Sheldon Filger-blogger for GlobalEconomicCrisis.com

Today the California based First Republic Bank was seized by the FDIC (Federal Deposit Insurance Corp.). It had 229 billion dollars in assets, making its demise the second largest bank failure in US banking history. Only a month ago, the number two spot was held by another California based banking institution, Silicon Valley Bank.

The FDIC worked out an agreement whereby First Republic’s assets will be taken over by JP Morgan Chase. In return, the FDIC will pay out about 13 billion to cover losses. Under the agreement worked out by the regulator, all of First Republic’s 84 locations in 8 states will reopen as branches of JP Morgan,

With the collapse of First Republic, the FDIC has had to grapple with three major bank failures in just over a month. This is further evidence that a banking crisis is underway in the United States, it is accelerating and is reflective of deep seated financial and economic weakness in the national and global economy.

It should be recalled that the Great Depression, which began with the stock market crash of 1929, became far worse and spread globally when a major Austrian bank, Creditanstalt, collapsed in 1931. The collapse of 3 American banks during the past month, including the second and third largest banking failures in American history, is the canary in the coal mine as the Global Economic Crisis worsens.

One of the leading banking institutions in the world, Deutsche Bank, is under steep pressure, as word circulated that the U.S. Department of Justice is seeking to impose fine and penalties on the German banking giant in the range of $14 billion. The assumption that the bank’s liquidity would be insufficient to meet such a liability, which DOJ is looking to impose on Deutsche Bank due to its mortgage securities  shenanigans  during the global financial collapse of 2007-08.

Stock prices for Deutsche Bank shares have undergone massive volatility. Undoubtedly there is much pressure on DOJ to slash the fines and penalties it is seeking from Deutsche Bank to a fraction of the $14 billion being floated. It is likely that DOJ will compromise, as everyone fears the counter-party risks if Deutsche Bank goes under. However, even with a reduced DOJ penalty, there may be other shoes about to drop at Deutsche Bank, which dues to its size, threatens the global financial system with a Lehman-like meltdown.

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The European Banking Authority, in conjunction with the European Central Bank, conducted a stress test of 123 leading banks within the European Union. A total of 24 banks failed the stress tests, which gauges the ability of a bank located within the EU to withstand macroeconomic pressures, which are rapidly accumulating not only in Europe but throughout the global economy. This represents a full 20 percent of all the major banks subjected to the stress test by the EBA and ECB. (http://www.eba.europa.eu/documents/10180/669262/2014+EU-wide+ST-aggregate+results.pdf)

Nine of the banks with failing grades are Italian; three are Greek and another three are Cypriote. Though only one of the banks  on the list of vulnerable banks is Irish (Ireland had previously been afflicted with a major banking crisis, requiring a massive bailout), that institution, Permanent TSB, is one of Ireland’s largest financial institutions. Permanent TSB was found to have a massive €854.8 million hole in its reserves. Overall, the EBA found that the banks surveyed in the stress test were short of 24.6 billion euros in capital reserves–the amount required in their modeling to withstand a three-year recession. This is the equivalent  of 31.17 billion U.S. dollars at current exchange levels.

Since the global economy imploded into systemic crisis in 2008, central banks and regulating authorities in major economies throughout North America and Europe have held periodic stress tests, apparently in an effort to reassure the public in those countries that their banks are in generally good financial condition. There is a suspicion among many that those stress tests are often rigged in a manner designed to present the most favorable indication possible regarding those banking institutions. The fact that this most recent stress tests undertaken by the EBA reveals that 20 percent of the European Union’s major banks are in trouble, and this at a time of economic stagnation throughout Europe, with increasing indications of looming recession, should serve as a warning klaxon on how fragile Europe’s financial health remains a full six years after the onset of the global economic and financial crisis.

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As further proof of the continuing global economic and financial crisis, Moody’s cut the credit rating on fifteen major banks, including the most powerful investment bank in the world. The list included  Goldman Sachs, JP Morgan Chase, Citigroup and Bank of America. The European Banks on Moody’s list included Deutsche Bank, HSBC and Barclays.

