When it rains, it pours. Bad news from the economic front keeps coming down on a daily basis. Today’s news is no different.
First, we see California’s Fremont General bank is on the verge of collapse.
Fremont General Corp., the California lender forced to exit the subprime mortgage business, was ordered by federal regulators to raise new capital or find a buyer.
The Federal Deposit Insurance Corp. called Brea-based Fremont undercapitalized and told management to take “prompt corrective action,” according to a company statement today. The FDIC imposed curbs on how much interest Fremont can pay to customers and said the bank can’t make any capital distributions to the parent company or affiliates. The agency also banned raises or bonuses to officers and directors.
Fremont has lost more than 90 percent of its market value in the past 12 months as the U.S. housing recession deepened. A year ago, regulators demanded the company stop making subprime loans because the bank hadn’t ensured borrowers could actually repay. Fremont had been the country’s fifth-biggest lender to consumers with poor or limited credit.
Fremont said March 18 it was evaluating alternatives that may include a sale or merger. Fremont’s operations include a bank with 22 branches. The bank had $7.96 billion in FDIC- insured deposits as of Sept. 30, according to a Nov. 8 news release.
Ratings company Standard & Poor’s on March 18 cut Fremont’s long-term counterparty credit rating to the lowest junk rating of D from CC.
Fremont’s bank specialized in lending to subprime customers. Now the bank is on the edge of solvency, having lost almost everything. Sure, those deposits are insured by the FDIC. But if you had your deposits in this bank, would you want to wait for the FDIC to get back to you in a couple months or so with post-Katrina federal government speed with your money? Could you afford to wait that long? Do you have confidence in the FDIC right now, knowing how many other banks out there are on the edge?
They are going to be overwhelmed. Fremont is just the latest bank in danger of going under. It could very well find a buyer and be saved, but then again, Fremont’s credit status is literally junk right now. Who would want to buy it? It’s dirt cheap sure, but it has an almost unknowable debt problem. Again, would you want to keep your deposits in any of Fremont’s 22 branches right now?
Meanwhile over in the Monolinke Nuke watch, Warren Buffett’s new effort to enter the monoline business is falling on hard times. The State of California is telling Buffett “Insurance? We don’t need no stinking insurance!“
Billionaire Warren Buffett’s new bond insurer may not get any business from California, the largest U.S. municipal debt issuer.
California Treasurer Bill Lockyer is leading more than a dozen state and local governments that say bond ratings exaggerate the risk of default, pushing up interest costs and forcing issuers to buy unneeded insurance. Lockyer said in a March 26 interview his state will shun Berkshire Hathaway Inc.’s venture because Buffett’s company supports the current ratings.
“It’s unfair to taxpayers,” said Lockyer, who estimates the present system may cost his state an extra $5 billion over the next three decades. “I hope Mr. Buffett will rethink that viewpoint. I don’t intend to do any business with his firm.”
Berkshire Hathaway Assurance was created in December after state regulators sought to help governments get coverage when losses jeopardized bond insurers MBIA Inc. and Ambac Financial Group Inc. The turmoil spread to auction-rate markets, where average debt costs almost doubled from January to more than 6.5 percent as of March 19. Instead of embracing Buffett’s company, some bond issuers began asking why they need insurance at all.
Elected officials and lawmakers point to a study by Moody’s Corp., the credit-rating firm in which Berkshire is the largest shareholder, that found only 41 defaults in 37 years. Missed payments are “extremely rare,” Moody’s concluded, prompting states including California and Connecticut to demand changes in ratings systems to reflect the low risk.
It’s rather ironic. California and other states have decided that the monolines are a pointless and unnecessary expense, and yet without the monolines, the bond auction system falls apart. Will bond traders even want to touch uninsured municipal bonds from California, a state that’s billions in the hole right now and facing the worst budget crisis in years? With plummeting home values (and corresponding falls in property tax revenue) how long can states like California and Florida stay above water without raising taxes in some other way?
No matter how you slice it, this is terrible for the current monoline insurer system. If states are getting out of the insurance game, then there’s less need for the insurers at all. They don’t generate new business, they go under…and boom, the Monoline Nuke.
Finally, there’s more evidence that the consimer spending engine I’ve been talking about this week is grinding to a halt.
Spending by U.S. consumers rose in February at the slowest pace in more than a year, another sign the economic expansion may be grinding to a halt.
The 0.1 percent rise in spending followed a 0.4 percent gain in January, the Commerce Department said today in Washington. The Federal Reserve’s preferred measure of inflation rose at the slowest pace since June.
“With flat real consumer spending, we’re going to be in a recession,” said Brian Bethune, director of financial economics at Global Insight Inc. in Lexington, Massachusetts, who correctly forecast the rise in spending. The inflation number suggests that “even though there are pressures on import costs, there is very little capability to pass those on to consumers.”
People buy less and that has a ripple effect throughout the economy, but here’s an extremely interesting passage in the article. Many folks have asked “will there be hyper-inflation?” My answer is that in the short term it’s possible, but in the long term the problem is a deflationary spiral as the dollar gets a massive readjustment.
Spending, which accounts for more than two-thirds of the economy, is tapering off as Americans face falling home prices, a loss of jobs and record energy costs. The slowing in inflation last month validates the Federal Reserve’s decision to focus on reviving growth at a time when prices were accelerating.
“This should be good news to some of the inflation-wary” members of the Fed, Joseph LaVorgna, chief economist at Deutsche Bank Securities Inc. in New York, said before the report. “We are not worried about inflation. Recessions always have a way of purging price pressures from the economic system.”
Which is true. The Fed’s most recent actions have actually been somewhat deflationary in the end because the sheer amount of loss of home equity from the housing depression has swamped the price increases brought on by a falling dollar…for now.
With the credit crisis leaving billions of assets locked up as illiquid mortgage junk of questionable worth, the Fed has actually been scrambling to prevent massive deflation in the system. The problem is that the Fed only has so much on its balance sheet before it has to start creating money out of thin air, and then inflation goes insane.
At the same time, with this level of trillions of dollars being taken out of the system by falling home prices, there has always existed a serious deflationary specter hanging over the Fed. The recession is lowering demand, and lowered demand is so far keeping so called “core inflation” in check, although food and energy inflation is going off the charts.
So we have two forces pushing on the dollar and prices. One is the slashing of interest rates, the plummeting dollar, and the spike in energy and food prices causing inflationary pressures. The other is the massive housing depression, the credit crisis, and the recession lowering demand, all causing deflationary pressures. So far the Fed’s drunken sailor spending has actually countered the month-to-month loss of equity in the housing market.
But one of those two has to give. My money’s on the former because the Fed only has X amount of money ($400 billion or so) left on its balance sheet and only so much rate left to cut. When the Fed runs out of these options, the massive deflationary pressures will still remain, and then we’re going to be in a world of hurt.
In that scenario, demand drops like a rock, fewer purchases are made, which means retailers, clerks, truckers and on down start getting laid off by the boatload, and that leads to lower demand…and more layoffs. A classic deflationary recession cycle could be on the way, and if anything else goes wrong in the financial sector (and you can bet it will) then the problem may explode into something much, much worse.
Be prepared.
