Commercial Construction Hurting Banks

Commercial Loans Now Nightmare for smaller Banks.

In my life time commercial real-estate markets have always been a lagging economic indicator not a leading indicator. When my younger brother who owns a Florida excavation company told me business was still booming in 2007 despite the tumbling housing market, I predicted he'd see a big fall off by 2008.



Now that it has come true, just how bad is it? The "experts" I listen to, including FDIC chairwomen Sheila Bair expect more defaults and bank losses on commercial loans. The FDIC agency reported that the banking industry lost $3.7 billion in the second quarter amid a surge in bad loans made to home builders, commercial real estate developers and small and midsize businesses.

The New York Times (Sept. 4th) published an article which stated,
Even as the economy may be recovering, banks across the country are confronting a worsening outlook for their construction loans, an area that boomed for much of the decade.

There are no "green shoots" for commercial construction and real-estate.


Reports filed by banks with the Federal Deposit Insurance Corporation indicate that at the end of June about one-sixth of all construction loans were in trouble. With more than half a trillion dollars in such loans outstanding, that represents a source of major losses for banks.

Construction loans were a primary source of revenue for many banks, particularly smaller ones without a national presence. Other types of loans were not easy to make. A handful of big banks came to dominate credit card loans, for example, and corporate loans were often turned into securities.

So, while plenty of leading economic indicators show positive signs and that the American single family housing market has improved...commercial real estate construction seems likely to get worse.

Banks have been taking losses and cutting back their commitments for a couple of years on home construction. At the end of June, $173 billion in construction loans related to single-family homes was outstanding, barely more than half the peak level reached in the fall of 2006, when the housing market was booming. At the end of June, $291 billion in commercial real-estate loans was still outstanding, (down only a few billion from the peak reached earlier this year).



“On the commercial side,” said Matthew Anderson, a partner in Foresight Analytics, a research firm based in Oakland, Calif., “I think we are fairly early in the down cycle.” Foresight estimates that 10.4 percent of commercial construction loans are troubled, but expects that to increase as the year goes on.

Now do not assume the American stock market must fall too, just because lagging indicators like commercial real-estate markets and unemployment are horrible. Yes, it can easly fall a 1,000 points, even if the worst is over. In fact, most bulls expect a 5-10% correction between September and October. But plenty of people perdicted in June when the DJIA was only at 8,200 it would fall back to 7,200 too. Those who listen to that advice lost another 10-15%.

The lesson to remember, is the stock market is a leading economic indicator. You'll recall it started falling in the fall of 2007 when few news reports foresaw any issues in commercial real-estate. In fact the usual Donald Trump disciples were touting real-estate investments while only a few outcast Economist like Nouriel Roubini were predicting doom. Even Ben Bernacke said he saw no real-estate bubble in 2007. If you are only investing when the news is great -you missed the boat along with 75% of the gains. Just one more reason I advise people to have a long term plan before they start worrying about what stocks to buy.

Last year, we learned the regulators, like the bankers, and Wall Street investment bankers did not comprehend the risks of the exotic instruments dreamed up by financial engineers. This year we are learning that the regulators, like the bankers, also failed to understand the risks of the generous loans that the banks were making. At the very time bankers should have been reducing commercial loans they were expanding, thus pushing the real-estate bubble into the stratosphere.

We're all hearing about empty malls due to over building which resulted in a glut of malls. Maybe we're just all shopped-out? Perhaps someone will do a research paper correlating our mountain of personal debt to our glut of malls.

Here just one example of a funeral being held in my area for what was to be the city's downtown area rebirth.

Columbus City Center was developed by the city as part of the Capitol South development, opening on August 18, 1989. It was pitched to investors and taxpayers as a "must have" to revitalize Columbus downtown. Now a building wholes economic life should be 50+ years is being torn down in less than 20 years (to make room for next big idea).



Ok, after writing this article and listening to these experts -I'm depressed.

If you're depressed over the economy and short on Prozac then go get a shot of inspiration at The Wright Inspiration Station TM or if you need an accounting or finance refresher course go to The Wright Education Station TM

Failure To Collect Leaves Taxpaper With More Bills

The FDIC And Member Banks (Not Taxpayers) Are Responible For Insurance Fund Losses

The FDIC was created by Congress with the 1933 Banking Act to protect bank depositors after the severe financial crises of the early 1930s and officially opened for business Jan. 1, 1934. The agency now insures deposits up to $250,000. Legislation passed by the Congress on February 1, 2006, merged separate insurance funds for banks and thrifts into a single Deposit Insurance Fund.