The Eurozone debt crisis, raging out of control, was clearly a  factor in the Moody’s downgrade. However, volatility and exposure to weak econometrics in the U.S. and China, questionable risk management and the negative outlook for profitability of these banking institutions amid the continuing  global economic crisis were also linked to the Moody’s downgrade. It should be recalled that since the crisis emerged, the ratings agencies have tended to be a lagging as opposed to a leading indicator of economic turmoil. It is likely that the financial risk to major banks is even worse than suggested by the most recent Mood’s downgrade.

In a previous post on this website and the Huffington Post, I warned that the current Obama strategy for conducting the war in Afghanistan is doomed to failure (see http://www.huffingtonpost.com/…/can-the-us-win-the-war-in_b_212831.html ). Of course, President Barack Obama did not consult me when he decided to vastly increase the U.S. investment in lives and treasure in pursuit of achieving what the Soviet Union and British Empire had failed at; subduing Afghanistan.

With all this focus on U.S. options for Afghanistan, little has been said about Al-Qaeda’s goal. Even official U.S. sources admit that Washington is spending over $5 billion a month to support 100,000 U.S. troops confronting as few as fifty (yes, 50) Al-Qaeda members presently situated in Afghanistan. Perhaps Al-Qaeda’s goal is to achieve a maximum return on investment; 50 of its members stationed in Afghanistan, in the process further eroding the U.S. fiscal imbalance at a time of acute economic crisis in America. The leadership of Al-Qaeda has stated on several occasions that they seek to draw the United States into an Afghan quagmire, inflicting upon it the same empire-shattering blow incurred by the once powerful but no longer existing Soviet Union.

The leader of Al-Qaeda, Osama bin Laden, has stated that his objective is to drain the U.S. financially, bringing about its fiscal collapse and ultimate insolvency. If that is in fact Al-Qaeda’s objective, it appears that not only Obama, but almost the entire political leadership in the United States which currently supports the war, both Democrats and Republicans, have become unwitting allies of Osama bin Laden. This is a policy that is bankrupt both figuratively and literally, especially with America currently gripped by a ruinous economic crisis.

How long will Washington be able to borrow vast sums of money in the global bond market, solely to pursue 50 followers of Osama bin Laden in Afghanistan? Perhaps only as long as the Federal Reserve can hold off the next stage of the American banking crisis and real estate meltdown. Once the United States is engulfed by a full-fledged sovereign debt crisis, it will be exceptionally difficult, to say the least, for a financially bankrupt U.S. government to justify throwing away nearly $100 billion a year on a war that has become increasingly devoid of rational purpose.

In February 2009, my blog referred to a story that appeared in The Daily Telegraph, a leading UK newspaper, headlined, “European bank bail-out could push EU into crisis.” The essence of the story was that The Daily Telegraph was shown a top secret document, leaked from the European Commission, the executive body that oversees the 27 nation European Union, which warned that the EU’s banking system was contaminated by an ocean of toxic assets. Though the story was ignored by the rest of mainstream media, for the most part, I think it is timely to look again at this secret EU document in the light of the current European debt crisis and growing rumours regarding the insolvency of many leading banks across the continent.

The confidential 17 page European Commission document warned that the European banking system could be holding as much as 18.6 trillion euros in toxic assets. Furthermore, in the wake of the European bank bailout that followed the collapse of Lehman Brothers, the document warned that the cost of a second Eurozone and UK bank bailout would exceed the financial capacity of the European Union. In other words, if Europe’s banking system enters a meltdown in the face of the sovereign debt crisis now plaguing European economies, the EU will be powerless to stop the implosion of the European banking and financial system.

Reviewing what the European Commission warned about more than a year ago, it appears that the document’s authors had an impressively prescient ability to forecast the current European sovereign debt and fiscal crisis. In stark terms, the EU document warned that, “It is essential that government support through asset relief should not be on a scale that raises concern about over-indebtedness or financing problems…Such considerations are particularly important in the current context of widening budget deficits, rising public debt levels and challenges in sovereign bond issuance.”

With Greece essentially insolvent, Spain in the grips of its own sovereign debt crisis and the UK and Italy teetering on the edge, not to mention Ireland, Portugal and Eastern Europe, it seems to me that the worst case scenario hinted at in the leaked document more than a year ago is no longer a speculative possibility, but unfortunately a chillingly realistic forecast of what may very soon be the next great global banking crisis.

