Stay the course as gold is the only real money

As market volatility increases, and all currencies are in a race to value-less-ness, understanding what is given by Richard will convince you to stay the course as gold is the only real money here, now and in the future.

The FDIC hit its stride in the new year, announcing five new bank closings this week. Nine banks have been closed so far in 2010.

Information released by the FDIC in connection with each new bank closing has been giving us a peek into the real condition of U.S. banks one year after the Financial Accounting Standards Board (“FASB”) suspended fair value accounting requirements. Across the board, we are seeing that banks have radically over-valued their least liquid assets on the basis of a fantasy called “hold to maturity.”

Banks’ fantasy valuations are put to the test when it becomes incumbent upon the FDIC to close the bank and protect depositors’ assets. At that stage, the FDIC has to find a willing buyer for the assets and fair market value is established. As a result, it is now costing the FDIC unprecedented amounts to close banks.

The problem actually goes one step further. As we know, the government’s current economic policy is one of Manipulation of Perspective Economics (“MOPE”) and Pretend and Extend. MOPE does not permit too much bad news to be released at any one time, and Pretend and Extend puts problems off to the future on a presumption that conditions will be quickly improving.

It would be too much bad news all at once to let it be known what banks’ fantasy-valued assets are actually worth. Therefore, instead of selling off banks’ assets “as is” and taking its lumps all at once, the FDIC is now routinely entering into loss-share agreements as to virtually all the assets sold. That allows the FDIC to not have to book the full extent of its losses at the time each bank is closed, but is also leading to the FDIC taking on the risk of huge future losses.

The FDIC is already broke, so any future losses it takes on are liabilities of the U.S. public. The combined policies of MOPE and Pretend and Extend are once again making it inevitable that quantitative easing must continue indefinitely.

Here is how this approach played out in the five closings this week:

The FDIC reported that Columbia River Bank of The Dalles, Oregon, had assets of $1.1 billion and deposits of $1.0 billion. Its estimated cost of closing the bank is $172.5 million – about 17.3% of the value of the deposits.

That means that at this point, the FDIC believes Columbia’s $1.1 billion in paper assets are only worth $827.5 million – an overstatement of 33%. However, the FDIC had to enter into a loss share agreement with respect to $697.4 million of those assets, so it’s impossible to say now what the assets are really worth or how much the FDIC’s eventual liability will be.

There have already been indications that the FDIC is seriously under-estimating its exposure under these loss share agreements. In mid-August 2009, the FDIC closed Colonial Bank of Montgomery, Alabama, at a projected cost of $2.8 billion. However, the FDIC entered into a loss share agreement with respect to $15 billion of Colonial Bank’s assets. Just four months later, in mid-December 2009, it was already being reported that because of this exposure, closing Colonial was likely going to cost the FDIC $5.6 billion, twice its original estimate.

In the case of Charter Bank, Santa Fe, New Mexico, the FDIC reported it had assets of $1.2 billion and deposits of $851.5 million. On paper it was very well capitalized. Yet the estimated cost of closing the bank is $201.9 million, and the FDIC had to enter into a loss share agreement with respect to $805.5 million of Charter Bank’s assets.

That means Charter Bank’s assets are really only worth about $650 million (by current estimates), and therefore were over-stated by $550 million (about 85%). It is costing the FDIC about 23.7% of the value of Charter Bank’s assets to close the bank. That is what we know now. The FDIC’s total future exposure may be much more because it shares the risk of $650 million worth of Charter Bank’s assets being worth less than presently estimated.

Taking the remaining three banks as a group, their total reported assets were $859.5 million, their total deposits were $786.1 million, and the projected cost of closing them is projected to be $157.3 million – about 20% of the value of their deposits.

That means that as a group, their reported assets of $859.5 million are really only worth about $628.8 million (by current estimates), and so were over-stated by about 37%. In addition, the FDIC had to enter into loss share agreements with respect to $679.5 million of those assets, and had to take an additional $20.1 million of assets on its own books for disposition (meaning it has 100% downside risk).

In summary, this weekend’s closings cost the FDIC a projected $531.7 million.

However, it also shares downside risk on $2.164 billion of the closed banks’ assets, and it had to take $20.1 million of assets onto its own balance sheet for disposition.