It’s October. Fall time. A GREAT time for outdoor activities. And a time for pumpkins, cider, and scary decorations. And the time of year when horror movies are released in anticipation of Halloween crowds and people tell scary stories around campfires on crisp autumn evenings.
But there’s one topic that REALLY is scary that TV shows and movies aren’t going to touch with a 10 foot pole—Zombie Banks.
What is a “zombie bank?” In short, it’s a bank that opens it’s doors every day, has smiling employees, takes deposits, and that may even look good on paper, but is dead inside. You really need to read this article. Zombie banks are behind the TARP bailout and will likely influence every part of our lives in the coming years. They’re one of the top threats to the dollar, our economy, and our way of life.
I’ll say up front that there are a dozen or more rabbit trails I could go down on this topic. I’m either going to gloss over or completely ignore them to keep the length within reason.
With that in mind, here’s a SIMPLE explanation on how we ended up with our current zombie bank situation:
Let’s say that a bank put up a sign saying that they’re selling Certificates of Deposit (CD) and customers come in and quickly buy $1 million of CDs.
The Federal Reserve says that the bank only has to keep $100,000 of the $1 million on hand and can loan out the remaining $900,000. This is the basis of the fractional reserve banking system. And it works as long as no more than 10% of the bank’s customers ask for their money at any one time. AND it works as long as a reasonable number of the bank’s borrowers perform on their loans.
So the bank throws caution to the wind and lends out as much money as they’re allowed. They write $900,000 worth of mortgages with that money and collect fees, points, and interest.
And, ideally, everyone pays back their mortgage.
The bank knows that some people won’t pay back what they owe and they set their interest rates accordingly. People who are a low risk pay a low interest rate and people who are a high risk pay a high interest rate. And, even if they aren’t able to pay, the bank can just turn around and resell the house and get most of their money back.
Anyhow, that’s how it used to work.
Up until about a decade ago, it took a 10-20% down payment to buy a house. This protected banks, the banking system, and…in reality…it protected home buyers. Banks also did underwriting to accurately determine borrower risk and assign interest rates accordingly. But that’s a whole other story. The main reason down payments and underwriting are important is that they make price fluctuations less dramatic and a crash less likely.
So, here’s what’s going on now.
Our example bank gave out $900,000 in zero-money-down mortgages to buy houses that were worth roughly $900,000 at the top of the market. They didn’t get down payments and they didn’t do underwriting, so they didn’t leave themselves a cushion for any loans to go bad. This is the equivalent of “letting it ride” at the craps table several turns in a row. There was no possible way that the market could keep growing at the rate it was, but banks kept moving forward as if the party would never end.
But as long as ALL of the mortgage holders make their payments, the bank can make the payments to their CD customers, and everyone’s happy. They know that a certain number of mortgages will get paid off each month due to refinancing or selling and they’ll have enough cash to pay off their customers when their CDs come due.
But it’s not working out that smoothly. Recent estimates are that 1/3 of US homeowners with a mortgage owe more than their house is worth. Even worse, 1/5 (20%) of mortgage holders are currently at risk of foreclosure.
And this plays out very interestingly.
If JUST 10% of the bank’s mortgages (worth $90,000) default and the bank is able to sell quickly and get 50 cents on the dollar–they just lost $45,000…and they have to find somewhere else to come up with $45,000 to pay their CD holders when their CDs come due.
Taking this to a personal level, I’ll knock off a zero and tell a quick story. What banks did was the same as you getting a $100,000 cash advance on a few credit cards, going to Vegas, betting $90,000 of it, and losing $4,500. The entire $100,000 plus interest has to be paid back, but now you’re down $4,500 with no way to make it up.
Going back to the bank…let’s look at where they’re at. They had $90,000 of mortgages go bad, so they still have $810,000 outstanding mortgages.
They got $45,000 cash when they sold the foreclosed home, so they’ve got their original $100,000 reserve + $45,000 = $145,000. Add it all together and: $810,000 + $145,000 = $955,000 in assets.