In the wake of last fall’s  $700 billion taxpayer funded bailout of the financial and banking sector, the so-called TARP program, the decision makers in Washington have been engaging in a fiscal masquerade. The objective: convince the public that America’s banks, with balance sheets choking on toxic assets, are actually well-capitalized and secure. This, despite clear evidence that at least $2 trillion in additional funding would be needed to clean up the nation’s problem banks. To convince U.S. citizens and global investors that all is well with the American banking system, Treasury Secretary Timothy Geithner concocted a misnamed “stress tests” to demonstrate the fiscal health of the country’s banks. Not surprisingly, the major banks “passed” the Geithner test, for the most part with flying colors. My readers will recall that I labelled the Geithner stress test a fraudulent exercise in deception. Now, it is reality that is casting its impartial verdict.

The Federal Deposit Insurance Corporation (FDIC),  over the past few days , closed several banks, including Alabama based Colonial Bank. This institution, with $25 billion in assets, represents the 6th largest bank failure in American history. So far, 2009 has witnessed 77 bank failures in the United States. In all of 2008, the year that the banking crisis exploded, 35 banks were shut down by the FDIC, and only 3 in 2007.

With the number of bank failures accelerating, and running far ahead of last year’s pace, it is preposterous to conclude that the U.S. banking sector is well capitalized and strong enough to endure a severe economic recession. Yet, that is exactly the fantasy world the key economic policymakers in the Obama. administration  are beckoning us to embrace.

This problem of cognitive dissonance is not a uniquely American one, however. In Western Europe there is a numbing resistance to understating how vulnerable that region’s banks are to the disastrous and worsening economic situation in Eastern Europe. As with America and the UK, former Soviet bloc countries have suffered a severe contraction in home prices. In addition, many East European homebuyers obtained their mortgages from banks located in Germany, Italy, Austria and other parts of Western Europe. The loans were structured in euros, and now virtually all the national currencies in Eastern Europe have severely declined in value in relation to the euro. The results is a wave of mortgage defaults, which are eroding balance sheets throughout the European banking system.

Action speaks louder than words. Economic realities in the United States, Eurozone and UK, and the multiplication of bank failures in America, point to the futility of trying to pretend a problem does not exist, then converting that ignorance into a solution. Just as the political decision makers lost control over the financial system in 2008, they seem headed down the same path now, having failed to learn from their recent mistakes, which have already inflicted such a fearful cost on the global economy.

“Commercial real estate is the next shoe to drop.”

James Helsel, Treasurer of the U.S. National Association of Realtors

 
Pennsylvania realtor and U.S. National Association of Realtors official James Helsel joined with other concerned parties in meeting with a congressional committee last week, conveying a collective message that was saturated with gloom and doom. A commercial real estate implosion has been predicted for months by many observers, including this writer. There is now mounting evidence that this sector of the economy is indeed in the grips of a severe contraction, with all indicators pointing to an accelerating price deflation spiral over a period that may extend to several years.

It has all happened before. In the early 1990s speculators drove the valuations on commercial space far beyond the bounds of prudence. When reality caught up, the worst crash in real estate prices ensued. It now seems increasingly clear that this early 90`s disaster is about to be eclipsed by the commercial real estate crash of the current Global Economic Crisis. In fact, commercial real estate prices have already fallen from their 2007 peak valuation by a greater figure than that which has crippled the U.S. residential housing market. As with the housing market, the commercial real estate contraction will adversely affect the balance sheets of the nation’s banks. However, the dynamics of that impact will be qualitatively different.

The subprime debacle in the housing market overwhelmingly impacted the largest U.S. banks and financial institutions. With commercial real estate, however, the pyramid becomes inverted. The bulk of the exposure to commercial real estate mortgages is held by financial institutions of small to medium size. Deutsche Bank real estate analyst Richard Parkus told the same congressional committee addressed by James Helsel that the four largest American banks have an average exposure of 2 percent to commercial real estate on their balance sheets. In contrast, the banking institutions that ranked between 30 to 100 in order of size had on average a 12 percent exposure to commercial real estate mortgages. What these figures suggest is that a massive collapse in the U.S. commercial real estate market will cripple a large number of regional and community banks, in comparison to a few “too large to fail“  institutions stricken by the subprime housing disaster.

