Indymac bank seized by us amid intensifying crisis

IndyMac Bank will reopen its doors today, but under a new name - as IndyMac Federal Bank - following its collapse last week. The US Federal Deposit Insurance took control of the California-based mortgage lender - worth around US$32 billion (Bt1 trillion) - on Friday following its suffering from a severe liquidity crisis. IndyMac's collapse was the second biggest in US history behind the 1984 failure of the $40 billion Continental Illinois Bank.

The failure of IndyMac speaks volumes about the predicament of the US mortgage industry, which is facing a mortgage and foreclosure crisis with house prices falling and mortgages going into default across the country. This comes at a time when the US economy is already heading into recession.

US authorities made the right decision to intervene in IndyMac Bank's case instead of allowing it to go under. If IndyMac were to be left to market forces, it would have run out of liquidity and brought down the whole financial market with it. Earlier, the US Federal Reserve engineered a similar bailout for Bear Stearns, the Wall Street investment banking firm. The logic was similar. Bear Stearns, which had the largest exposure to the sub-prime related products, was saved to prevent a systematic risk to the financial system. The shareholders alone would be punished.

The bailout helps IndyMac continue as a going concern. This would assure the financial markets that it's business as usual (although it can't be "usual" in the strict sense). Within a few months, the Federal Deposit Insurance Corp will divest itself of IndyMac, so that it can become a private operation again.

It is the same old story of financial sin at IndyMac. It expanded rapidly during the real estate and home building boom. It provided home loans to customers without requiring evidence or other assets because it believed that the US housing market would increase forever. If the customers failed to pay their mortgages, IndyMac would take over the homes and resell them for profit.

IndyMac also found investors who stepped in to bundle its mortgage loans into securities backed by the mortgage and future payments of the customers. The mortgage-backed securities have come to be known as the US sub-prime products, which are now rattling global financial markets.

Now the housing bubble has burst and IndyMac has begun to realise losses. It has also found it difficult to raise funding to keep on going because the credit market has been tight.

In the meantime, customers are starting to panic. They don't know whether they will get their money back.

The Federal Deposit Insurance Corp offers a 100 per cent guarantee of personal investments up to $100,000. About 95 per cent of the $19 billion in deposits in the bank are insured, but that leaves $1 billion not covered by FDIC guarantees. According to the agency, 10,000 IndyMac customers could lose as much as half of that amount, or $500 million. The agency says the failure will cost the Deposit Insurance Fund between $4 billion and $8 billion, based on preliminary estimates.

Again, like Bear Stearns, IndyMac faced a run from its customers. Since June some $1.3 billion has been withdrawn from the bank following rumours that its business was in big trouble. The liquidity run caused the federal authorities to intervene. Shareholders and management have to take the hit.

Share prices of IndyMac have also faced a meltdown. A year ago, its share price was traded at $28. On Friday, it was worth just 28 cents. With 10,000 staff, IndyMac would have to shed 3,800 jobs.

After the collapse of IndyMac, investors naturally asked which banks would be the next to fall. US mortgage finance giants Fannie Mae and Freddie Mac have surfaced as potential problem financial institutions. Both have also been facing a meltdown of their shares, losing about 75 per cent of stock value since the beginning of the year.

But US authorities have yet to decide how to deal with both firms. There were rumours in the financial markets that Fannie Mae and Freddie Mac might need federal bailouts. But Treasury Secretary Henry Paulson has indicated that the authorities would like to keep both firms in their present form, while Fannie Mae and Freddie Mac have sought to assure the financial markets that they are operating with adequate capital.

How the financial markets react to the closure of IndyMac today will be interesting to watch. In the meantime, the US and other global authorities will have to stay vigilant to prevent the financial turmoil in the US from rattling the world.