The Market Ticker

After three articles in four days on the FDIC, banks, and what sure looks to me like a willful refusal to enforce the law over a period of more than two years, it appears time to once again talk about what should be done in the banking and regulatory systems.

I continue to return to my "roots" in this regard: transparency good, accounting clarity good, game-playing and book-cooking bad.

In short:

1. We must promulgate regulatory rules that require servicers to act when loans become delinquent: the rules for when a loan is "performing" and "not performing" must be standardized and applied evenly, the time delinquent before a loan goes into foreclosure (or charge-off) must be defined by regulation, and a requirement to dispose of assets acquired through foreclosure actions via either private sale or public auction must be evenly enforced.  I would suggest that any loan that is 60 days delinquent must be considered non-performing and foreclosure (or charge-off) must be initiated at or before 90 days delinquent.   Multiple banks, including some very large ones (Wells Fargo anyone?) have redefined the time a loan can be non-performing before it is called "delinquent" over the last two years, effectively "cooking their books" by creating a distorted view of loan status.
2. Foreclosure dispositions must be true sales.  Banks must be prohibited from bidding on their own foreclosure properties at auctions; this sort of "shill bidding" is prohibited in most auction formats and there is no reason to permit it in this case.
3. The practice of holding foreclosed inventory off the market, or of failing to act on delinquent loans must result in severe and immediate regulatory enforcement action.  Such practices severely distort the financial picture that a firm's financial statements project.
4. Loans that are subordinate to an underwater mortgage that has defaulted must not be allowed to be carried at any material value.  There is simply no recovery value of materiality on this paper and claims that there is "no market" for this paper are false; these loans trade daily, albeit for (literal) pennies on the dollar.
5. All off-balance sheet entities must be consolidated.  Period.  I've been over this one before; off-balance-sheet entities were the means by which ENRON was able to accumulate a horrifying liability-to-asset ratio "under the radar" and our banks have abused the SPV/SIV entities in the same fashion.  There is absolutely no reason to create such an entity except as a means of intentionally understating liabilities and leverage ratios; intent to deceive is the definition of accounting fraud.  That we still have these monstrosities accounting for more than a trillion dollars in "assets" outstanding is an outrage.
6. Institutions that carry paper without taking a reasonable recovery value mark when those loans are delinquent (by a standardized set of rules as set forth above) must be treated as having committed accounting fraud and their executives investigated, indicted and prosecuted. 
7. Any person involved in backdating deposits or otherwise gaming bank capital ratios must be indicted and imprisoned.  There is no excuse for "simply suspending" or "firing" people involved in such abuses as occurred with IndyMac.  If I cheat on my taxes I am exposed to indictment and imprisonment; why should those who conspire to do the same thing at a bank be walking around free while the taxpayer absorbs billions in losses?
8. The FDIC must enforce "Prompt Corrective Action" evenly and rapidly.  The law is supposed to prevent losses to the depositor's insurance fund; it has been willfully ignored and the consequence has been horrifying losses on a repetitive basis.  Properly-enforced Prompt Corrective Action (PCA) prevents losses to the insurance fund as banks are seized before asset values fall below liabilities.  The entire purpose of a "Tier Capital Ratio" is to provide ample early warning to regulators so they can step in and close institutions before a negative net worth situation develops.  If the FDIC will not act as the law requires then Congress must add "teeth" in the form of criminal penalties to the "PCA" law and demand enforcement.

 "Too big to fail" and "bailout nation" have become a bad excuse for accounting games, willful regulatory misconduct and accounting fraud. 

We have far too many "walking dead" banks that under any reasonable interpretation of PCA should have been closed months or even years ago.  Indeed, The Market Ticker began publication precisely because of the accounting games at Washington Mutual (formerly NYSE:WM) where it was paying out dividends in excess of its cash earnings, effectively trying to claim that "capitalized interest" booked on dubious loans in a declining market were actual money.  Regulators should have demanded that WaMu suspend dividends in the spring of 2007 and seized the firm if it was unable to correct its deteriorating asset performance within months, rather than effectively allowing the bank to collapse in the fall of 2008. 

Loss ratios against asset bases being absorbed by the FDIC when banks are seized over the last two years are not an accident or a reflection of the times - these losses are occurring due to willful, deliberate malfeasance throughout our banking regulatory structure, including The Fed, OTS, OCC and the FDIC itself, all of which have adopted "extend and pretend" as an operating mantra in direct and willful contravention of the Prompt Corrective Action law.

We will not find a durable economic and financial bottom until I and everyone else can once again read a set of financial statements and expect that the numbers printed on the page actually represent the firm's financial condition.

After ENRON and the debacle from The Tech Wreck you would have thought our regulatory agencies would have learned that nothing good comes from trying to sweep insolvency under the rug; that only multiplies losses.  Instead we have not only had to suffer the insult of hundreds of billions of dollars in taxpayer-borne loss, but also active complicity and willful misconduct of our government that has once again sat back and watched firms with severely-deteriorating asset bases continue to claim that "everything's fine" while the fire that began with the curtains spreads to the ceiling and the room fills with smoke.