Banks Using Your Tax Dollars For Mergers, Acquisitions

This post first appeared on Minyanville.

Banks, it appears, may finally be tired of losing money.

The $700 billion bailout plan rushed through Congress was aimed at shoring up the American financial system, providing banks with capital that they could then blithely begin lending again.

The law of unintended consequences -- already familiar to us following the recent spate of unprecedented government intervention -- is once again rearing its unsightly head.

The Wall Street Journal reports that, rather than extending credit to embattled American consumers, banks may use recently allocated taxpayer funds to gobble up competitors. Zions (ZION) and BB&T (BBT) are eager to go shopping for attractively priced banks, and are considering accepting government funds to do so.

Many argue this is a healthy, natural progression as the banking sector consolidates and prepares for its eventual recovery. Others, however, aren’t pleased to see taxpayer funds funneled into takeovers, which will do little to pump credit into the economy in the near term.

Furthermore, as Professor Sedacca noted on this morning's Buzz and Banter, banks like KeyCorp (KEY) are tapping the government for cash - only to turn around and dole it out to shareholders in the form of dividends. Good for equity owners; not so good for taxpayers.

Lending money to consumers in the past 12 months has been a losing bet. Banks -- obligated to make good on credit lines handed out during better times to individuals and businesses alike -- are finding themselves with more bad loans than they know what to do with. American Express (AXP), heretofore the lender of first resort to the world’s wealthiest, saw third-quarter profits tumble 24% on a 51% jump on credit-loss provisions.

Banks, like any responsible economic actor, act in their own best interests. Irrespective of whatever pressure Treasury Secretary Hank Paulson or French President Nicolas Sarkozy puts on financial institutions to start lending again, government officials cannot force money into the real economy.

The massive amount of liquidity being pumped into the financial system may be a short-term fix for the panic gripping world markets, but self-preservation is paramount during hard economic times. If an acquisition makes more financial sense than extending credit to struggling consumers, banks won't think twice.

A few lost customers or a few angry borrowers is a small price to pay for survival - and the chance to emerge on the top of the heap.

Builders Dislike Taste Of Own Medicine

This post first appeared on Minyanville.

Turnabout, apparently, isn’t fair play.

After years of graft, deceptive lending and millions in profits on shoddily built houses, homebuilders are getting their just desserts.

The Wall Street Journal reports that banks, under pressure from regulators and shareholders to reduce their exposure to the housing market, are backing out of construction loans en masse. Builders, for their part, are crying foul.

Construction loans are like credit cards for big development projects: As the building goes up, developers draw on the loan to buy materials, pay employees and settle up with contractors. Banks like KeyCorp (KEY), Bank of America (BAC) and now-defunct IndyMac were active in the space, particularly in boom areas like southern California.

Recently, however, plummeting home prices have called the value of such projects into question. Banks are now refusing to honor their end of the bargain. If ground hasn’t been broken or the project is only partially complete, developers are left in the lurch: They're forced to repay the loan, post cash or sell the property. If they refuse, banks can push the project into foreclosure - and developers into bankruptcy.

Construction loans often carry personal guarantees, obligating builders to pony up their own assets if a deal goes sideways. In turn, builders are taking lenders to court, arguing that they have no cause to renege on their commitments. Banks, on the other hand, argue that property values have fallen to such an extent as to make many projects uneconomical.

As long as it can find an appraiser willing to value the property at a level that supports this claim, the bank has the upper hand. Finding an appraiser willing to do their bidding isn’t hard to do, since they value properties based on what their clients (i.e. banks) want.

The fact that builders are being forced into financial shackles by questionable appraisals does have a touch of morbid irony. During the boom, big developers like Centex (CTX), KB Home (KBH) and Lennar (LEN) built homes, then lent borrowers money to buy them. Since they controlled the loan origination process, they ordered appraisals from cronies who inflated the prices. Builders reaped the benefits, while homeowners got stuck with a home they paid far too much for.

Now that they’re on the other side of the fence, developers don’t find the game quite as fun. "If banks want to get out of residential lending, that's fine; let's sit down and figure it out," said one builder. "But that isn't being done. The rug is literally being pulled from under us and games are being played."

While banks may be acting in bad faith, minimizing their exposure to risky loans by any means necessary, it's doubtful that courts will find against them. Judges are already buried under foreclosure filings stemming from the irresponsible actions of builders gone wild.

So builders shouldn't expect much by way of sympathy.

IndyMac: Too Big to Fail?

This post first appeared on Minyanville.

Federal regulators may soon be forced to decide if IndyMac Bank (IMB) is too big to fail.

IndyMac?

Spun out of Countrywide (CFC) in the late 1980s, IndyMac is a Southern California thrift and mortgage originator specializing in loans a couple of notches above subprime. Known as “Alt-A,” these mortgages thrived during the credit boom, when verifying a borrower's income was considered due-diligence overkill.

IndyMac aggressively issued these loans, along with billions in option adjustable rate mortgages, or option ARMs, to become the country’s second largest private mortgage lender. Countrywide is was number one.

Since the mortgage market stumbled last year, however, IndyMac's shares have plummeted. They now sit at just 70 cents per share, down from over $47 in December 2006.

Thanks to Senator Chuck Schumer, the Federal Reserve may need to decide whether IndyMac’s potential demise is too great a risk for the fragile financial system to bear. According to The Wall Street Journal, Schumer sent a letter to banking regulators last week suggesting that they look more closely into the bank’s financial strength - and the potential implications of its collapse.

The letter kicked off a small-scale bank run, with frightened customers yanking $100 million, or 0.5%, out of total deposits.

Yesterday, in a statement to the Securities and Exchange Commission, IndyMac said it hoped the stampede caused by Schumer’s letter would soon subside; branch traffic is already slowing. The bank claims to be working closely with the Federal Deposit and Insurance Corporation (FDIC) to strengthen its balance sheet.

At issue isn't whether another troubled mortgage company will go bust - IndyMac certainly wouldn’t be the first. But Schumer’s involvement is likely to force Chairman Bernanke’s hand, compelling him to determine which firms fall under the shadow of the Fed’s umbrella.

By orchestrating a bailout of Countrywide by Bank of America (BAC), as well as of Bear Stearns by JP Morgan (JPM), the Fed set a dangerous precedent. While there may have been sound arguments for saving these firms to prevent outright financial panic, can the same be said about IndyMac, a bank with a market capitalization of just $70 million?

And what about KeyCorp (KEY), Fifth Third (FITB) or Zions Bancorp (ZION), all of which have recently gone to the rapidly closing financing window?

These are questions regulators must answer, and soon.

Struggling companies -- especially banks -- need to go bust, in order to stimulate healthy new growth. The Fed's propping-up of doomed institutions only forestalls or hampers this process.

The financial system is bloated with firms that should go out of business - and it's time that it went on a diet.