FBI Probing 14 Companies in Subprime Lending Crisis

According to Bloomberg, "The Federal Bureau of Investigation is investigating 14 corporations for possible accounting fraud and other crimes related to the subprime lending crisis, officials said.

Neil Power, chief of the FBI's economic crimes unit, wouldn't identify the companies, though he said the cases involve 'valuation-type stuff.'"

We warned about these problems in 1991. In 2001, we worked to create the first investment vehicle designed to address subprime lending problems. Fraudulent valuation is a key component in predatory home mortgage lending.

A key question concerns the lack of early warning from the Federal Reserve Board's Consumer Advisory Council: "The Consumer Advisory Council was established in 1976 at the direction of the Congress to advise the Federal Reserve Board on the exercise of its duties under the Consumer Credit Protection Act and on other consumer-related matters.The council membership represents interests of consumers, communities, and the finance services industry." All three have been damaged in the subprime lending crisis. Most Council members appear to be industry insiders.

On a more positive note, The Federal Reserve Board on Monday announced the termination of the enforcement action against Black-owned United Bancshares, Inc., Philadelphia, Pennsylvania. Written Agreement dated February 23, 2000. Terminated January 22, 2008. United Bancshares, Inc. owns United Bank of Philadelphia.

Douglass National Bank fails

According to the Kansas City Star, "Douglass National Bank, the Kansas City area’s only black-owned bank, failed Friday under the weight of mounting loan problems. It will reopen Monday as part of a Louisiana bank.

The bank’s failure is the first in the nation this year and the first in the area since Superior National Bank failed in April 1994.

Douglass’ two Kansas City, Kan., offices and one in Kansas City will reopen as branches of Liberty Bank and Trust Co. of New Orleans.

Liberty is a profitable $327 million bank with 14 branches in Louisiana, Mississippi and Texas."

Douglass National Bank reports $1.3 million dollar loss

According to the Kansas City Business Journal, "Troubled Douglass National Bank lost $1.3 million in 2007, the Kansas City-based bank reported in its latest filing with federal regulators."

As we noted yesterday (1/24/08) in an article by Marissa Fajt in the American Banker Newspaper ("Prospects Said to Be Dim for Struggling K.C. Bank")

"The bank had a deal to sell itself, but it fell through in October, and William Michael Cunningham, social investing adviser with Creative Investment Research Inc. in Washington, said he has been wondering since then if Douglass could survive on its own.

'Given the trouble they have been in and the problems they have — lack of income, a buyer backing out, and real estate issues — it just wouldn't surprise me if they had reached the tipping point..Douglass is likely to have trouble meeting its capital needs, because there are not many investors or investment funds looking to put money into a small minority bank.."

Banco Popular de Puerto Rico Upgraded

Following a reduction in subprime market exposure, ratings for the holding company that owns one of the largest Hispanic banks were upgraded today. Moody's "changed the rating outlook on Popular Inc. (BPOP) and its units to stable from negative. The company is rated A3 for senior debt and its unit, Banco Popular de Puerto Rico, is rated C+ for bank financial strength and A2 for deposits.The outlook change follows Popular's sale of a significant portion of its Equity One mortgage and consumer loan portfolio to American International Group Inc. The outlook was downgraded to negative Dec. 24, 2007.

Moody's said the transaction will reduce the company's exposure to U.S. subprime mortgages and significantly strengthen its holding company liquidity position since Popular has largely financed its U.S. consumer finance business with short- and medium-term wholesale borrowings at the parent company level."

Of course, we still have issues with AIG, Popular, and the rating agencies, but this change indicates that value may be returning to the minority banking sector faster than we had anticipated.

Global Stock Market Plunge and Minority Banks

According to the Washington Post, "Stock markets around the world plummeted today, as a financial crisis that began in the market for U.S. home mortgages spread to almost all corners of the global economy."

This challenges both theories concerning global equity market independence and equity portfolio risk management techniques that rely on global diversification to control risk. This is particularly troubling: there may be no safe haven for equity investors.

