Credit Derivatives Still Forcing Banks to FDIC Takeover

A flavor of a credit derivative is a pool of mortgages that are packaged up into securities called Mortgage Backed Securities (MBS). No one knows just how large the MBS market is in total, but according to the Bank of International Settlements the total value of the credit derivative market is approximately $500 trillion. Warren Buffett said it the best when he stated back in 2002 that "derivatives are financial weapons of mass destruction". These financial weapons almost brought down the entire financial system in the US back in September/October 2008, and they are still doing damage today.

Here we are about a year later, how is the financial sector doing? Associated Press noted that as of August 21, 2009; "81 institutions have failed, which is the most since 1992 at the height of the savings-and-loan crisis". The Guaranty Bank with about $10 billion in assets failed this past weekend, which is the 10th largest financial institution to fail in US history. Wall Street Journal noted that, "Guaranty's woes were caused by its investment portfolio, stuffed with deteriorating securities created from pools of mortgages originated by some of the nation's worst lenders". Next question is what is the scope of this problem...

According to the FDIC, there are about 9,400 banks in the US. About 15% of these banks are involved to some degree with MBSes. In addition, banks have to deal with their losses in the commercial real estate market, which I outlined in the Commercial Real Estate Conditions article. Remember when the government performed financial institution stress tests earlier this year? There was much controversy on how that was done, and the results were largely skewed. Shortly thereafter, the Weiss Research Firm did their own more fair and much less criticized stress tests. Out of the nineteen banks stress tested, "seven institutions -- JPMorgan Chase & Co., Citigroup, Wells Fargo & Co., Goldman Sachs Group, GMAC LLC, SunTrust Banks, Inc., and Fifth Third Bancorp are at risk of failure". Let's see how the continuing domino effect of bank failures plays out later this year and into next.