Wednesday, March 09, 2011

Another Example of Government Waste

Disclaimer: The following is a 100% true story. In order to protect the people who supplied me with the critical information, never mind myself from any disclosure laws this uneducated writer might unknowingly break, I have switched out all the critical names of people and places with aliases. I'm not Woodward or Bernstein. This is just a perfect example of some of my own personal thoughts on our government.

About a year and a half ago, a small-town local bank called Southeast Atlantic bank were approached by the FDIC with some distressing news. Apparently the Federal Gov't has been studying the bank's financial practices intensely since shortly after the housing crash. After going through their findings, they came to the bank's offices personally to report three things. First, the FDIC were NOT happy with people SEA bank were in business with. Second, they had found that the bank had a $25 million shortfall in their bottom line. Third, if the bank did not rectify this shortfall, there would be dire consequences.

On the first note of the bank's major customers, this is a symptom of the economy. The sources that I talked to assured me that roughly 3/4 of the people mentioned in the report were regular customers SEA bank have been in business with for better part of almost two decades. While yes, since the housing crunch, these top notch customers took a rough hit, it wasn't just the get rich quick schemes of many of the big hitters tried to take advantage of before they lost HUGE and then received their bailout. These were regular customers with a long and impeccable LOCAL banking history that were actually by and large doing business as usual when the bottom fell out.

As far as the $25 million shortfall, SEA bank actually said that they understood that this was obviously not the strong financial base they wanted for themselves or their customers. But they also felt a local upswing and the community was in the middle of bouncing back. Given time, the senior officers felt confident in righting the ship and getting their bottom line back into the black. The one year ultimatum was daunting, yet knowing the area, and being on the ground floor of the local economy, they looked at the next twelve months with a careful sense of hope, even with the federal government looking over their shoulder(and at times directly influencing the directions of day to day operations).

Fast forward to the first week of this year, the bank had recovered just shy of $16 million of the $25 million. Sparing the suspense, it wasn't enough. Most officers above teller were removed(quietly) and the FDIC replaced SEA with Big Middle America Corporate bank. Most of SEA were saddened by the government's decision, especially after a year of unpaid overtime and hard work, but understood in the end. After all, the were millions in the hole. Those are the breaks.

So far, everything is pretty understandable. I feel bad that any local business goes out of business, bank or no, but it does scream to the heart my feelings of the status of business in America. If you lose money, you don't get to play any more, whether you are a bookstore, coffee shop, or even a bank. That is of coarse, you reallllly suck, then you can have $8 billion to right the ship.

That unfortunately is not all. Because Big Middle America Corporate bank apparently got a pretty sweet deal. Now I'm not a banker, but it seems to me that in order to absorb this institution's assets and debits it would require just under $10 million of additional capital to basically cover the remaining shortfall. That money would expectadly come from FDIC guarantees, or just the Federal government in some fashion. Strange enough, I talked to some bankers and they outlined how this was exactly so(Footnote: I could not understand the hows and the ways this is so, but the bottom line is what is important here). The actual end result was the federal gov't paid them $20 million instead of ten. That seems high to me, but I can let that go. The final caveat though is the FDIC guaranteed $90 million in bad loans to BMAC to cover any and all future shortfalls. That $90 million is basically free money they can piss away to no cost to anyone except the taxpayer.

The final math on this is this. A local, stand alone bank faces a shortfall of just under $10 million. Somewhat understandably the government shuts down this bank. A very large corporate bank is paid $110 million to take the place of the small local bank when it could very easily cost $10 million. That is $100 million of wasted taxpayer's dollars to fix a $10 million problem.

My questions and comments: This is a sad representation of how consistently the government treats the smaller players in the business world and how it blankly rewards those that are big enough.

I'm fine with replacing businesses that lose money, big or small. But if you are going to step in and outright replace it, do it for what it costs, not ten times for what it costs.

Finally, this fiasco cost taxpayers $110 million. That is real money, especially considering this is going to fix an extremely local, somewhat uncomplicated, and small town operation of less than 20 employees. What scares yours truly is if this is the way the government handled this problem, how much more money is being thrown away to similar, uncountable situations from coast to coast.


Cousin Pat from Georgia said...

Still in the millions? Amateurs.

I don't think this is $90M of wasted money, I think this is $90M of insurance paid out directly to taxpayers so they don't lose any money.

While SEA may only be $10M down on their books, they put $90M worth of depositor money at risk due to their failure. The depositors are the community folks with money in the bank, and a those folks can't afford to lose $90M in one lump. If that happened, the cost would be far more than $90M, as the community would have to deal with that money just evaporating.

For whatever reason, SEA had made loans that took a loss, but those loans were made with depositor money. FDIC steps in because they insure depositors, not the banks, and arrange the sale of SEA to BMAC because BMAC has the capital and financial health to cover a certain percentage of the deposits. That last $90M is the insurance money from FDIC to cover SEA losing depositor money, so BMAC can cover all deposits.

I don't think that's wasted money,because it is a whole lot easier to lose $90M from a federal but capitalized insurance corporation than from the pockets of the community, which is where it would otherwise come from. I don't even think Glynn County could afford $90M of citizens' deposits to just evaporate one day due to misfired loans.

jerztronics said...

Sorry Pat. I wasn't clear enough. All the loans on the books were already insured. The $90 million was basically a blank check written by the government for NEW loans BMAC bank would be able to issue. If this big bank had that much capital available, why would it be necassary for the government to guarantee almost $100 million of free money?

Cousin Pat from Georgia said...

Maybe my online research was faulty, or I was looking at the FDIC report on the wrong bank. I'm far from an expert here.

If the FDIC issued $90M to BMAC as a basic blank check so they could issue new loans, they're doing it to cover the hit BMAC takes for buying SEA and assuming their faulty debt. While BMAC might have financial health and capital, the faulty assets may prevent them from issuing new loans at the rate preferred by whoever wrote the blank check.

Those new loans create capital in the form of interest to both the bank and depositors, allowing BMAC to have the stream of income required to remain healthy and returning interest to their depositors while they restructure the faulty loans.

Is this waste? Technically. The FDIC could have just insured all the depositors, closed down SEA, and sold all the faulty loans peicemeal to other banks in the community. Depositors could take their money elsewhere. It would have been far cheaper from a straight numbers sense, but that keeps capital from being created (interest) while that restructuring goes on.

And what happens if no local bank wants to buy the faulty assets from SEA, or buys them for pennies on the dollar? That contracts capital.

So the more expensive/wasteful short term spending is deemed preferable to the theoretical long term effects of just closing things down. Bankers and financiers tend to prefer the stability that comes from banks buying failing banks over the instability of failing banks contracting capital.

Cousin Pat from Georgia said...

All this might have something to do with a loss-share agreement between BMAC and the FDIC.