And, they still owe CD holders $1 million.
You could look at all of those mortgages that the bank has as assets…but they’re not. They’re more like a time bomb.
The REAL bank assets are what they can sell the houses for and the ability of the borrowers to pay.
In the example above, the bank borrowed $1 million from CD holders.
They turned around and loaned out $900,000 to borrowers to buy houses worth $900,000.
But the houses aren’t worth $900,000 anymore. If they only lost 20% of their value, then the bank only has $720,000 of real estate collateral…IF the houses sell for top dollar. They basically have to pray that homeowners will continue to pay on a mortgage where they owe more than the value of their house. That’s the banks’ only hope of not going bankrupt.
Because every time the bank does foreclose they take a bath.
They learned this pretty quickly, so they stopped foreclosing…unless you’ve got a nice house in great shape in a high demand area that the bank can sell quickly. If you’ve got one of those, the bank will foreclose and sell your house as quick as possible for top dollar.
By doing so, they can somewhat control comparable sales and make it look like the rest of the bank’s inventory of houses are worth as much as the few that it actually sells.
A similar thing happened in the 80s. Farm banks in the Midwest had to come up with cash in a hurry. Some of their borrowers had fully mortgaged farms and others only borrowed enough money for seed and fertilizer each spring. The banks foreclosed on their best customers with the smallest loan to value ratios so that they could either 1. Get cash quickly when the farmers refinanced or 2. Get a property back that they could sell quickly.
If you carry this out, you can see what’s happening. The banks are getting rid of their best houses and holding on to all of their worst houses…but on paper, they’re claiming that their worst houses are worth as much as the best houses that they sold.
So the banks are keeping these dead assets. They’re letting mortgage holders pay partial payments, or sometimes no payments at all. I’ve got a couple of friends who have both lived in million dollar houses for over a year without making payments because the bank couldn’t afford to foreclose on them.
When they do foreclose on non-perfect houses, they don’t sell the house, because they can’t let a bad sale tank the value of the rest of their portfolio.
Hmmm…a bank that gets rid of good assets and holds on to dead assets. The name “zombie” seems kind of appropriate, doesn’t it? Hold on, because it gets deeper.
Where’s the $45,000 that the bank lost going to come from? TARP bailouts, direct cash injections from the Fed, buyouts, 25% interest rates on credit cards, and as many junk fees as possible…or, they go bankrupt.
But remember, my example is about $1 million. In reality, we’re talking about billions or hundreds of billions with the larger banks. When you go from $1 million to $100 billion, the $45,000 turns into $4.5 BILLION that the bank has to come up with to pay back people they’ve borrowed money from, like CD holders. And that’s why this is such a serious problem.
“Stress Tests” are exposing many of the true condition of these zombie banks, which is allowing them to get bailed out or taken over before they actually run out of cash.
So, what are banks doing? They’re trying to hoard as much money as possible to be able to weather defaults in their portfolio. In a sense, they’re acting like us “preppers,” except their survival supplies are cash, cash, and more cash.
Most are sitting on new money that they’re getting in. They’re sitting on stimulus money. They’re sitting on deposits. And they’re not lending. If they are lending, they’re lending money primarily from the Fed that’s been borrowed from China that taxpayers have to pay the interest on and eventually pay back.
In addition to being a method of self-preservation, fewer mortgages mean less income from origination fees and points—It’s kind of like a farmer starving to death over the winter in hopes that he’ll have seed to plant next spring. It may work short term, but it’s not a sustainable model.
As a result of this, and other issues, it’s harder to get a loan now. Most banks that ARE lending are requiring borrowers to have a down payment, a job, and a good credit history.
And so, we come full circle and the end result is fewer buyers and more houses available which means less competition for houses and lower prices.
In short, the banks aren’t acting like banks anymore. They’re dead. They’re zombies. And these zombies really ARE scary.
Some of these dead banks have had their heads lopped off already…Countrywide, Merrill Lynch, Wachovia, & Bear Stearns to name a few. They were taken over by Bank of America, Wells Fargo, and JP Morgan.
