60 Minutes profiles an FDIC bank takeover

Wonder what happens to a bank when it's taken over by the FDIC? 60 Minutes was recently allowed unprecedented access because the FDIC wants the public to know what happens during one of these takeovers. FDIC Sheila Bair says they expect to spend $65 billion on these takeovers over the next five years -- certainly relative chump change versus the recent stimulus package, and an amount that may certainly rise. From a CBSNews.com story:

A lot of people are worried about their banks these days. While devastated giants like Citigroup get bailed out again and again and again, many smaller banks are failing. The federal agency that takes over unsound banks is the Federal Deposit Insurance Corporation - the same people who guarantee depositors won't lose their money.

Most every Friday night now the FDIC seizes several banks. You haven't seen these takeovers happening because they're done secretly at night to make sure there's no needless panic by depositors. But last week 60 Minutes and correspondent Scott Pelley were given extraordinary access to one of these operations because the FDIC wants you to know what happens to your money when your bank has failed...

A primer on FDIC deposit insurance

Confused about FDIC insurance? You're not the only one, and have about 300 million other residents of the U.S. in equal company. I think that this country seriously needs to consider adding a Consumer Finance course to all high school curricula, because it seems that most banks have done a really poor job of educating people about FDIC insurance and it limits.

Here's a good primer from a MarketWatch.com article:

If you are sitting on deposits of over $100,000 at any bank, you are at risk.

Do you have too much money in the bank? Don't panic. You don't need to start running around, shopping for a dozen banks to hold your money. At least, not yet.

First, find out if your bank carries additional insurance. The great news for folks in Massachusetts is that all state chartered banks are required to carry additional coverage through the Depositors Insurance Fund. DIF covers all deposits over the FDIC limits, so depositors don't have to do a thing. See this page for more information.

That's great for Massachusetts residents. What about the rest of us?

It turns out there is no national insurance program for all banks. However, there is an interesting alternative. It's called the Certificate of Deposit Account Registry Service, or CDARS. See this page for more information.

If your bank participates in the program, you can have up to $50 million dollars in Certificates of Deposit and still have full FDIC coverage for your funds.

How does it work? You deposit money into CDs at your bank. Your bank spreads the CDs out among enough other banks to ensure that the part of your money in each bank is under the FDIC limits. In other words, you get the benefit of having 5, 10, or even 50 bank accounts with less than $100,000 in each account -- without the headache of opening, tracking and managing all those accounts yourself.

All you have to do is sign a document agreeing to allow the bank to spread your money around. CDARS says there are no additional fees to you. And you only get the one bank statement.

Without sitting on endless hold with your bank, how can you find out whether it participates in CDARS? Just go online and see. You can look up your institution, and if they aren't listed, you can find one near you that is a participant. See this CDARS page.

Before you move your money, have a friendly chat with your banker and urge them to join the program. If they're too busy to bother, then it's time to move your money to get full protection.

Now's the time to understand what part of your money is protected and what part isn't. Banks protected by the Federal Deposit Insurance Corporation insure accounts as follows -- you can have a separate account in each category:

• $100,000 for a single depositor (owned by one person, in the name of one person).
• $200,000 for a joint account (owned by two people, in the name of both people).
• $250,000 retirement accounts, including traditional and Roth IRAs, SEP IRAs, SIMPLE IRAs, Section 457 deferred compensation plan accounts (self-directed or not), self-directed defined-contribution plan accounts, self-directed Keogh plan (or H.R. 10 plan) accounts. See this FDIC page for more information.

The FDIC also insures revocable trust accounts, insuring the interests of each beneficiary up to $100,000 for each owner if all of the following requirements are met:

• The beneficiary is the owner's spouse, child, grandchild, parent, or sibling. Adopted and stepchildren, grandchildren, parents, and siblings also qualify. In-laws, grandparents, great-grandchildren, cousins, nieces and nephews, friends, organizations (including charities), and trusts do not qualify.
• The account title must indicate the existence of the trust relationship by including a term such as payable on death, in trust for, trust, living trust, family trust, or an acronym such as POD or ITF.
• For POD accounts, each beneficiary must be identified by name in the bank's account records.

More bank failures to come?

