Economies: IndyMac is dead, long live IndyMac

The collapse of US bank IndyMac is no huge surprise: it was woefully exposed to poor quality, misrepresented and fraudulent borrowing. And it was the amongst the biggest of the 90 banks that the Federal Deposit Indemnity Corporation has on its list of banks giving it cause for concern.

Although FDIC says it does not expect those 90 banks to fail, there is still considerable cause for concern.

FDIC's first response in a crisis is to close the bank without warning, and then to either take over the management of the bank or to hand it to another bank to manage. That latter course has been seen increasingly frequently in the past year – but direct management has not been common. That FDIC has taken that step in relation to IndyMac is perhaps indicative not just of size of institution but also the a concern as to what might be found once the digging starts. In accordance with usual FDIC practice, IndyMac branches will be open this morning and anyone with less than USD100,000 in their accounts will, if they wish, be able to go and get their money. But, FDIC is anxious to point out, there really is no need – that money is guaranteed safety by the US government whose word, if not actually a bond, FDIC say is as good as gold.

But not every customer of IndyMac will be able to walk into the bank and get their hands on money: aside from amounts above USD100,000, the real bite will be felt by customers who have secured lines of credit which they have not exhausted, including revolving credit.

FDIC has, simply, frozen all such arrangements until the value of the underlying securities can be accurately ascertained. In short, not just “asset backed securities” have been discredited, so has lending secured on assets. Unaffected, says FDIC, will be those customers who have taken out equity-release loans i.e. secured loans charged against the equity in a property by, for example, elderly people known as “house rich, cash poor.” However, it is not clear whether that saving will apply to others who took Bernanke's advice given to the US Senate in November last year where he said that equity release schemes would help support cashflow for families struggling to meet their bills including paying their mortgages.

FDIC has also taken an unusual step to try to prevent panic in the markets as people run from bank to bank reducing deposits in one to below USD100,000 and creating accounts elsewhere below the threshold. Provision is to be made for those with uninsured deposits (i.e. amounts above USD100,000) to be allowed to withdraw up to 50% of the additional amount.

If the US banking sector is shored up at all this morning, it will be as a result of the US government's announcement that it is to take steps to prevent the collapse of Freddie Mac and Fannie Mae.

Later today, Freddie Mac will try to rescue itself with a huge call to the market. Yesterday, it said “the company is adequately capitalized, has a large liquidity portfolio and access to the world's debt markets.” But that's not what the markets think and the share price of Fannie Mae and Freddie Mac nosedived by almost a fifth in a single day last week. A bit if a bounce on Tuesday was wiped out and in the past three quarters the shares of the two companies have tracked each other down and are now well below USD20 down from more than three times that.

Fannie Mae and Freddie Mac were the reason that there was much sputtering in the US last week. Standard and Poor's said last week that these two state-supported financial institutions are in such poor shape that they threaten the credit rating of the entire US government. Fannie Mae is causing even more concern than Freddie Mac as a result of fraudulent accounting – although none of the senior management have been charged with any offence.

The pair of Fs are special: they have issued bonds, etc. backed by the US Treasury. But a collapse would mean that the US Treasury has to make good on its guarantees.

And those guarantees could be worth as much as USD50 billion (that's real billion, not those diminutive American things). And that's enough to seriously disrupt the US Treasury's forecasts and its management of the economy.

Given the likelihood of impending recession, that would mean that there's a serious problem brewing, and currently there are no good ideas beyond offering more guarantees. So the question is how much those guarantees are worth.

It may be that the only way out of this mess would be for the two institutions to be nationalised, albeit temporarily. That won't go down well in the US, particularly with the current White House incumbents. And even the Democrats are not anxious to start to directly manage institutions.

Whilst there has been some movement in that direction in the FDIC's takeover of IndyMac, there is not likely to be much appetite for the creation of a national state-owned mortgage institution.