In 2006 and 2007, global economic activity was very strong. This was due, in part, to $458 billion dollars spent by the US, between 2003 and 2007, on the Iraq war. In an earlier age, stimulus of this magnitude would have all but guaranteed that the US would not fall into recession in 2008. To date, several factors have intervened:

1. The US has outsourced the Quartermaster function. Thus, critically important military support functions, including meal preparation and service, are now handled by foreign nationals. Economic stimulus generated by these expenditures now accrues to the laborer's nation of origin, not to the US.
   
2. An extremely small set of US and foreign firms have received the majority of the money spent on the war. Thus, economic benefits from these expenditures have been narrowly allocated, further limiting impact.
   
3. A financial market crisis of unprecedented scale, scope and breadth, created by greed and supported by fraud, combined with a partisan, ideology driven approach to fiscal and monetary policy has severely limited the ability of policymakers to respond in a timely and realistic manner.

Important secondary and tertiary impacts are beginning to be felt. According to the Chicago Tribune, "Retail sales unexpectedly dropped in December, capping the weakest year since 2002." For the banking industry, the net result is a growing risk of contagion: even banking institutions not directly involved in subprime lending are starting to fail, as consumer spending slows.

Bottom line: we expect the FDIC to shut down several minority-owned banks over the next three months.

A Socially Responsible Economic Stimulus Plan

We attended House Budget Committee hearings today.

As the New York Times noted, the Chairman of the Federal Reserve Board, Mr. Bernanke, testified that "A recession is probably not on the horizon, but quick passage of an economic-stimulus package plus aggressive action by the Federal Reserve are the appropriate prescription for the ailing economy.."

Let's hope he is right on the first count. As Fed Chair, he is pledged to political neutrality, so he cannot be specific on the second. We, of course, have no such limitation. Our suggestions follow.

Any economic-stimulus package should target low to moderate income consumers. We suggest implementing a $30 billion dollar increase in food stamp benefits. Given new distribution technology (EBT), this part of the stimulus plan would hit the economy first and quickly and, as an added benefit, would go a long way toward beginning to even the income distribution in the country. Benefits should be expanded to include more and newer consumption necessities, like disposable diapers and low cost (not greater than $400) computers.

Further, we would include a significant tax credit, up to $5 billion total, for investments in community development banks. (Our reasoning: someone will need to take the place of the lenders who got caught up in the Subprime lending mess.) We might also include a significant rebate for the purchase and use of energy efficient technologies.

We would also implement at full rebate of tuition, books and fees for low to moderate income (80% or lower of area median income for at least the last four years) persons studying at any accredited four year college.

Finally, we would include $20 billion for infrastructure repair projects (vetted, of course, to eliminate all pork) focusing on bridges. We suggest the infrastructure work first target US counties with an unemployment rate at least twice the national average.

Aggressive action by the Federal Reserve should focus on repairing the regulatory safety net that allowed subprime lending to damage the markets. This includes working with States as they seek to uncover subprime lending fraud.

Part of the economic recovery plan should require the Federal Reserve conduct a complete census (not a survey) of all subprime loans and borrowers. This would include collecting information on loan terms and conditions, reported borrower income at the time of closing, property location, and other demographic information on the borrower. We understand that a complete census will not be cheap (we estimate this would cost at least $100 million) but it will allow a better understanding of the exact nature of the problem.

Alternative Investment Roundup, January 27 through 30, 2008 in Scottsdale, AZ

"Bringing Together Leading LP’s and GP’s – Over $1 Trillion in LP Assets Represented"

Complimentary attendance for Qualified Plan Sponsors
See list of attending Institutional Investors (click here for details)

The Alternative Investment Roundup is four concurrent conferences at the same location. The Conference examines Private Equity, Hedge Fund, Institutional Real Estate and Portable Alpha Strategies. The programs share networking events, offering an opportunity to meet a wide array of alternative investment professionals and investors.

Over 500 senior decision makers attended last year’s event. Creative Investment Research is a Media Sponsor for this year's event.