect, commercial paper, you know, you and I would be meeting at McDonald's this morning. "BECKY: Instead. "BUFFETT: Yeah. Right."4

THE QUESTION, THEN, IS IF THERE IS ANYTHING ON THE HORIZON THAT COULD DERAIL RECOVERY AND PRECIPITATE SUCH A THREAT. TO CLOSE THIS BRIEF REPORT, HERE ARE SOME ISSUES THAT HAVE BEEN MENTIONED OF LATE AS DANGERS TO THE ECONOMY: INCREASE OF US BUDGET DEFICIT "... the U.S. budget deficit poses a greater risk to the financial system than the collapse in commercial real estate prices."5 WINDING DOWN OF STIMULUS PACKAGES "It's not clear that these economies can continue to move forward without stimulus."6 CREDIT IS SHRIVELLING UP "US bank lending is contracting at an unprecedented annualized pace."7 "Both bank credit and the M3 money supply in the United States have been contracting at rates comparable to the onset of the Great Depression since early summer, raising fears of a double-dip recession in 2010 and a slide into debt-deflation."8 TROUBLES IN BANKING: THE FDIC IS RUNNING LOW ON INSURANCE FUNDS AND MORE BANK FAILURES LOOM "U.S. bank regulators are considering tapping a line of credit with the U.S. Treasury Department and may explore other lesser-known options to replenish the dwindling fund that safeguards bank deposits."9 " ... the number of financially sound banks is declining and ... the ranks of troubled institutions are growing. ... figures show more stress in the banking industry in the second quarter of 2009 than in the immediately previous periods."10 "... banks are neither at the beginning or the end of the problems presented by a difficult economy ... They are in the middle and significant challenges still remain.'"11 TOO BIG TO FAIL BANKS ARE EVEN BIGGER NOW, INCREASING RISK TO THE ECONOMY "Unfortunately, measures taken during the past year – while necessary - have only reinforced the idea that some financial firms are simply too big to fail. Today, we now have fewer players in critical areas of our markets. The market is even more concentrated and interconnected

than before. And unless we adopt needed reforms, our system will be more, not less, fragile after this crisis."12 PRIME LOAN FORECLOSURES ARE RISING "The broadening of the foreclosure crisis to include prime loans due to high and rising unemployment ... threatens the economic recovery."13 ADJUSTABLE RATE MORTGAGES ARE COMING DUE "... option ARMs [adjustable rate mortgages], which accounted for $750 billion in mortgages made from 2004 to 2007 ... remain a risk, especially because many are not eligible for refinancing. About a third are already in default ..."14 COMMERCIAL REAL ESTATE LOANS ARE GOING BAD "Commercial loans are likely to be the biggest drivers of future bank failure..."15 "... a downturn in the commercial real estate market could derail the country's recovery."16 "Most commercial property mortgages made within the last few years are headed for default ... more than $1 trillion in values will be lost over the next few years ... Penner estimates that almost $2 trillion in commercial property debt will come due in the next four years. 'Who is going to refinance all these loans?' ..."17 "As things stand, this next wave of the crisis will sabotage the recovery -- driving up bank failures, FDIC bailouts and problems for some large insurance companies. Indeed, Congress will surely wind up having to bail out the FDIC itself."18 "... without immediate changes in bank regulations and laws governing Real Estate Mortgage Investment Conduits (REMICs), this next wave of the credit crisis will sabotage economic recovery — driving up bank failures and bailouts by the FDIC. The recession could become a depression."19 IF GM AND CHRYSLER DON'T MAKE RADICAL CHANGES, THEY ARE IN TROUBLE "... either the government will need to step in again, or the companies will need to liquidate, with much of the attendant misery that the government sought to avoid in 2008 and 2009."20 That misery was expressed in this pre-bailout headline: "GM, Chrysler Failure Would Push Economy Into Abyss"21 LACK OF HOUSEHOLD SPENDING THREATENS RECOVERY OF US ECONOMY, 70 PERCENT OF WHICH DEPENDS ON CONSUMER SPENDING "There is no way that this recovery can be sustained unless we see a pickup in household spending. The big question out there is will we see Americans spend again to keep this recovery alive ..."22