But, like a bad zombie movie, they’re turning their new “hosts” into zombies as well. BOA, Wells, and JP Morgan are all dealing with the “rot” and “decay” that they picked up when they acquired these fallen banks. And right now that rot and decay could take down another set of banks.
So, what’s this mean for you? Well, in May, I wrote about why economic collapse was inevitable here: http://secretsofurbansurvival.com/124/is-economic-collapse-inevitable/
In short, it still is. Here are some of the specific reasons that have to do with Zombie Banks:
-Artificially high residential and commercial real estate prices due to banks not foreclosing so as to not tank their entire portfolios. We won’t have a healthy, sustainable market until banks have gotten rid of their “dog” properties.
-Artificially high real estate prices due to interest being rates so low that the risk premium has been removed. We won’t have a healthy, sustainable market until mortgage interest rates are higher than the rate of inflation.
-Artificially high financial stock prices due to credit default swaps not showing up as the liability that they truly are.
-Artificially high real estate prices due to investors and families making incredible (unsustainable) sacrifices to pay the mortgages on their 2nd homes and investment properties that they can’t sell because they owe more than the homes are worth.
There are 9 more reasons that I covered on the post above.
In other words, no matter how many times you hear that we just had “recovery summer” or that the economy has turned the corner, it won’t be sustainable until the recovery is built on a healthy foundation.
So how do you deal with this? The answer is to focus on fundamentals & slow, steady progress. Learn new skills on a regular basis. Stockpile staple foods that you already eat. Do what you can to get in better physical shape. No time? No money? Other problems? Join the club with everyone else trying to get prepared. As a friend of mine has recently started telling me, “Life’s tough. Get a helmet.”
Preparedness is like eating an elephant. You just can’t do it all at one sitting. If you try to, you’ll get sick. Just keep making steady forward progress. Measure your progress by the skills that you’ve DONE (not just read about) and the amount of supplies you have.
And just like you can’t eat an elephant by simply reading about how others have done it, you can’t get prepared for surviving disasters by only reading about how others have done it. You need to DO things to get prepared.
As you know, I wrote a step-by-step 12 week online course to help you get your plans organized and making forward progress on your preparations. It focuses on developing skills…not simply telling you how cool I am. (Although my mom, my dog, and my 3 year old are all pretty impressed with me.)
But seriously…over 4,000 people have gone through the SurviveInPlace.com Urban Survival course and had outstanding results. It will take you through the major skills and knowhow that you’ll need to survive a disaster in an urban environment. To read more about it, please go to www.SurviveInPlace.com.
Last week, I told you about a generous family from Missouri who went through the course earlier this year and decided to “Pay it forward” and pay for someone else to go through the SurviveInPlace.com Urban Survival Course.
We had 111 comments last week…about half of which were entries for the contest. Because of the response, I’m actually going to give away more than one copy of the course, and you have a chance to decide who gets it. Here’s how it will work.
To vote, go to last week’s Newsletter at: http://secretsofurbansurvival.com/446/urban-survival-skills-you-can-practice-today Then, scroll down to the comments and if you see one that you think deserves to win, click the little green “+” box next to the author’s name. Try to just vote for 1, since any more than that will dilute your vote, but you can vote for as many as you like. By all means, if you made an entry and you like your entry, vote for yourself.
I’m not going to have access to the internet for a day or two, and the person with the most votes when I get back will win the written and audio version of the course, as well as my book, “Urban Survival Guide.” The next two highest vote getters will receive the written AND audio version of the course. And finally, I’ll personally pick a fourth winner to receive the written AND audio version of the course.
Back to “Zombie Banks”…how are they impacting your survival planning? Have you checked your bank? You can do in many cases by googling, “Wells Fargo Stress Test” or “Bank Of America Stress Test.” Bloomberg has a consolidated report from the May stress tests at: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ahZSJ1g3M8BY
Share your thoughts and experiences by commenting below.
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