The Great American Hole Gets Deeper by the Day

Adam Lass
March 6, 2009 — 1,568 views  
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More cold hard facts as to just how deep in debt we REALLY are.

I promise to stop soon. I really do.

It brings me very little pleasure to upset you this way on such a constant basis. In fact, I look forward to the day when this column is full of nothing but hot stock tips.

But I'd rather bring a steady diet of hard cold facts, than any sort of hollow sugary confection. In the end, it's healthier for all of us to face up to the problems at hand now, before they grow even larger.

And so with that in mind, I have an update on the bank situation and a heads up on another brewing crisis along the same lines. On Monday, I showed you the growing gap between the Federal Deposit Insurance Corporation's growing responsibilities and the funds it has set aside to cope with same.

Washington Concedes the Growing Gap

Well, I've got good news and bad news on this front. FDIC Chairman Sheila Bair has officially conceded both the size of this gap and its truly awful potentialities.

In a letter to all insured banks, she warns that "rapidly deteriorating economic conditions" will cause the wave of bank failures to continue well into 2010. She also warns that the Deposit Insurance Fund (DIY) - our only bulwark against the complete destruction of any personal banked funds - is at risk of insolvency before the end of 2009.

I suppose it is bracing to hear a Washington bureaucrat be so forthright as to the sword of Damocles that hangs over her charges. Unfortunately the cure she is recommending may be worse than the disease.

The Fatal Cure

Bair proposes to hit every bank in her portfolio with a round of "substantial assessments." In point of fact, this program has already begun under cover of darkness. Last week, the FDIC imposed a series of "program fees," including a "one-time emergency fee," in an effort to staunch the DIY's bleed-out.

The problem is, these increased assessments may preserve the soundness of large banks, but they sound the death knell for otherwise solvent smaller banks who are hanging on by their fingernails. These guys have done their best to play by the rules, but they just don't have the clout in Washington that the big houses can bring to bear.

Independent Community Bankers of America President Camden Fine says that these fees could wipe out 50% to 100% of his clientele's 2009 earnings. In an interview with Bloomberg's Alison Vekshin, he reported receiving thousands of e-mails and phone messages from angry bankers worried that Washington was sacrificing them on the altar of expediency.

Despite all this blowback, Chairman Bair refuses to tap the FDIC's $30 billion line of credit at the Treasury Department, insisting instead that banks and not taxpayers should foot this bill. As I said: It is refreshing to hear a Washington cog insist that the industry she watchdogs pay its own way. However, she may very well be destroying that industry as we know it.

Another Massive Hole

Now let us turn our attention away from Washington and toward Chicago, where, I am told, the local transit authority has a small problem with its pension fund. Actually, it's a $1.5 billion problem. That's how big their shortfall was... in 2007, when the market was sailing. As things stood, this 62% funding gap left the CTA unable to pay retirees as soon as 2013.

Not to worry, CTA officials thought. We'll just do what everyone else is doing, and borrow to fill the hole. This is an "awkward" solution in the best of times. If nothing else, the recent crash has been an object lesson as to where excess leverage can leave a person, fund, state or even country.

Unfortunately, this harsh reality intruded most rudely into Chicagoland's little fantasy world. Since the beginning of 2008, the CTA has been paying out more to bondholders than they are earning on the borrowed funds, further exacerbating the Authority's funding gap. In the end, the bill for this debacle will most likely end up on the taxpayer's tab as well.

Now normally I wouldn't bother you about such a paltry local issue. After all, what's a billion or two between friends? But this particular crisis is not merely local. Indeed, when I dug into things a bit, I discovered that numerous state pension funds around the country are coming up short in a similar fashion.

You Expected to Make What? Are You Joking? You're Not Joking? Oh MY God!

The idea is that bond funds are to be borrowed at, say 2%, and then invested so as to earn, say, 8% to 10%. The income produced is used to both service the debt and fund operating costs, capital projects and pensions.

I'm serious here: The Teacher Retirement System of Texas - the seventh largest pension fund in the country - expects to make 8% off its endowment. In reality, it has been making 2.6% for over a decade. The largest public pension fund in the country, the California Public Employees Retirement System, has built in 7.75%-8% into its projections...and has not done better than 3.32% in recent memory. Except for 2008, when it lost 27%.

Brace yourself now: tot up the estimated shortfalls for funds across the country, and you have yet another trillion dollar hole that Washington will be forced to fill. And by "Washington," I of course mean you, me, and most all our anticipated descendents.

To paraphrase that cute little Chihuahua from the old Taco Bell ad: "I think we are going to need a bigger shovel."

About the Author

Adam Lass is the creator of the WaveStrength Analytic System and contributor to Taipan Daily. He has written numerous articles and special investment reports for several major financial publications.

Adam Lass