"Only 8 percent of U.S. adults plan to increase household spending, almost one-third will spend less, and 58 percent expect to 'stay the course,' a Bloomberg News poll showed. More than 3 in 4 said they reduced spending in the past year."23 Unemployment has hit consumer spending, which accounts for about 70 percent of U.S. economic activity. Without more help from consumers, the economy will have trouble pulling out of the longest recession since World War II."24

1 Source: "August Oversight Report: The Continued Risk of Troubled Assets," Aug. 11, 2009, Congressional Oversight Panel, pp. 4,5 (emphasis added) http://cop.senate.gov/documents/cop-081109-report.pdf 2 Source: MSNBC http://www.msnbc.msn.com/id/26841599 3 Source: C-Span http://zerohedge.blogspot.com/2009/02/how-world-almost-came-to-end-at-2pm-on.html 4 Source: CNBC http://www.cnbc.com/id/29595047 5 Source: John Taylor, economist, quoted by Reuters http://www.cnbc.com/id/32527814 6 Source: Mark Zandi, economist, quoted by the Associated Press http://finance.yahoo.com/news/World-emerging-fromdeep-apf-2306723103.html?x=0 7 Source: Zero Hedge and Albert Edwards, analyst http://www.zerohedge.com/article/albert-edwards-global-creditcrunch-not-receding-it-intensifying 8 Source: Ambrose Evans-Pritchard, journalist http://www.telegraph.co.uk/finance/financetopics/recession/6190818/UScredit-shrinks-at-Great-Depression-rate-prompting-fears-of-double-dip-recession.html 9 Source: Reuters http://www.reuters.com/article/ousivMolt/idUSTRE58H34F20090918 10 Source: The New York Times http://finance.yahoo.com/banking-budgeting/article/107585/what-the-stress-tests-did-notpredict.html 11 Source: James Chessen, economist, quoted by Marketwatch http://www.marketwatch.com/story/fdics-problem-list-oftroubled-banks-tops-400-2009-08-27?siteid=nwham 12 Source: Federal Deposit Insurance Corporation http://www.fdic.gov/news/news/speeches/chairman/spsept1809.html 13 Source: Mark Zandi, economist, quoted by The Los Angeles Times http://www.latimes.com/business/la-fi-mortgagedefaults21-2009aug21,0,4202530.story 14 Source: The New York Times http://www.nytimes.com/2009/08/27/us/27arms.html?_r=3&ref=business 15 Source: Sheila Bair, FDIC chairman, interviewed by CNBC http://www.cnbc.com/id/32651797/site/14081545 16 Source: ABC News http://abcnews.go.com/Business/fed-reviews-smaller-banks-delinquent-commerical-realestate/story?id=8595972 17 Source: The Dallas Morning News and Ethan Penner, real estate financier http://www.dallasnews.com/sharedcontent/dws/bus/industries/commrealestate/stories/DNcommercial_11bus.ART.State.Edition1.3cf344e.html 18 Source: The New York Post http://www.nypost.com/p/news/opinion/opedcolumnists/facing_the_next_real_estate_collapse_5NbxrlBoP3xbtOHa9TG mTO 19 Source: Scott S. Powell and David Lowry, analysts, writing in The Atlanta Journal-Constitution http://www.ajc.com/opinion/commercial-real-estate-crisis-139350.html 20 Source: Congressional Oversight Panel report quoted by ABC News http://abcnews.go.com/Business/tarp-report-raisesquestions-automaker-bailout/story?id=8520812 21 Source: Bloomberg http://www.bloomberg.com/apps/news?pid=newsarchive&sid=agI3NWvegYUI 22 Source: Bernard Baumohl, economist, quoted by Reuters http://www.reuters.com/article/ousivMolt/idUSN0829208920090908 23 Source: Bloomberg http://www.bloomberg.com/apps/news?pid=20601068&sid=a4V3eqGKWJx8 24 Source: The Associated Press http://finance.yahoo.com/news/Stocks-fade-as-traders-worry-apf-712486094.html?x=0 Collected and presented by Economic Signs of the Times http://economicsignsofthetimes.blogspot.com/