SAN DIMAS, Calif. -- As it divvies up its $700 billion relief plan, the Treasury is dividing banks into two categories: healthy enough to save and too-far gone. So said Dwight Johnston, Western Corporate FCU's vice president of economic and market research, during his Oct. 13 weekly economic podcast, OnDeck, and again on Oct. 15 to Credit Union Times.
Johnston also predicted the demise of some large, name-brand regional banks during the next few months, saying that some banks simply have too many losses to save. Additionally, despite lawmakers' and banks' best intentions, many bad mortgage loans have such poor underwriting, they can't be saved by refinancing, recasting or even more creative solutions. California, Ohio and the Southeastern U.S. will be the scene of the biggest conservatorship shockers, he said.
"We're talking banks with a lot of real estate lending, with residential, commercial and construction loans. That sort of top-heavy loan makeup," Johnston said. "Big regional banks, especially those that were trying to expand into national banks and went into hot areas and did a lot of lending are prime candidates."
However, the failures aren't likely to cause hysteria among the public or in the markets, he said, because the FDIC pledged to guarantee transaction account balances and senior debt, as well as consumer deposit accounts up to $250,000.
How accurate is Johnston? His Columbus Day broadcast correctly predicted, one day early, that the Treasury would first offer relief to healthy banks. He didn't correctly predict healthy banks would be forced to participate in the program, but he said he wasn't surprised, as no bank wanted to be the first to take the Treasury up on the deal.
"They did that to get the ball rolling because up until now, it's been all voluntary, and nobody wanted to be the first," he said.
Will credit unions receive a piece of the Treasury's $700 billion bailout pie? While Treasury Secretary Henry Paulson's Oct. 14 comments included plans for banks, thrifts and the FDIC, credit unions and the NCUA were noticeably missing, sending industry tongues wagging.
Johnston chuckled when asked if he thought credit unions were purposely snubbed, saying he doesn't think there is any anti-credit union conspiracy afoot, despite Paulson's March 31 recommendation to eliminate the federal credit union charter.
Rather, Johnston said, credit unions aren't in dire straits and don't require the swift, urgent action the banking sector does. Plus, investing in cooperative financial institutions would require more creativity than simply buying preferred shares because credit unions don't have any.
"I think we'll see something before too long," Johnston said, regarding how much, if any, relief will be earmarked for credit unions.
Why did the Treasury decide to inject capital into banks instead of buying distressed securities? Johnston said he thinks the problem turned out to be worse and more complex than officials initially thought.
"Frankly, Wall Street and all our officials have been in denial throughout this whole thing, so there never really was a plan for how to attack the problems," Johnston said during the podcast.
Southwest Corporate FCU's Brian Turner, director of advisory services, said he thought the Treasury decided to inject capital into financial institutions because the market for mortgage-backed securities is still too volatile, making it impossible to determine what the investments are worth. The capital injection should eventually produce the same net result though, he said.
"Originally, I think they had planned to buy these distressed assets from institutions, and somehow work out the details later," Turner said. "Call it recapitalization or whatever you want, the net effect is the same. I think the capital injection strategy was mostly in response to difficulties in coming up with market value for distressed securities."
That being said, Turner agreed that some regions of the country could see some bank failures and added that it's no coincidence the biggest bank losses have come in regions with the most subprime and ARM lending. Southwest's home state of Texas didn't see the kind of huge real estate value gains and drops in affordability that California did, for example; and in turn, Texas won't see as many, if any, bank failures.
Will taxpayers and homeowners see any benefit from Paulson's plan? Johnston said the Treasury would have to provide some direct benefit, in order to save face with the American people. After the election, the government, possibly through Fannie and Freddie, will attempt to help financial institutions write down the principle on some mortgage loans by absorbing a share of the loss.
"Yes, there will be cries of outrage and moral hazard, but I don't think that'll hold it back," Johnston said. "They're already talking about right away, even before the election, pushing through a three-month moratorium on foreclosures, which is just ridiculous. It doesn't help a thing, to push those loans three more months behind."
What does it all mean for credit unions? Both economists agreed that the future is only as bright as the employment rate. Johnston said credit unions should benefit from the problems that plague the banking industry; however, the success of individual credit unions will hinge on the financial stability of members. Some community and employer based credit unions have cause for concern, he said.
Household debt is a major long-term problem, Johnston added, and could hamper the nation's recovery.
"The debt ratio has actually gotten worse this year, even though it's not like consumers have added a ton of debt," he said. "The problem is the average consumer added a normal year's worth of charges without paying off as much as usual."
Turner agreed that consumer debt is an issue, saying he was currently preparing a session on the topic for Southwest's Oct. 28-29 economic forum.
"You certainly have to be a lot more proactive in balance sheet management these days, you can't take a 'whatever happens, happens' attitude," Turner said. "Basically, credit unions are going for the best relative value available without having to resort to fancy structures. We've already seen what happens when you try to go that route."
Despite rising delinquencies and charge-offs, member loans continue to be a relatively good investment value, Turner said. However, balance sheet managers must keep an eye on liquidity.
"Liquidity is the name of the game right now, and even though there's a high price to pay for carrying a lot of excess cash, credit unions must be prudent in maintaining strong liquidity profiles," Turner said, adding good liquidity management will be crucial next year for both natural person credit unions and corporates.