The FDIC was put in place to protect the depositors, not the banks. FDIC is a insurance organization where member banks pay premiums for the right to wear the FDIC label. No one I know has an interest in putting money into a Non-FDIC insured bank. If you are a banker who wishes to grow your business and profits you need FDIC on your door.

In short the Banking industry should be responible for their decisions and the FDIC insurance reserves. Lots of bright minds have pointed this problem out over many years e.g. The Wharton Financial Institutions Center issued a whitepaper in 2002.

The Last Real-Estate and Banking Party Bar Tab Cost Taxpayers $125 Billion

The ultimate cost of the S &L crisis is estimated to have totaled around $160.1 billion, about $124.6 billion of which was directly paid for by the US government—that is, the US taxpayer, either directly or through charges on their savings and loan accounts. Why did the taxpayer get left holding the bag? Simple, not enough FDIC premiums were charged for the risk the S&L's were taking in leveraging up on a real-estate boom.

Congress passed the Federal Deposit Insurance Corporation Improvement Act (FDICIA) in 1991 to prevent taxpayers from getting stuck paying the bar tab for the banking and real-estate industries parties, again.

Congress Passed the Federal Deposit Insurance Corporation Improvement Act (FDICIA) in 1991.

This legislation authorized the Federal Deposit Insurance Corporation (FDIC), for the first time in its history, to charge higher deposit insurance premiums to S&Ls and Banks posing greater risk to the FDIC Insurance Fund. This historic piece of legislation empowered the FDIC to charge members premiums linked to risk.

A 1996 report by accomplished economist Frederic Mishkin a longtime friend and research partner of Fed Chairman Ben Bernanke reaffirms the need for the FDICIA stating the provisions were designed to serve two basic purposes: 1) to recapitalize the Bank Insurance Fund of the FDIC and 2) to reform the deposit insurance and bank regulatory system so that taxpayer losses would be minimized.

The United States General Accounting Office (GOA) issued a report in November 1996 entitled Bank and Thrift Regulation. The very first sentence of the executive summary states, "The thrift and banking crisis of the 1980s caused deposit insurance fund losses estimated at over $125 billion. One of the many factors contributing to the size of the federal losses was weakness in federal regulatory oversight".

As Austin Powers would say, "Deja Vu Two Baby!"

Now take a guess as to what the FDIC and Congress choose to do during the economic boom years of 1996-2006? The biggest reasons for our FDIC reserve shortage is because most banks paid no premiums from 1996 to 2006. Yes, it's a little reported fact that they paid no insurance premiums for 10 years.

Not one private insurance company would stop charging premiums on your auto, homeowners, health, or life insurance for 10 years -----simply because you had no losses. Does some one need to have a Ph.D. in Insurance and Risk to know that's not prudent?

Yet, James Chessen, chief economist of the American Bankers Association, said that it made sense at the time to stop collecting most premiums because "the fund became so large that interest income on the fund was covering the premiums for almost a decade." There were relatively few bank failures and no projection of the current economic collapse," he said. Anyone else wondering what value economist add? Can we export economist to china?

The rising bank losses mean that the FDIC's ratio of deposit insurance funds (DIF) to our bank deposits is down to 0.22%, far below its obligation under the insurance statute to keep it between 1.15% and 1.50%. Said another way, the goal was to only have about 1.5 cents in the rainy day fund and we have only zero cents.

Failure To Collect Premiums For 10 Years May Leave Taxpayers Paying Another Bill

The FDIC and congress concluded years ago that only 1.25% in FDIC reserves were needed to maintain the financial soundness of the fund. So, when the Deposit Insurance Fund (DIF) reached the magic number during the boom years, bankers (didn't want to pay) and regulators saw no advantage to having 2.5% in reserve. But between 1996 to 2006 bankers were jumping into the real-estate boom leveraging up their money lending practice. The S&L crisis became a distant memory.

