Capital? What Capital?

One of the FDIC's favorite games prior to closing a community bank is to demand the bank raise more capital.  "Hey, Community Bank, you're down to 2.5% capital to asset ratio.  Better go raise more capital."  In this economy, CB has to beg and scrounge to find some capital.  $10 million later, the FDIC says, "Great, but we've written down your loans.  Now you're down to 2.3%.  Better go raise more capital."  CB had exhausted its resources last time, so the next $10 million comes straight out of the directors' pockets.  The FDIC says, "Put that money in your loan-loss reserve where it doesn't count as capital.  And by the way, we wrote down your loans again.  That takes you to 1.9%, so we're going to have to close the bank."  After beefing up CB's value by $20 million, the FDIC hands it over to Regional Bank.

True story.  How do we know this was intentional?  Because the FDIC's paperwork for closing CB was dated three months prior to closing, and the $20 million was raised during those three months.  One month prior to closing, RB was the sole bidder despite interest from several buyers, and it bought the bank for pennies on the dollar, plus the FDIC loss share guarantee.  After the FDIC had already decided to close CB, the directors were scrambling to save it, even if it meant wiping out their own savings.  This was not their cash cow, they were totally committed to it. 

CB had always been profitable while having a low capital-to-asset ratio.  They were risk-averse, did not jump on the real estate bubble, and didn't grow too fast.  Their only mistake was investing in mortgage-backed securities with triple-A ratings that later turned out to be worthless thanks to Wall Street.  But they still had strong core earnings and were completely viable despite the losses.  We're sure RB thought it was a pretty good deal.

Let's face it:  there is no capital available in this economy.  When the FDIC demands a community bank raise capital, they are asking them to do the impossible.  Even if they do find capital, the FDIC can decrease the value of a bank's assets on a whim.  For whatever reason they see fit, they can tell the bank to put the money in the loan-loss reserve where it doesn't count as capital.  They have the power to put a bank on either side of that magical 2%, and can tease the bank as long as they want.

It's all a game, pure and simple.