There are mounting concerns on Wall Street that other banks could follow IndyMac down the FDIC drain, which some attribute to the consequences of a long-term lack of leadership (i.e., since 2000) regarding the banking system. First, from a CNBC article (hat tip, Brian McDonald):

Chris Thornberg at Beacon Economics says, “IndyMac was the first major institution that wasn’t too big to fail.” He says as the Feds are busy worrying about “the big boys”—Fannie and Freddie—hundreds, maybe thousands, of smaller, regional banks will now realize they have no savior...

So who’s next? Two interesting takes on that.

Thornberg says, “We’re still early in this cycle.” He says regional banks don’t suffer the bulk of their problems until late in a credit downturn. We can expect to see home loan delinquencies to continue to spread to personal loans, car loans and student loans. He also says the next big shoe to drop is regional banks with a lot of exposure to builders, including commercial builders who are building condos or other projects that will fail...

“A lot of people are blaming Chuck Schumer,” Thornberg says. “All Chuck did was point out what investors should’ve known all along. IndyMac was in big, big trouble.”...

Richard Bove at Ladenburg Thalmann has a different take on who may be next. In a report, he looks at all the FDIC-backed institutions, comparing each bank’s bad loans to its overall assets through two ratios...

Bove blames regulators for not doing much of anything to prevent us from getting to this point. “Regulators should have the courage to stand in front of a mania and stop it,” he says. “This requires a courage that simply is not in evidence in Washington either on the positive or negative side.” He’s concerned about what happens next. “All of the actions are to deepen the trend. It really is beyond inexcusable for top policymakers to argue that large financial institutions should be allowed to fail. It is, of course, just as inexcusable to look the other way while excesses are driven through the system.”

Next, from the New York Times:

As home prices continue to decline and loan defaults mount, federal regulators are bracing for dozens of American banks to fail over the next year...

The nation’s banks are in far less danger than they were in the late 1980s and early 1990s, when more than 1,000 federally insured institutions went under during the savings-and-loan crisis. The debacle, the greatest collapse of American financial institutions since the Depression, prompted a government bailout that cost taxpayers about $125 billion.

But the troubles are growing so rapidly at some small and midsize banks that as many as 150 out of the 7,500 banks nationwide could fail over the next 12 to 18 months, analysts say. Other lenders are likely to shut branches or seek mergers...

Now, as the Bush administration grapples with the crisis at the nation’s two largest mortgage finance companies, Fannie Mae and Freddie Mac, a rush of earnings reports in the coming days and weeks from some of the nation’s largest financial companies are likely to provide more gloomy reminders about the sorry state of the industry.

The future of Fannie Mae and Freddie Mac is vital to the banks, savings and loans and credit unions, which own $1.3 trillion of securities issued or guaranteed by the two mortgage companies. If the mortgage giants ever defaulted on those obligations, banks might be forced to raise billions of dollars in additional capital.

The large institutions set to report results this week, including Citigroup and Merrill Lynch, are in no danger of failing, but some are expected to report more multibillion-dollar write-offs.

But time may be running out for some small and midsize lenders. They vary in size and location, but their common woe is the collapsed real estate market and souring mortgage loans. Most of these banks are far smaller than the industry giants that have drawn so much scrutiny from regulators and investors...

“Failed banks are a lagging indicator, not a leading indicator,” said William Isaac, who was chairman of the F.D.I.C. in the early 1980s and is now the chairman of the Secura Group, a finance consulting firm in Virginia. “So you will see more troubled, more failed banks this year.”

And yet IndyMac, one of the nation’s largest mortgage lenders, was not on the government’s troubled bank list this spring — an indication that other troubled banks may be below the radar...

The agency does not disclose which banks it thinks are troubled. But analysts are circulating their own lists, and short sellers — investors who bet against stocks — are piling on. In recent weeks, the share prices of some regional banks, like the BankUnited Financial Corporation, in Florida, and the Downey Financial Corporation, in California, have stumbled hard amid concern about their financial health. A BankUnited spokeswoman said the lender had largely avoided risky subprime loans...

An important issue for the regional and community banks will be whether they have managed to sell their riskiest loans to Wall Street firms.

And the government may have fewer failures than in the past because private investment funds might buy some troubled lenders. Regulators are considering rule changes that would allow private equity firms to buy larger shares of banks, and several prominent investors, like Wilbur Ross, have raised funds to leap in.