View Full Version : James Turk on IndyMac Failure

07-12-2008, 04:55 PM
America's Second Biggest Bank Failure
by James Turk at GoldMoney.com

Late Friday afternoon (July 11th) federal regulators swooped in on California-based IndyMac Bank and closed its doors. With $32 billion in assets, it is according to The Los Angeles Times the second largest bank failure in US history. IndyMac will re-open its doors on Monday morning as a ward of the FDIC.

Some background will be helpful to put this bank failure into perspective. IndyMac is ground-zero of the sub-prime crisis and the poster-child of imprudent lending. Founded in 1985 by Countrywide Bank, whose own recent failure was masked by its acquisition by Bank of America, IndyMac pioneered the issuance of so-called Alt-A mortgages to borrowers who do not fully document their income or assets, which typically means borrowers with blemished credit histories or real estate speculators looking to 'flip' houses during the bubble years. Alt-A mortgages were considered to be less risky than the subprime loans which started the current financial crisis last year, so IndyMac's plight may cause everyone to re-think that credit quality fairy tale.

IndyMac sold most of the loans it originated, but it also drank its own poison by holding some of these loans on its books, which is the important point. The liquidation value of IndyMac's assets may be instructive to help us understand what lies ahead for the unfolding financial crisis. By applying IndyMac's experience to the value of the questionable mortgage assets still within the global banking system, we can begin to understand the scope and magnitude of the problem.

IndyMac's $32 billion in assets are funded by $19 billion of deposits, with funding for the $13 billion balance having been provided primarily by debt and a little equity. About $1 billion of deposits are above the insured limit, so the FDIC is insuring about $18 billion of deposits, but here is the interesting - and scary - stuff. The FDIC press release states: "Based on preliminary analysis, the estimated cost of the resolution to the Deposit Insurance Fund is between $4 and $8 billion."

Think about this statement for a moment. After liquidating the bank's assets, not only will IndyMac shareholders and holders of IndyMac debt be wiped out, the FDIC's insurance fund will still take a "$4 and $8 billion" hit so that the $18 billion of insured deposits in IndyMac are made whole. So let's do a little math here.

After liquidating $32 billion in assets, the FDIC still has to add some $4 billion to $8 billion more to make sure $18 billion of deposits are made whole. So in the worst case scenario, the liquidation value of IndyMac's $32 billion of assets is $10 billion, or in other words, the true market value of IndyMac's assets is only 31% of their stated book value. In the FDIC's best case scenario, the liquidation value of IndyMac's $32 billion of assets is $14 billion, which is still only 44% of their stated book value.

So here is the all-important question. Can we infer from this liquidation analysis of IndyMac that the true value of sub-prime and Alt-A mortgage debt still in the banking system is something less than 50% of stated book value?

I don't have the answer to that question. If anybody does, it is the bankers themselves, and they aren't talking. They do not want to disclose how bad off they remain, even after already writing off more than $300 billion of assets globally (as reported by London's Financial Times). They no doubt must be panicked about what's yet to come.

So how big is the potential problem? My guess is that even bankers really don't know the answer to that question, but there are some estimates worth considering.

Investment guru John Paulson had his hedge-fund correctly positioned to benefit from the sub-prime meltdown, so given this record, his estimates of the problem are probably better than most. According to the Bloomberg he says that "global writedowns and losses from the credit crisis may reach US$1.3 trillion." That estimate seems reasonable in view of the IndyMac experience, given that at least $3 trillion of inferior loans probably remain on bank books at present. Keep in mind too that the amount of inferior loans will grow as economic conditions continue to weaken.

All of this does not bode well for the dollar. The federal government is readying the printing press to create even more dollars to plug the black-hole on bank balance sheets, but there is another black-hole that they need to begin worrying about.

The FDIC deposit fund only has $53 billion of assets, and around 10% or perhaps more of that is now going to be used to bail-out IndyMac. So how safe is the FDIC? How safe is the dollar, or more to the point, how safe is your wealth held in dollars? Not very.

Even putting aside the subprime financial problems yet to come and the countless dollars the federal government will be creating in the future to bail-out other IndyMacs when they hit the wall, consider how rapidly the dollar is already being debased. For example, a 1-year T-bill pays about 2.2% interest, but the CPI is rising at 4.2%. Thus, in one year you have lost 2% of your purchasing power, but probably even more because the true rate of inflation is much higher than 4.2% (John Williams of ShadowStats estimates the rate of inflation is over 10%).

In contrast to this loss of purchasing power from holding dollars, gold has risen seven years in a row at an annualized average rate of 17.4%. This year gold is already up 14.9%, and silver is doing even better. It has risen 26.7% so far this year.

Given that inflation is becoming worse by the day as crude oil and other commodities climb higher and given that the Federal Reserve is not raising dollar interest rates to fight inflation and save the dollar from a collapse, it is safe to expect more of the same from gold (appreciation) and the dollar (depreciation). The following chart shows that the dollar remains perched on the edge of the precipice, as discussed in my previous alert.

The dollar is sitting on the bottom trendline of its recent uptrend channel, threatening to fall into the abyss. Avoid the dollar. Own gold and silver instead.