2009 Could Bring Big Trouble for Banks, Insurance, and Pensions

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Mike Larson discusses how Federal Home Loan Banks are a vitally important source of funding for U.S. banks. In this issue of Money and Markets, Mr. Larson explains how U.S. banks, the insurance industry and U.S. pensions are in a considerable amount of trouble.

Mike Larson discusses how Federal Home Loan Banks are a vitally important source of funding for U.S. banks. Mr. Larson explains how U.S. banks, the insurance industry and U.S. pensions are in a considerable amount of trouble.

There are 12 Federal Home Loan Banks spread around the country. They sell debt into the capital markets to raise money, using their AAA ratings to borrow cheaply. That money is then used to make advances to banks that are members of the system and take collateral in exchange, often mortgages or mortgage-backed securities. The banks use the money they get from the Federal Home Loan Bank, along with cash raised elsewhere from their own debt sales and depositors, to make loans. The banks are required to own stock in the Federal Home Loan Banks and that stock helps capitalize the regional Federal Home Loan Banks.

The problem is that the Federal Home Loan Banks own billions of dollars worth of mortgage backed securities. Those securities have plunged in value. So Federal Home Loan Banks are facing potentially huge write-downs on their portfolios. They may also be losing money on derivatives they employ. And that's what is stressing the system.

Specifically, the Seattle Federal Home Loan Bank just warned that it may miss one of its capital targets. It may be barred from paying dividends on the stock member banks hold in it, potentially impacting those institutions counting on the money. Also, the San Francisco Federal Home Loan Bank also said earlier this month that it was facing impairment charges and that it would not pay a fourth-quarter dividend as a result. And, Moody's recently warned that eight out of the 12 Federal Home Loan Banks could ultimately face capital problems, thanks to losses on their $76 billion of mortgage securities not backed by Fannie Mae and Freddie Mac.

It's not just the banks that are in trouble. The insurance industry is taking a pounding, too. Losses on residential mortgage securities, commercial real estate investments, and other holdings are hammering capital levels throughout the sector. The insurers are also getting hit because they guaranteed minimum returns on variable annuities and the market subsequently tanked. One estimate says the insurance industry may have to raise up to $50 billion in capital. Unless market conditions ease up, that kind of money just won't be available from private investors.

There's also a dismal picture for the nation's pension funds. States, corporations, and municipalities promised benefits to retirees based on assumptions about the returns for various asset classes. But those returns are deteriorating, causing funding shortfalls of epic proportions.

The consulting firm Mercer recently estimated that the pension funds of big U.S. companies are underfunded to $409 billion. At the end of 2007, they were running a $60 billion surplus. That huge swing could drive up corporate borrowing costs and drive down corporate earnings. It could also lead to reduced business investment as companies are forced to divert money from equipment and facilities budgets to their pension funds. Advisory firm Watson Wyatt recently estimated that U.S. corporations will have to boost pension fund contributions to $111.2 billion in 2009 from $50.5 billion in 2008.

"Now it's true that the government-backed Pension Benefit Guaranty Corporation (PBGC) insures the basic benefits for more than 29,000 plans. But with so many companies falling into bankruptcy these days, it's increasingly likely the insurance premiums the PBGC receives won't be enough to cover its obligations. The agency was already running a deficit of more than $11 billion as of September 30. And that number is poised to rocket higher," Larson states.

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About Mike Larson and Money and Markets

Mike Larson joined the company in 2001, and has more than 10 years of experience researching and writing about personal finance, investing, and the housing and mortgage industry. In 2003, Mr. Larson was named associate editor of the company's monthly Safe Money Report. In this role, he is responsible for writing and editing as well as analyzing trading opportunities for clients. Mr. Larson is also a regular contributor to the company's daily e-letter, Money and Markets.

Before joining Weiss Research, Mr. Larson was a personal finance reporter for Bankrate.com, where he wrote extensively on mortgage lending, banking, residential real estate, and Federal Reserve Board policy. His responsibilities included analyzing economic data and interest rate trends for a weekly column and developing rate forecasts for a regular index feature. Previously, Mr. Larson held positions at Bloomberg News and the Boston Herald.

Recognized as an interest rate and mortgage market expert, Mr. Larson's views have been quoted in the Washington Post, Chicago Tribune, Dow Jones Newswires, Reuters, Sun-Sentinel and the Palm Beach Post. He has also appeared as an investment expert to discuss the housing market on CNBC, CNN, and Bloomberg Television. His writing has been acknowledged by both the National Association of Real Estate Editors and the Massachusetts Press Association.

Among the first analysts to call the housing slide, Mr. Larson's new policy paper, "How Federal Regulators, Lenders and Wall Street Created America's Housing Crisis: Nine Proposals for a Long-Term Recovery" has received broad media coverage following its July 2007 submission to the Federal Reserve and FDIC. Mr. Larson holds B.A. and B.S. degrees from Boston University.

Money and Markets (http://www.moneyandmarkets.com) is a free daily investment newsletter from Dr. Martin Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Weiss Research, Inc. is located in Jupiter, Florida. For more information about our editors, or to set up an interview, please contact Jennifer Moran at 561-627-3300 or visit http://www.moneyandmarkets.com.


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