I will not blame any President, Party or Federal Reserve Chairman for this crisis. They, like us, have a vested interest in America too. Still, I'd expect Greenspan and Bernacke, two Ph.D.s in economics, along with the over 100+ Ph.D.s working on the Federal Reserve staff, to be smart enough to connect-the-dots. Purhaps a few were two busy flipping homes to notice. No wonder Dean Baker, a fellow Ph.D. in economics, is endorsing the bill to audit the Federal Reserve policies, Baker wrote last week, "The country now has almost 25 million people who are unemployed or underemployed as a result of the Fed's disastrous policies". Other economist and financial experts outside the Washington D.C. belt-way raised flags to congress ahead of the Freddie Mac and Fannie Mae debacle. All one needed to do was watch tv to know we were in a real-estate bubble.

Our FDIC Chairman Warned Congress in 2001...No Action

Now FDIC Chairwoman, Sheila Bair, has already testified that the agency's failure to collect premiums from most banks for years was surprising to her and a concern. As a Treasury Department official in 2001, she said, she testified on Capitol Hill about the need to impose the fees, but nothing happened. Congress did not grant the authority for the fees until 2006, just weeks before Bair took over the FDIC. She then used that authority to impose the fees over the objections of people within the banking industry. "That is five years of very healthy good times in banking that could have been used to build up the reserve," she said.

I'm hearing on average, each failure costs the FDIC nearly 30% of a bank's assets.

Now-Needy FDIC Collected Little Premiums for 10 years

The Coming Deposit Insurance Bailout

FDIC May Need Special Fees

FDIC, Banking & Real-Estate Deja Vu Two

click on graphics to enlarge

It took eight years from the start of the Savings & Loan crisis in the 80's and 90's to reach a peak in bank failures from the last real-estate boom turned bust. Let's hope we are not in for 6 more years of large quantities of bank failures. Mr. Bill Isaac JD who headed the Federal Deposit Insurance Corporation during the banking crisis of the 1980s said he doubts we'll come close to the volume of failures of the S&L crisis. Still, history is repeating its self. It's like a domino effect. First it effects the largest financial institutions leveraged to real-estate sales through the mortgage securitization and derivatives markets. Next came large Insurance companies and regional banks with large investments in real-estate and related loans. Now it's smaller state banks effect by commercial real-estate construction loans.

One single common denominator jumps out...real-estate. Yes, REAL-ESTATE SPECULATION fueled by historic low interest rates, easy credit, little money down and excessive value appraisals.

Real-Estate Implodes, Banks Fall and FDIC Funds Nose Dive

At the tail end of the Savings & Loan (S&L) debacle L. William Seidman, former chairman of both the Federal Deposit Insurance Corporation (FDIC) and the Resolution Trust Corporation, stated,"The banking problems of the '80s and '90s came primarily, but not exclusively, from unsound real estate lending".

In May of 1991 the Los Angeles Times reported, "The FDIC faces problems with the bank insurance fund expected to be insolvent by the end of the fiscal year. The House and Senate banking committees have passed separate bills providing $70 billion in temporary borrowing authority for the fund, with the money to be repaid by premiums from the banking industry. Seidman's replacement at the FDIC will run the fund at a time of great uncertainty for the banking industry, during a depression in commercial real estate that threatens the solvency of many banks".

For years after the 80's and 90's Savings & Loan financial crisis had ended hundreds to thousands of Articles, Whitepapers and Books were written on what created the problem and what was needed to prevent a future meltdown. To insure we learn from our past mistakes the FDIC has web pages listing FDIC reference books deticated to the S&L crisis memory.

Congress Passed the Federal Deposit Insurance Corporation Improvement Act (FDICIA) in 1991.

This legislation authorized the Federal Deposit Insurance Corporation (FDIC), for the first time in its history, to charge higher deposit insurance premiums to S&Ls and Banks posing greater risk to the FDIC Insurance Fund. This historic piece of legislation empowered the FDIC to charge members premiums linked to risk.

A 1996 report by accomplished economist Frederic Mishkin a longtime friend and research partner of Fed Chairman Ben Bernanke reaffirms the need for the FDICIA stating the provisions were designed to serve two basic purposes: 1) to recapitalize the Bank Insurance Fund of the FDIC and 2) to reform the deposit insurance and bank regulatory system so that taxpayer losses would be minimized.

