The Federal Deposit Insurance Corp. on Monday agreed to sell IndyMac, a failed bank it took over last July, to a group of sharp Wall Street operators. They're paying about $15 billion, leaving the FDIC with a loss of about $9 billion on the bank. The government will probably be glad to get rid of IndyMac after just eight months, as it would like to unload all the other failed companies and bad assets the Treasury Department and Federal Reserve has amassed. But there's reason to think they should wait awhile before selling.
Markets, which are presumed to be rational, are in fact frequently bipolar. Prices get distorted—too far upward during bubbles and too far downward after they pop. Now, they're down. Nobody today wants to buy banks or financial firms or subprime mortgage-backed securities, whose value has fallen by 90 percent or more since the peak.
So it's no surprise IndyMac is selling for a song. Buyers base their purchasing decisions in part on benchmarks, recent sales of similar property. Think what would happen to the market value of your house if the four identical homes surrounding it had just traded hands in foreclosure sales. What's more, when you put something expensive up for auction—a mansion, a yacht, a big lender—in this environment, you won't get many bidders. Wall Street banks are hoarding the capital they've received from the government, hedge funds are erecting drawbridges to keep investors from leaving, and private-equity firms are licking their wounds. And with oil prices at less than $50 a barrel, the Persian Gulf sovereign wealth funds aren't feeling particularly flush. The FDIC noted that it "received considerable initial interest from potential bidders" for IndyMac. But how many serious bidders were there?
Last July, Merrill Lynch was so eager to get rid of a portfolio of collateralized debt obligations that it practically paid a hedge fund to take it off its hands. The investment bank sold a batch of CDOs originally valued at $30.6 billion to Lone Star Funds for $6.7 billion. Merrill also agreed to finance 75 percent of the purchase, with the CDOs themselves as collateral. The buyer took on little risk, and Merrill, even after the fire sale, could still suffer further burns.
Something similar is going on with IndyMac. Since taking over IndyMac, the FDIC has done some heavy lifting, restructuring the bank's funding mix, aggressively modifying loans, and absorbing between $8.5 billion and $9.4 billion in losses. The consortium is paying $13.9 billion and is committing to pump in another $1.3 billion after the deal closes. In return, it gets a bank with 33 branches and $6.5 billion in deposits, a loan portfolio of $16 billion, a securities portfolio of $6.9 billion, and a big mortgage-servicing business. (Full details are here.)
The track record of private-equity types who stepped in to buy stakes in faltering financial companies in late 2007 and early 2008 was dismal. But this new crew is pretty smart, and their timing is much better. The investors, led by former Goldman Sachs executive Steven Mnuchin, include J.C. Flowers & Co., which cleaned up while cleaning up a failed Japanese bank; Paulson & Co., the hedge fund that minted money by shorting subprime-mortgage bonds; and other funds associated with George Soros and Michael Dell.
Many private-equity and hedge-fund managers are wonderful people—charitable, kind to small children and animals. But you never want to be on the opposite side of a trade from them. During a boom, you don't want to buy what they're selling. The corollary, of course, is that in a down time, you don't want to be selling what they're buying. Especially on these terms. The FDIC could still be on the hook for $1 billion or more in further losses.
That's why it's odd that the FDIC chose to sell so quickly. The government has the ability to be patient. Its long-term borrowing costs are as low as they've ever been. And consider the experience of the Resolution Trust Corp., the body set up to hold the assets dumped into the government's lap after the savings-and-loan debacle. Rather than try to flip illiquid assets—golf courses, office buildings—quickly at a time of slow economic growth and scarce credit, the RTC took about five or six years to dispose of nearly $460 billion in assets. As David John and J.D. Foster of the Heritage Foundation argue in this paper, the ultimate cost to taxpayers of the bailout—$124 billion—was limited because of the RTC's disposal strategy. "Because the RTC's assets were sold gradually instead of being dumped on the market all at once, the total cost to the taxpayers was significantly lower than early estimates that losses could reach several hundred billion dollars."
One of the problems with our financial system is that it is too pro-cyclical. Think about how Fannie Mae's loan limits are based on average home prices or how the FDIC stops collecting insurance premiums after a run during which there are no bank failures. The system can be pro-cyclical on the downside as well—foreclosures tend to beget distressed sales, which lower home prices, which lead to more foreclosures. By moving to sell banks and financial assets sooner rather than later, the government may be adding to the supply of an asset that nobody wants at exactly the wrong time. Instead of selling now at a low price and remaining on the hook for losses, the FDIC might consider holding out for a higher price later and demanding that it share in the upside. Otherwise, the cleanup risks being a continuation of the trend of socializing risk and privatizing profits.