"Fair Value"

A little insight into one way regulators are taking down community banks, also explained very well in this article.

One of the problems which led up to the economic meltdown was Wall Street valued its investments by what they deemed was an appropriate price (you can imagine how well that worked).  When the government instituted mark-to-market accounting, Wall Street instead had to value its stocks and bonds by the actual selling price on the exchanges at the end of the day, every day.  Hence, "fair value."

FDIC Exposer will never claim to be an expert on banking regulations, but here's our take on what's going on now:  after the Glass-Steagall Act prohibiting lenders and investors from mingling in a single company was repealed in 1999, Wall Street suddenly because a conglomerate of giant ("too big to fail") corporations gobbling up every sector of the financial industry.  When their investment parts blew up, the banking parts went down with the ship.  Oops...

So, since the meltdown put the focus on Wall Street, and Wall Street "banks" used mark-to-market "fair values" for the investment side, surely the same should be applied to the banking side.  Wouldn't that only be "fair"?

Not really.  Investments are liquid, their values change constantly throughout the day and can readily be sold on the open market, and the current selling values are there for all to see.  Bank holdings, not so much.  Money is tied up in loans that are bringing in regular income in the form of interest and principal payments, and those loans are going to provide income for a long time - say, 30 years for a mortgage - or the principal will be paid off early at whatever date the borrower wants.  The bank is bound by contract and can not call in a performing loan whenever it wants its capital back.

Let's say we do apply "fair value" to banks.  Any sane person would think that "fair value" of that loan is the amount of principal owed the bank, not the collateral.  If you sell your house for less than the amount owed on the mortgage, you have to pay the difference.  The collateral does not become the asset unless the bank forecloses, and only then should it be valued by how much the bank sells it for.  Right?

Oh, FDIC Exposer, how naively optimistic you are!  A little regulation called FAS 157 passed in 2007 requires loans to be valued at the current market value of the collateral.  If you've ever had a house appraised, you know that current market value is determined by an educated guess.  You won't know the value until the house actually sells.  Now let's say the FDIC has their own appraiser.  If they are determined to shut down a bank*, those appraisals may not be too favorable.  Banks can counter with their own appraisals, but who do you think wins that one?

Let's say the FDIC does want to be fair in determining market value.  When half your neighborhood has gone into foreclosure, and banks sell at a loss to get them off the books, the value of your home plummets.  You may have no intention of selling, the market could bounce back in a year or two, and you have never missed a mortgage payment, but as far as the regulators are concerned, the bank just lost tens of thousands to millions of dollars worth of assets.  Can things get any worse?

You betcha.  When the FDIC closes a bank, it auctions off alot of the assets.  The FDIC has no stake in how much it gets.  The bank's assets flood the market all at once, and they are sold at pennies on the dollar.  $30,000 lots are now worth $1,000.  And every bank with loans in that area now have to value their lots at the same price.  Never mind that those lots are likely to increase in value over time, and the banks have no intention of selling them at such a low price.  Unless...

Congress had the brilliant idea of coming up with a magical number that determined the viability of a bank.  If a bank's capital falls below 2% of its assets, the FDIC shuts down the bank in a move lovingly titled "Prompt Corrective Action".  In order to avoid that magical number, the FDIC makes the bank sell assets to raise capital, including performing loans that provide income, and those assets sell at that bargain-basement price set by the FDIC itself.

As the FDIC closes more and more banks, and the market is flooded with more and more firesales, every bank has to keep writing down the value of its assets and raising capital in a vicious cycle.  Wall Street banks are big enough to offset minor things like this, but community banks are kept on the razor's edge.

Community banks aren't the only ones who suffer - homeowners are caught in the trap too.  They have to sell their houses at ridiculously low prices, if they can find a buyer.  If they want to buy a new house, they can't get a loan because that would eat into the bank's capital.  The market freezes except for the bottom feeders.  Instead of the market bouncing back in a year or two, we could be stuck here for decades.

Community banks are fighting for their lives and the lives of its customers.  These are not reckless entities and greedy individuals who ran Wall Street into the ground.  Apart from bad real estate investments during the housing boom, they have no excesses to rein in.  And yet they bear the brunt of the new regulations.

Instead of being the enemy of community banks, the FDIC could be their biggest supporter.  Every bank's viability should be examined, and the non-viable ones should be shut down.  The FDIC can work with banks rather than against them, but they choose not to.  From the boots on the ground to Washington, DC, the FDIC is actively destroying our communities.

"Fair value" should be what a community bank is worth to the community.  And that's why we want to expose the FDIC.


*In many cases, the FDIC is indeed determined to shut down community banks regardless of their viability.  This is especially the case when those on high decide that the FDIC can save money by shutting down banks sooner rather than later, a practice which catches too many viable banks.  Actual examples will be provided when anonymity is no longer a concern.