Though publicly quiet on this gathering storm, behind the scenes the economic policymakers in the Obama administration are deeply worried by this growing danger of a wider banking crisis brought on by a massive collapse in commercial real estate. The Federal Reserve is also in a state of high anxiety, for the same reasons. By June of this year, there were already 5,315 commercial properties in default, a figure that is more than double the number of commercial real estate defaults in all of 2008.

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Many loans initiated when the prices of commercial properties were at their peak will be coming due over the next 3 years, including $400 billion by the end of 2009, and nearly $2 trillion by 2012. With unemployment skyrocketing, real disposable income shrinking and nearly 7% of income now being saved by the chastened American consumer, it is a foregone conclusion that a greater proportion of these loans will become non-performing. In the current economic climate, there are simply no options available in terms of refinancing and securitization. As with housing, a glut of foreclosed commercial properties will further depress prices, creating a vicious concentric circle of financial doom.

Ultimately, the coming collapse in the U.S. commercial real estate market is not only inevitable; it is round two of the banking crisis. Having barely escaped alive from the consequences of the subprime housing collapse due to trillions of dollars in taxpayer aid and quantitative easing from the Federal Reserve, combined with Timothy Geithner’s stage-managed “Stress Test,“ it is difficult to see an escape route for the American banking sector once the ravages of the commercial real estate storm have hit with gale force. That must be what the Obama administration and the Fed are frantically consulting on behind the scenes, hoping against hope that they have a TARP 2 ready in time. In the final analysis, a very large number of small to medium sized banks in trouble can pose just as great a systemic risk to the global financial system as was the case with a small number of banking giants. What happens to the concept of “too big to fail“  in that scenario?

A few weeks before these antics a more sober assessment of America’s banking health was delivered at the National Press Club in Washington by Dr. Martin D. Weiss, the head of Weiss Research, a global investment research firm. Previously, Weiss had accurately forecast the demise of Bear Stearns and the implosion of the U.S. investment-banking sector. However, at the National Press Club he offered a more chilling prediction: 1,568 U.S. banks and thrifts risk failure. Included in that number are several of the largest American banks, including J.P. Morgan Chase, Goldman Sachs, Citigroup, Wells Fargo, Sun Trust Bank and HSBC Bank USA. The numbers and depth of the banking problem highlighted by Dr. Weiss are far larger and much more ominous than has been portrayed by the Federal Reserve, Treasury Department and FDIC. He backed up his dire analysis with documentation and precise mathematical modeling. For example, he refers to the government’s justification for a hideously expensive taxpayer bailout of AIG, based on the firm’s exposure to the fragile investment vehicles known as Credit Default Swaps, or CDS. The policymakers maintain that AIG’s $2 trillion in CDS exposure represented an unacceptable systemic risk, meaning AIG was “too big to fail.” However, Weiss points out that Citigroup alone holds a portfolio of $2.9 trillion in Credit Default Swaps, while J.P. Morgan Chase possesses a staggering $9.2 trillion of these toxic instruments, about five times the exposure that led AIG to demand that the government rescue it, or see the global financial system implode.

The essential point Dr. Weiss made at his press conference is that the degree of exposure U.S. banks have to a variety of toxic assets is beyond what the U.S. government and, by extension, the American taxpayer is financially capable of rescuing. Continued bailouts of insolvent banking institutions will not repair a broken financial order, but may very well cripple the overall economy.

Earlier, NYU economics professor Nouriel Roubini had already gone on record as declaring that much of the U.S. banking sector was functionally insolvent, and that bailing out zombie financial institutions would only replicate the Japanese “lost decade” of the 1990s, when Tokyo’s preference for keeping alive insolvent banks instead of closing them down led to a prolonged L-shaped recession. Roubini and other critics of both Bush and Obama administration policies on bank bailouts have looked to the Swedish model for resolving a profound banking crisis, which involved temporary short-term nationalization, closing down insolvent banks, while those banks that can be salvaged are cleaned up of their toxic assets, recapitalized and then sold back to the private sector. “You have to take them over and you have to split them up into three or four national banks, rather than having a humongous monster that is too big to fail,” Nouriel Roubini has argued.

