FDIC Begins Loan Sharking Toxic Assets with Fed Blessing
So here's what happened, and let me make this as simple as possible just in case you still don't understand what exactly toxic assets are. Granted, we're giving up the delicate intricacies of packaged securities by making it this easy to digest but in the interest of making this clear, we'll just have to chalk that up and move on.
Imagine in the years leading up to the financial crisis, the big investment banks were all belly-up to a 21 table. Of course, Goldman Sachs was probably counting cards too but we'll leave that be. AAA securities, of which these banks could not get enough, were the hand and the dealers were sometimes the same ones playing the game (which is fine, dealer gets to play too, right?).
Well just because a bundle of mortgages was rated AAA did not mean the hand held two Queens and an Ace. In fact, perhaps we wouldn't be in the trouble we're in now if more of them did.
Instead, after everyone had cleaned up on their 21s, with the smarter investment banks choosing to stand on 16 instead of gunning for that 5 of clubs, now the FDIC must come in and buy back the cards that tipped investor hands over 21. And since everyone was smoking the financial crack back in those days, the FDIC has quite a mess on its hands. It doesn't matter that it was the banks' choice to yell "hit!" on 18, nor does it matter that the taxpayer is the one who has to foot the bill (wtf, I didn't get a trip to Reno out of this deal). They're doing it whether you like it or not - and in fact, it's launching today!
The U.S. Federal Deposit Insurance Corp is launching the first test of its Legacy Loans Program to help banks rid their balance sheets of toxic assets so they can raise new capital and increase lending, the agency said on Friday.
The FDIC insures the deposits of U.S. banks and acts as the receivership for failed institutions by liquidating assets.
In the test transaction, a receivership will transfer a portfolio of residential mortgage loans to a limited liability company in exchange for an ownership interest in that entity, the FDIC said in a statement.
Accredited investors will be offered an equity interest in the limited liability company under two options.
The first is an all-cash basis, which is how the FDIC has recently sold receivership assets, with an equity split of 20 percent to the investor and 80 percent to the FDIC. The other option is a sale with leverage, under which the equity split will be 50-50 between the investor and the FDIC.
The FDIC said it will be protected against losses by the limits on leverage amount, the mortgage loans collateralizing the guarantee, and the guarantee fee.
"The FDIC will analyze the results of this sale to see how the Legacy Loans Program can best further the removal of troubled assets from bank balance sheets, and in turn spur lending to further support the credit needs of the economy," the agency said.
The clock is ticking for the FDIC to swoop in and clean up this mess before recent FASB changes force banks to move these assets from the dark moldy realm off balance sheet and into the light. And we are still a little mystified as to why the Federal Reserve would endorse a move like this knowing it will expose giant capital holes in already fragile banks but hey, who are we to ask why the Fed does what it does?
As we told you in June 12th's Fed Embraces FASB Changes, Toxic Asset Shuffle:
From the FRB's website, Federal Reserve responds to new accounting standards:
The Federal Reserve notes the Financial Accounting Standards Board's publication today of Statements of Financial Accounting Standards No. 166 and 167 (FAS 166 and 167), which will have a material effect on banking organizations' accounting for off-balance sheet vehicles. These statements, which become effective in 2010, address weaknesses in accounting and disclosure standards for off-balance sheet vehicles. The new standards amend Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (FAS 140), and FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities (FIN 46(R)).
The Federal Reserve is reviewing regulatory capital requirements associated with the adoption of the new accounting standards. In conducting this review, the Federal Reserve is considering a broad range of factors including the maintenance of prudent capital levels, the record of recent bank experiences with off-balance sheet vehicles, and the results of the recent Supervisory Capital Assessment Program (SCAP). As part of the SCAP, participating banking organizations' capital adequacy was assessed using assumptions consistent with standards ultimately included in FAS 166 and FAS 167.
Banking organizations should take into account in their internal capital planning processes the full impact of FAS 166 and 167 and assess whether additional capital may be necessary to support the risks associated with vehicles affected by the new accounting standards.
Now a sane person might wonder why in the hell the Fed would decide to do this knowing how bad off the banks are and that their only saving grace might be the fact that the majority of their toxic assets are off balance sheet, right?
And for the record, nearly two months later, we are still wondering why the Fed likes this idea but have a sneaking suspicion that this FDIC clean-up job has something to do with it.
Run, Sheila, run, the clock is ticking and you've certainly got your work cut out for you!