What is the cause of the banking crisis?

What You Should Know If Your Bank is in Trouble
By Edmond P. Freiermuth

The recent FDIC takeover of IndyMac Bank, seizure and sale of Washington Mutual and forced sale of Wachovia, indicates that the seize-up in credit markets has spread from global and investment banks to regional and community banks. While the vast majority of the banks in the United States are in sound condition, there may be more failures to come. Business owners should know the facts about being a depositor or a borrower in a FDIC-insured bank. Here are some frequently asked questions.
What is the cause of the banking crisis?

During the past decade, two key financing flaws occurred. First, the mega-banks began to package and sell the loans they made. This process, called asset “securitization,” allowed for the origination of loans at an unprecedented scale. The banks that originated the loans kept little of the debt on their books. Second, the underwriting standards for giving loans were “liberalized” to such an extent that millions of traditionally unqualified borrowers were granted loans they could not repay. This created trillions of dollars of high-risk securitized debt.
As home foreclosures rose, the entire asset class of securitized debt became suspect and investors no longer wanted to own securitized debt, also known as “paper.” This led to a chain reaction: Banks could no longer sell off loans and were forced to look for other sources of money to lend and those sources quickly tightened up. Now banks are in a position where they can’t make many loans because they themselves can’t borrow the money to make loans. Banks need to make loans to make money.
While big banks and investment banks made substantial disclosures (acknowledged losses of $400 billion so far) and received cash injections earlier in the year, regional and community banks are now going through the same process. This is especially true in U.S. regions that experienced the greatest benefits of hyper-growth in real estate-related industries. California and Florida are the two biggest states impacted by what could reasonably be called a real estate depression.

Additional worries are coming from the fact that Freddie Mac and Fannie Mae (holders of about half of all U.S. mortgage debt) may not have enough cash or credit to continue buying mortgages. Without a bailout from the U.S. government, the housing market could effectively shut down. The U.S. economy is resilient and will get through this test. But the banking industry losses will be severe--perhaps exceeding $1 trillion over the next two years.

Liberal lending in all of the arcane new forms created by the world’s investment banks and commercial banks drove the global economy for the past 10 years. The mutual funds, banks, money markets and individuals who invested in “paper” will bear the losses and are likely to be extremely wary in the future (at least for a while). So, banks will be required to hold more of the loans they create. Although The Federal Reserve and other central bankers will provide liquidity to the banking system, chastened lenders are unlikely to be quite so cavalier in extending credit to borrowers without demonstrable means of repayment. In addition, regulatory oversight will be increased.
How should businesses with more than $100,000 in FDIC-insured deposits in a single bank protect their assets?
The FDIC insures business deposits on a per-taxpayer-ID basis up to $100,000. To fully protect bank deposits over $100,000 you can take one of two actions.
• If you are borrowing money from the bank, pay down the amount of the loan outstanding such that your depository account balance does not exceed $100,000.
• You can transfer funds in excess of $100,000 to other banks.
How can individuals protect more than $100,000 in an FDIC-insured bank?
Individuals can get more coverage by designating different ownership categories to their accounts at the same bank. For example, a husband and wife can qualify for $600,000 in total FDIC coverage at one bank by opening the following five account types.

What does it mean if a bank is on the FDIC’s watch list?
It was recently reported that 90 banks are currently on the banking regulators’ “watch list.” Being on the list does not necessarily mean that failure will occur. It does mean that the banks’ ability to grow, without significant injections of additional capital, will be curtailed. The banks on the list may be required to shrink their outstanding credit.
If you bank with a bank on the watch list, the bank might reduce your revolving credit line, decline to make you a term loan, or increase your interest rate.
How can business owners perform due diligence on a bank?
The common stock of most banks is publicly traded. As such, they are required to file periodic financial reports with the U.S. Securities and Exchange Commission. Additionally, all banks must also file periodic Call Reports with bank regulators. Banks also publish financial statements that are available just by asking your relationship manager/loan officer. These documents contain a wealth of information about banks.
Are there any signs that a bank might be in trouble?
The single greatest warning sign that indicates that bank is in financial trouble is when regulators issue a “cease and desist order” to the bank. Other signs a bank is in trouble include:
• Seriously declining stock value
• High executive turnover
• Recent changes in the management of your account
• No longer ranked as “well capitalized” by regulators.
Additionally, if bankers seeking your business should suddenly inundate you with offers, it may be that they know something about your bank that you don’t.

What happens if your business has a loan from a bank that gets taken over by the FDIC?
If the FDIC takes over a bank, it attempts to find a buyer for the bank for the full value of all assets. If the FDIC cannot find a buyer, it will sell liquid assets such as government securities and then try to sell loans, in bulk, to another lender, or lenders. In either case, if you have a loan with a bank that has been taken over, you may see changes in the payment method or terms of the loan. In the worst case scenario your loan may be called, forcing you to find a new lender. If your business is not performing well and/or is leveraged more than 3:1, it may be difficult to find a new lender. It’s good planning to have a back-up line of credit.
If your business has a loan from a bank that is taken over by the FDIC, you should immediately begin searching for a banking relationship with a new lender.