The United States General Accounting Office (GOA) issued a report in November 1996 entitled Bank and Thrift Regulation. The very first sentence of the executive summary states, "The thrift and banking crisis of the 1980s caused deposit insurance fund losses estimated at over $125 billion. One of the many factors contributing to the size of the federal losses was weakness in federal regulatory oversight".

Bank Failures Will Continue As The Economy Improves

The chart above shows the American S&L failures over 15 years. This puts into historical perspective our current financial crisis. The common denominator? If you guessed real-estate speculation...you're correct. Ageing has few benefits and you often find yourself in a state of deja vu.

Three more U.S. banks failed on Friday, bringing the total to 84 so far this year, as the industry continues to grapple with deteriorating loans on their books.

112 Banks have failed over the last three years

FDIC Chairman Sheila Bair said this week that bank failures will remain elevated as banks go through the painful process of recognizing loan losses and cleaning up balance sheets. The total of 84 failures this year marks a sharp rise over the 25 last year, and the three failures in all of 2007.

She noted that the banking industry's performance is a lagging indicator and will continue to suffer even as the economy begins to improve.

2,935 small Savings & Loans institutions failed between 1979-94, setting the stage for the rise of big national banks

The U.S. is no stranger to prolonged periods of bank failures, the Great Depression resulted in many more failures. America experienced the loss of the Savings and Loan industry between 1987-91. More than 2,300 financial institutions went under peaking with the failure of 534 banks in 1989. This became know as the S&L debacle or S&L crisis.

Now those perdicting impending doom, that everyone wants to hear in a crisis, point out how the prime loan and commercial real-estate crisis is just picking up loss momentum this year. Well, they are correct. Lenny Dykstra could be the poster child for both problems. Read the Lenny Dykstra Bubble Signal.

But this comes as no suprise to students of past real-estate cycles. At the dusk of day you can count on it getting darker outside. And just as dusk leds to the darkness of night...night leds to day. To us old-timers this is deja vu all over again. Like the stock market the roaing 20's witness a great real-estate boom. We saw it again after WWII from the 50's to the 70's and again from the early 90's throught 2006.

Now a harder forecast to make is estimating the impact of this crisis on the stock market. That will need to be the subject of another Article. Still, one doesn't need to be a financial wizard to recall that one of the greatest 20 year booms in the market began during the 80's financial crisis.

While the size of assets is greater, the cost to FDIC will be less

So, how does this crisis compare to the S&L failures. It's too early to compare total failures as history teaches more are coming. In terms of assets, bank failures for 2008 totaled approximately $370 billion. This compares to approximately $164 billion in 1989, which was the worst year for the savings & loan debacle. If we adjusted that total for inflation, it would be roughly $300 billion today. So, 2008 is the worst in terms of assets for bank failures compared to the worst single year of the S&L crisis.

However, during the S&L crisis, bank failures hit nearly $150 billion or more per year for three years running. Total assets of failed institutions back then was $519 billion. If we adjust for inflation, we get a total in today’s dollars of over $800 billion. But, based upon the current 2009 trends and 2010 estimates this crisis would clearly be much worse than the S&L crisis.

The S&L Crisis cost FDIC $125 billion

While totaling up the assets of the failed banks is interesting, a more important point for taxpayers is what is the likely cost to the FDIC of taking over these banks? An FDIC report cited $124 billion as the cost to taxpayers for the S&L debacle. This includes costs to the Federal Savings and Loan Insurance Corporation (FSLIC) and the Resolution Trust Corporation (RTC).

The FDIC estimates this crisis will cost $70 billion

The FDIC estimate for the cost of taking over these banks is not $370 billion. The lastest estimate (Aug. 28th 2009) for the cost (projected through 2013) to the FDIC for these failures is $70 billion. That’s a lot of money, but still modest given the level of assets at the failed institutions. Still, given the FDIC has already doubled the size of forecasted losses in just 9 months it may be wise to assume 12 months from now the estimates could be even higher.

Even if we assume the FDIC is off by 50%, then the total cost will be $105 billion. That’s still a long way from $124 billion for the over 2.395 S&Ls that failed over 15years. And after adjusting for inflation the cost is far less catastrophic then the S&L debacle.

So, as little Orphan Annie sang in the hit movie musical during the 80's recession,"The Sun is Going To Come Out Tommorrow."

Failed Bank List

FDIC May Need Help

The Official FDIC Statement