Bank Run

Remember that scene in Frank Capra’s “It’s a Wonderful Life” when George Bailey (played by the earnest James Stewart) is trying to save his father’s “cheap, penny-ante Building and Loan”? As rumors swirl around the bank’s potential demise, the depositors line up and demand their money---a classic bank run. Given the stories of the past week, some are wondering if we are experiencing a little truth that is stranger than fiction.

Last week, Pasadena, CA-based IndyMac Bancorp was seized by federal regulators, in the third largest banking failure in US history. During the height of the housing boom, IndyMac was a prolific mortgage specialist and became one of the largest savings and loans in the country. The FDIC took over and reopened the doors for business on Monday, sparking concerns among depositors of similar savings and loans throughout the country. As experts attempted to identify “the next IndyMac,” investors and depositors became nervous about the viability of various regional banks.

National City Corp, based in Cleveland, OH, was forced to issue a statement it was “experiencing no unusual depositor or creditor activity.” That may be so, but investors didn’t buy it and the stock plummeted by 15%. Similarly, Washington Mutual said that it “significantly exceeds all regulatory ‘well-capitalized’ minimums for depository institutions.” Shares fell by over a third and closed at $3.23 on Monday. One astute friend noted that you could now purchase a share of WaMu for less than a gallon of gas.

The failure of IndyMac and rumors of other problems lead us to review the rules of the Federal Deposit Insurance Commission (FDIC). If one of the nation’s banks fails, the FDIC protects individual accounts up to $100,000 per deposit per bank or $250,000 for most retirement accounts. Some have wondered why the amounts remain at these levels despite inflation, but the reality is that by law, the FDIC can’t increase the coverage until 2011. However, even if you have more than $100,000 in the account, you may be partially reimbursed. In the case of IndyMac, regulators believe that depositors will eventually get 50% of the uninsured amounts.

[There is an important note for those who use a bank for saving and investing: the FDIC does not insure money invested in stocks, bonds, mutual funds, life-insurance policies, annuities or municipal securities, even if these investments were bought from an insured bank. Those assets are usually covered by Securities Investor Protection Corporation (SIPC), which covers up to a ceiling of $500,000 per customer, including a maximum of $100,000 for cash claims, held by a customer at a financially troubled brokerage firm.]

If you have more than the $100,000 in an account, one way to protect yourself is to spread out your money at a variety of institutions. If you think that’s too much of a pain in the neck, then open different accounts—an individual account for you, one for your spouse and then perhaps a joint account for the two of you. That way, you can maintain $100,000 per account. Make these changes before bad news emerges, because the FDIC does not create a warning for banks that are in trouble.

Ben speaks and the market actually rallies!

I woke up yesterday to more bad news: the overseas markets were taking a beating as investor anxiety over the credit crisis and upcoming earnings season were gripping traders from Tokyo to London. The domino effect started in the US on Monday after negative news about the mortgage lenders hit the wires. When nerves are raw and emotions are high, problems can catalyze downside action in a matter of minutes, but in this environment, it feels like seconds.

The trouble started after a Lehman Brothers report estimated that mortgage lenders Fannie Mae and Freddie Mac could be forced to raise approximately $75 billion ($46 billion for Fannie and $29 billion for Freddie) in capital, diluting existing shareholders, if a proposed accounting rule change were enacted requiring companies to move certain off-balance sheet securities onto their books. These were the investment vehicles that were used to sell off, or securitize debt instruments such as mortgage securities. Even without the rule change, some analysts believe that additional capital will be a necessary ingredient for each company’s ability to survive the housing crisis and the associated credit losses. Still, it was the Lehman report on Monday that did the most damage, as both companies fell to their lowest levels in more than 14 years--FNM dropped more than 16% to $15.74 and FRE fell nearly 18% to $11.91.

The selling continued overnight and into Tuesday, as the news sunk in about the two mortgage giants. To add insult to injury, the FDIC announced that it would bar IndyMac Bancorp from making new mortgages, which further fanned the flames for jittery financial sector investors. Japanese markets tumbled Tuesday after a one-day respite, and resumed their two-week slide, sending the Nikkei 225 Stock Average 2.5% lower to close at 13033.10, after falling below the 13000 level intraday for the first time in nearly three months. The results were similar across Europe and within a couple of hours of the US opening, things looked pretty messy.

That’s why the timing of Fed chief Ben Bernanke’s comments at a mortgage-lending forum hosted by the FDIC was particularly fortunate. Bernanke described a plan to expand the central bank’s authority over financial firms and “In doing so, we aim not only to make the financial system better able to withstand future shocks, but also -- by reducing the range of circumstances in which systemic stability concerns might prompt government intervention.”

Given the news swirling on Tuesday morning, investors could be forgiven for being hopeful that Mr. Bernanke would succeed in making “the U.S. financial system itself more stable.” After his comments, the market opened to the upside and traded higher throughout the day, with the S&P 500 closing up 1.7% on the day. Some of that action occurred on the back of nearly $6 drop in crude oil, but for a change, Bernanke’s comments definitely got the day off on the right foot. Of course a day does not make a trend, but it sure is preferable to the alternative!