According to the International Monetary Fund, the global financial and economic crisis has already created more than $4 trillion in credit losses due to toxic assets. If nothing else, the IMF estimate on the scale of the economic and financial disaster thus far should compel the Washington political establishment to face the painful yet necessary truths regarding America’s precarious situation. However, it appears that fantasy is preferred over reality within the corridors of power.

The procrastination of policymakers in Washington in facing dark reality, and preference to avoid any public takeover of troubled banking institutions while simultaneously subsidizing these financial dead men walking with almost unlimited taxpayer funds, at the same time maintaining the fiction, as Timothy Geithner has just done, that all is basically fine with the “vast majority” of U.S. banks, is to insure the inevitability of a systemic banking collapse in the United States. The conglomeration of reckless, greed-induced banking practices by the oligarchs of finance and inept, reality-denying policymakers is sending much of the American banking sector on a Wagnerian death ride into a financial apocalypse. Many of the U.S. banks are in fact doomed to fail, and no contrived stress test or Geithner speech can alter that outcome. And that isn’t even the worst part. For when mass banking failures occur in the United States and overseas, a global economic depression will be an irreversible outcome.

The European Commission is the executive branch, based in Brussels, that rules over the 27 nations that constitute the European Union. In the confidential EC document perused by The Daily Telegraph, its authors revealed that European banks may be holding as much as 18.6 trillion euros in toxic assets, roughly equivalent to $24 trillion dollars. The secret document issues the stark though not surprising warning to the political leaders of the member states of the EU that the amount of money required to salvage the European banking system, which had only months ago received its own version of a TARP-style bailout, would defy the financial and political capabilities of those countries.

The language in the EC document states the cold facts with harsh simplicity: “estimates of total expected asset write-downs suggest that the budgetary costs-actual and contingent-of asset relief could be very large both in absolute terms and relative to GDP in member states.” This assessment recognizes that whatever portion of the $24 trillion dollars of toxic assets European banks have on their balance sheets that will need to be written off, and that proportion is clearly substantial, cannot be made good by the European Union. To put that $24 trillion figure in perspective, it exceeds by at least six trillion dollars the combined GDP of the entire EU, and dwarfs the GDP figure for the United States, which stands at $14 trillion.

With the growing recognition that the U.S. and U.K. banking systems are effectively insolvent, the secret report issued by the European Commission reveals that the Global Economic Crisis has metastasized to the point where the damage to the world’s financial system is even more egregious than earlier bleak estimates. As the costs to the public purse, meaning the taxpayers, multiplies exponentially, some policymakers are beginning to understand that infinite bailouts of insolvent banks are an unsustainable model for resolving the crisis. As the EC reports puts it, “it is essential that government support through asset relief should not be on a scale that raises concern about over-indebtedness or financing problems…such considerations are particularly important in the current context of widening budget deficits, rising public debt levels and challenges in sovereign bond issuance.”

Alas, here is the contradiction. The degree of recapitalization essential for restoring a solvent and functional banking system far exceeds what policymakers in the U.S., U.K. and remainder of the EU have committed thus far. Yet, as the EC report makes clear, providing the required injection of new capital into the banking systems is not feasible for practical and political reasons. So what we are left with are still more costly bailouts that will overwhelm with debt generations of Americans and Europeans, while mummifying essentially moribund banks in a state of dysfunctional preservation.

Now that the banking collapse that has ensued during the Global Economic Crisis has spread from America to the European continent, are Asian banks immune to this contagion? Even if they have so far been spared the worst ravages, they should not feel overly secure. The rampant demand destruction sweeping the globalized economy will inevitably transform collateral held by Asian financial institutions into under-performing assets on their balance sheets. Once that happens, will any part of the globe retain a solvent, functional banking system?

As the news gets more bleak and dire, the time remaining for an effective policy response to the global banking collapse is rapidly approaching zero.