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Regulatory Reform Is a Waste of Time and Money


We need new leaders for the US Treasury, the Federal Reserve, and the FDIC.

Editor's Note: This article was written by Richard Suttmeier, chief market strategist at, which is a fundamentally-based quant research firm in Princeton, New Jersey, that covers more than 5,000 stocks every day.

Our banking regulators caused the financial crisis by not regulating and not recognizing the problems in time to prevent "The Great Credit Crunch."

Overly simplified, if Timothy Geithner, as president of the New York Federal Reserve,
actively monitored the risks of its contra-party trading partners, known as the primary dealers, their overexposures to risky derivatives could have been stopped before they imploded. The banks considered "too big to fail" are all primary dealers, as were Countrywide, Bear Stearns, Merrill Lynch, and Lehman. The Federal Reserve didn't follow the basics of risk management procedures in the day-to-day operations of the Federal Reserve Open Market Trading Desk, which is the eyes and ears of the Federal Reserve.

Geithner didn't do his job as regulator of the primary dealers and this lack of supervision allowed many to employ risk leverage that he should have known was beyond the means of the banking system to handle should a liquidity problem occur. Because the New York Fed reports to the Chairman of the Federal Reserve, the Alan Greenspan/Ben Bernanke Fed was also guilty of not providing prudent judgment with regard to the growing exposures to risky loans in the entire banking system. The Bernanke Fed still ignores the growing notional amount of derivative contracts, which ended 2009 at a record $213.6 trillion, up $48.8 trillion or 29.6% since the end of 2007, when the concerns in the banking system should have orchestrated a gradual unwinding of these potentially risky structures.

Treasury Secretary Henry Paulson came over from Goldman Sachs (GS), one of the creators of the toxic securities structures. His firm created and sold securities that turned out to be toxic around the world and used the term government-backed if a mortgage-backed derivative contained securities backed by a GSE such as Fannie Mae (FNM) and Freddie Mac (FRE). This wrong practice was shared by the other Wall Street firms that over-levered the world. Now the debt and mortgage securities of Fannie and Freddie are on the backs of US taxpayers, with unlimited costs through 2012.

The FDIC under Sheila Bair
allowed community and regional banks to become extremely overexposed to construction-and-development loans and commercial real estate loans. The Federal Deposit Insurance Corporation (FDIC) knew that 40% of the banking system was overleveraged to C&D and CRE loans and even so, didn't enforce the regulatory guidelines that were finally approved by the US Treasury, Federal Reserve, and FDIC at the end of 2006.

If our banking regulators acted pre-emptively, as they clearly should have, "The Great Credit Crunch" could have been lessened if not prevented. Now the same trio of regulators headed by Geithner, Bernanke, and Bair, who caused the problems, are being cheered for successfully preventing the second depression. In my opinion we don't need more regulations, we should have hired regulators who knew the guidelines and had the guts to enforce them.

Let's review those ignored guidelines once again.

Back in the fall of 2005, the Federal Reserve, US Treasury, and the FDIC realized that community banks were loaning funds to the housing and real estate markets at a pace above what these regulators thought as prudent. Guidelines were set and monitored via quarterly filings to the FDIC. These guidelines were formalized by the end of 2006. They included the following stipulations:

Overexposure to construction-and-development loans: The first guideline states that if loans for construction, land development, and other land are 100% or more of total risk capital, the institution is considered to have loan concentrations above prudent risk levels, and should have heightened risk management practices.

Overexposure to construction-and-development loans including loans secured by multifamily and commercial properties: If loans for construction, land development, and other land, and loans secured by multifamily and commercial property are 300% or more of total risk capital, the institution would also be considered to have a CRE concentrations above prudent levels, and should employ heightened risk management practices.

There are 380 publicly traded banks overexposed the C&D loans, and another 372 overexposed to CRE loans only. That's 752 publicly traded banks that are candidates for the ValuEngine List of Problem Banks.

Looking at all 8,012 FDIC-insured financial institutions we find 1,514 overexposed to C&D loans, and another 1,312 overexposed to CRE loans only. That's 2,896 banks, or 36.1% of the 8,012, at risk of failure.

Looking at loans versus loan commitments, which I call pipeline, even more banks are feeling additional stress. A "normal" or "healthy" pipeline is when 60% of the C&D and CRE loans are outstanding versus a bank's total commitment to these types of loans. Of the 8,012 FDIC-insured financial institutions only 594, or just 7.4%, have a pipeline between 55% and 65%. Most bank failures have a pipeline above 80%, which is a sign of collection problems: 4,172 banks, or 52%, have this stress characteristic. Of these, 1,406 have a pipeline that's 100% funded, which is 17.5% of all banks.

The daily chart for the Dow is overbought with stock market overvalued.

My annual pivot is 10,379 with today's pivot at 10,704, and annual and semiannual resistances are 11,235 and 11,442. With 10 of 11 sectors overvalued according to ValuEngine my prediction remains -- Dow 8,500 before 11,500!

Source: Thomson / Reuters

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