More Bank Failures This Week

Regulators closed banks in Illinois and Nevada this evening. The Federal Deposit Insurance Corp. (FDIC) seized two banks, Western Springs National Bank and Trust and Nevada Commerce Bank. Total losses to the FDIC are expected to be about $63 million.

Since the beginning of 2009, the FDIC has closed 325 banks, mostly small regional banks that weren't considered Too Big To Fail. Thankfully, there is reason to be hopeful, by this time last year, regulators had closed 42 banks. We now stand at 28 for the year.

Why have so many banks failed?

For starters, these banks loaded up on the bad paper created by the Wall Street Subprime securitization factories. The toxic assets soured and they took huge write-downs.

For another reason, the federal government made a concerted effort to fix the big banks, while at the same time ignoring issues that lead to multiple small bank failures. This Too Big To Fail concept led decision making throughout the crisis.

If you follow my posts, you know I speak from the standpoint of a Fannie Mae and Freddie Mac shareholder. I can tell you about at least one small bank that failed because the government didn't stand behind their implicit guarantee of Fannie and Freddie Preferred Stocks.

The Wall Street Journal recently reported,

"Small banks were the most frequent users of the Federal Reserve's discount window during a 14-month period in 2008 and 2009, among them seven units of an Illinois bank-holding company that turned to the emergency-lending facility a total of 330 times before they failed."

"FBOP Corp., based in Oak Park, Ill., got short-term funding from the Fed more often than any other financial firm, according to data released by the central bank last week."

"FBOP was battered by the U.S. takeover of Fannie Mae and Freddie Mac, which wiped out preferred shares in the two mortgage giants held by FBOP."

Why Did These Banks Hold Fannie and Freddie Preferreds?

The preferred stocks were issued with documentation that was clearly crafted to give the impression of the Treasury's seal of approval, but with no legal ramifications for not standing behind the investments.

For example, in the Fannie Mae Series T Preferred Offering Circular, it states:

"As a federally chartered corporation, we are subject to the limitations imposed by the Charter Act, extensive regulation, supervision and examination by OFHEO and the U.S. Department of Housing and Urban Development (“HUD”), and regulation by other federal agencies, including the Department of the Treasury and the SEC."

Many investors purchased these securities believing that the U.S. Government would never let them default on their dividend payments. They were sold to investors as investment grade agency securities. However, in September 2008, dividend payments were suspended. Just two months earlier, Ben Bernanke and James Lockhart stated that these companies were adequately capitalized.

It doesn't stop there.

Buy These Stocks "Without Limit"

In April 2002, the Comptroller of Currency, a division of the Treasury, issued letters to banks that stated the following:

"A national bank may invest in perpetual preferred stock issued by the Federal National Mortgage Association (“Fannie Mae”) and by the Federal Home Loan Mortgage Corporation (“Freddie Mac”) without limit,”

That's right. The Treasury told banks to buy Fannie and Freddie preferred stocks "without limit" and then they suspended the dividends to the same stock shares.

Volcker, Issac, and Meyer Call It Boneheaded

In the book, "Senseless Panic: How Washington Failed America," Paul Volcker and other authors write "Wiping out Fannie and Freddie preferred stock was a boneheaded idea. It sent shock waves throughout the world."

$37 billion in securities that were believed to carry a U.S. Government guarantee were wiped out. And even more interestingly, subordinated bondholders were saved. A large portion of these securities were held by the Chinese.

Congressman Manzullo Wants to Know Why the Chinese Were Spared

In the following video, Congressman Manzullo asks Geithner why these events unfolded the way they did. Geithner says that he cannot answer for the actions of his predecessor.