When the FDIC takes over a bank, how long do businesses have to wait before they can access their money?
If your total depository accounts are within the FDIC insurance limit of $100,000, you should be able to gain full access to funds within a few days. If your accounts are above the limit, it could take much longer and the exposure to loss could be significant for the excess amount. It all depends upon how bad the condition of the bank is, and when and how much the FDIC believes will ultimately be received from the sale or liquidation of the assets. Typically, the FDIC makes a preliminary estimate of the expected loss and then allows access to a certain percent of the uninsured funds on deposit in a few days.
How long will the turmoil in the credit and equity markets last?
Expunging the excesses caused by irresponsible lending and borrowing will take another 18-24 months to correct. There will, regrettably, be more bank failures.
Vistage Speaker Ed Freiermuth has more than 30 years' experience in financing and advising businesses of all sizes. He has worked directly with the CEOs and senior managers of more than 250 companies. As an independent business consultant, he works closely with lending officers, attorneys, accountants, venture capitalists, investment bankers and others seeking to resolve complex financial, marketing and operational challenges.
Keeping Your Cash Safe: How to Insure up to $50 million in Bank Deposits
By Paul Diamond

As confidence erodes in the U.S. financial system and the government scrambles to create a plan to restore that confidence, many business owners are wondering about the safety of their cash. While treasury bills, notes and bonds are typically viewed as the safest place for cash, there are new insured and convenient bank options.

Currently, the Federal Deposit Insurance Corp. (FDIC) insures up to $100,000 of a personal bank account and the same amount for a business bank account. If your bank were to fail, the FDIC guarantees that you will get up to $100,000 of your money back. Beyond that, historical averages show that claimants typically get back about 73 cents on the dollar. What’s the solution to insuring 100 percent of your business or personal cash that exceeds $100,000?

Enter CDARS (pronounced "cedars"). The Certificate of Deposit Registry Service allows people and businesses to work with one bank—their own bank—and get FDIC insurance on all of their cash, up to $50 million placed in Certificate of Deposits. CDARS is owned by Promontory Interfinancial Network, which has brought together some 2,500 financial institutions in the U.S.

Here’s how it works
If your bank is a member of the CDARS network, it can place your money in CDs at other banks that are members, thus spreading your money across multiple banks to take advantage of the FDIC insurance of $100,000 at each bank. If your bank is not a member, you can most likely find a member in your region.

You earn one interest rate on all the CD investments placed through CDARS. There’s no need to tally disbursements for each CD. You receive one statement that details all of your CD investments. There are no annual fees, subscription fees or transaction fees. You get all of the interest from the CD product that you choose. You can also select from maturity dates ranging from four weeks to five years and choose the terms that best suit your investment needs.

For many businesses, CDARS can be a valuable cash management or long-term investment tool. By providing access to up to $50 million in FDIC insurance through a single bank, CDARS can help simplify your job and improve your business' financial performance.

What’s the downside of CDARS?
The downside is that mostly smaller banks participate in its network. Typically, large national banks like Washington Mutual and Bank of America are not members. Additionally, CDARS makes its money by charging participating banks a transaction fee, so the CD rates you get through CDARS may be lower average CD accounts.

Insured money-market funds
On September 19th, the Treasury said that it will offer insurance coverage to money-market shareholders. It then clarified the announcement on September 21st, saying the insurance was “for amounts held by [money-market investors] as of the close of business on Sept. 19, 2008.” This means that any money investors had in a money-market fund as of the close of business on Sept. 19th, 2008 may be insured, if the money-market fund elects to pay the premiums for the new insurance. This insurance is slated to last for one year.

Money-market deposits made after September 19th are not eligible for coverage. Additionally, investors who lost money in money-market accounts prior to September 19th are not covered by this new insurance. Investors in the Reserve Primary Fund, which saw a 3 percent decline in value on Sept 16th and 17th, will not be covered for those losses by the new Treasury program. Call your money-market account to find out if your funds are covered.

Getting more FDIC coverage without using CDARS
Individuals can get more coverage by designating different ownership categories to their accounts at the same bank. For example, a husband and wife can qualify for $600,000 in total FDIC coverage at one bank by opening the following five account types.

What is the cause of the banking crisis?

During the past decade, two key financing flaws occurred. First, the mega-banks began to package and sell the loans they made. This process, called asset “securitization,” allowed for the origination of loans at an unprecedented scale. The banks that originated the loans kept little of the debt on their books. Second, the underwriting standards for giving loans were “liberalized” to such an extent that millions of traditionally unqualified borrowers were granted loans they could not repay. This created trillions of dollars of high-risk securitized debt.
As home foreclosures rose, the entire asset class of securitized debt became suspect and investors no longer wanted to own securitized debt, also known as “paper.” This led to a chain reaction: Banks could no longer sell off loans and were forced to look for other sources of money to lend and those sources quickly tightened up. Now banks are in a position where they can’t make many loans because they themselves can’t borrow the money to make loans. Banks need to make loans to make money.
While big banks and investment banks made substantial disclosures (acknowledged losses of $400 billion so far) and received cash injections earlier in the year, regional and community banks are now going through the same process. This is especially true in U.S. regions that experienced the greatest benefits of hyper-growth in real estate-related industries. California and Florida are the two biggest states impacted by what could reasonably be called a real estate depression.

Additional worries are coming from the fact that Freddie Mac and Fannie Mae (holders of about half of all U.S. mortgage debt) may not have enough cash or credit to continue buying mortgages. Without a bailout from the U.S. government, the housing market could effectively shut down. The U.S. economy is resilient and will get through this test. But the banking industry losses will be severe--perhaps exceeding $1 trillion over the next two years.

Liberal lending in all of the arcane new forms created by the world’s investment banks and commercial banks drove the global economy for the past 10 years. The mutual funds, banks, money markets and individuals who invested in “paper” will bear the losses and are likely to be extremely wary in the future (at least for a while). So, banks will be required to hold more of the loans they create. Although The Federal Reserve and other central bankers will provide liquidity to the banking system, chastened lenders are unlikely to be quite so cavalier in extending credit to borrowers without demonstrable means of repayment. In addition, regulatory oversight will be increased.