IndyMac Bank's sale by the FDIC is a farce for the US Taxpayer

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Good news reported by the New York Times. A consortium of private equity firms are close to finalizing a deal to buy IndyMac Bank from the FDIC for an undisclosed sum. The FDIC had to rewrite some rules to let the private equity firms put together the deal, but let’s go ahead and help the FDIC expedite that still-walking time-bomb off of the federal balance sheet.

From the Times:

The buyers include private equity firms J.C. Flowers & Company and Dune Capital Management and the hedge fund firm Paulson & Company, these people said.

The proposed deal is unusual because it is one of the first transactions involving unregulated private equity firms acquiring a bank holding company. Federal regulators have been locked in a heated battle throughout the credit crisis as banks continued to fail and private equity firms initially came to the rescue, but then backed off because of regulatory concerns.

In September, the Federal Reserve eased regulations to allow private equity firms and hedge funds to acquire portions of bank holding companies without being subject to undue regulation. Previously, a private equity firm that held more than 24.9 percent of a bank was required to register as a bank holding company and it restricts the investor?s ability to make investments outside of the banking industry.

Privatize the Risk

The IndyMac sale is good news because as we all know, IndyMac is a walking time-bomb of bad negative amortization and no-documentation liar loans waiting to happen. With a loan underwriting process built in a similar fashion to those of WaMu and Countrywide (”a thin file is a good file”) they are up to their necks in loans that will continue to sour at an alarming rate.

Option ARM loans and no-doc Alt-A loans, those that made IndyMac famous, are typically set on a 5-year reset or recast period at which points payments balloon and defaults come pouring through the door. The government is smart to get rid of this pig before it blows up.

The private equity firms are no-doubt getting a deal on the pricing of the assets; but since no one has any idea exactly how these loans are going to play out they are definitely playing russian roulette with their investors dollars. But guess what? I don’t care. Because it’s not tax payer money (unless the FDIC has to get in and bail out the bank a second time). This is how the market is supposed to work and I’m glad to see the bank go back to the private sector.

Will the US Taxpayers Recoup Their Expenses?

When the bank went under the LA Times reported that it would cost the FDIC between $4 and $8 billion for the government to seize and operate the bank. CNN estimates that it will have cost $8.9 billion when all is said and done. Will the sale recoup the costs that were incurred by the U.S. Taxpayer to keep this bank from folding? I hope the answer is yes, but it looks like that won’t be the case. The leading group is said to have raised only $2.5 billion for funds to invest in distressed banks. That the taxpayers have to subsidize this sale is unthinkable. And the joke that is the government’s bail out of Wall Street and greedy banking icons continues unabated.

The taxpayers should not have to eat the costs of this takeover that was necessitated by the malfeasance of the leaders of IndyMac bank and their careless financial alchemy.

The only solace we can take from having to shell out cash to keep this sucker afloat is that the future losses will (hopefully) come out of someone else’s pocket.

Update: The Wall Street Journal reports that the deal is shaping up to be a $14 billion sale which would recoup the losses of the FDIC and also turn a nice profit. That’s healthy and what we should be seeing. I can tone down my rant a bit. What is unnerving is the go-forward loss-sharing provisions. These provisions would have the FDIC eat losses past a certain level. A backstop for the deal if you will. This is a bad idea, although may be necessary to make a sale possible. These sales should be “as is” with the buyer taking the risk; but we’ve already seen the government’s all-to-willing practice of offering to socialize losses from this melt-down so I wouldn’t hold your breath.

From the WSJ:

An announcement of a sale agreement could come by Wednesday, according to people familiar with the situation. The expected deal for roughly $14 billion also could include a loss-sharing agreement that would have the Federal Deposit Insurance Corp. backstop losses on loans beyond a certain level, a person familiar with the talks said.

IndyMac Bank Can’t be Saved Again

The eyebrow-raising element of this sale is of course the private equity firms which until recently needed to subject themselves to additional regulatory oversight in order to poach on failing banks. But the FDIC, seeing, shall-we-say, a lack of buyers in the market, decided to loosen the regs to give these suckers a chance to buy up the goods. But this begs an important question. Will the FDIC step in again if these private firms fail in their turn around effort?

Of course they will, because it is still a depository bank. I just hope that should these private equity firms fail in their gamble (and they will in the next 2-3 years unless they’ve got deeper pockets than we know) we (the taxpayers) will not be saddled with more bad debt and a bank in worse shape than it is now. I hope that these private equity firms have enough skin in the game that they can’t just play scientists and turn a heaping pile of banking mess back to the FDIC at the first sign of trouble. But, alas, I imagine they will.