FDIC's Plan to Sell Troubled Loans Could Cause More Bank Failures, Bloomberg Reports

To those who believe much of the recent credit crisis was caused by the securitization and sale of subprime debt to investors, paired with credit default swaps based on those obligations, the FDIC's plan to auction more than $1 billion in assets seized from failed banks next month is puzzling.But Bloomberg reports today that bankers and observers believe the FDIC's plan is downright dangerous and may trigger writedowns and further bank failures nationwide.

"These banks can't believe that the regulator they pay to protect them is going to sell these loans to someone who can flip them and cause them serious losses," said Robert Reynolds, a lawyer at Reynolds Reynolds & Duncan LLC in Tuscaloosa, Alabama, who represents 25 lenders that took part in financing the W Hotel. "Our banks just cannot believe they're being treated in a way that ultimately hurts the FDIC's insurance fund, because some of them are right on the edge."

Almost half of the loans were originated by Silverton Bank N.A., whose collapse last May was the biggest in Georgia history. Community banks that joined Silverton in providing $80 million for the 237-room hotel and condominium complex, as well as backing for 39 other projects, could be forced to write down their stakes to reflect sale prices.

The auctions may have wider repercussions. Of the $50.4 billion in loans seized from failed banks currently held by the FDIC, 63 percent involve participations by other lenders, according to data provided by agency spokesman Greg Hernandez.

The article notes that 140 banks failed last year, and FDIC Chairman Sheila Bair has said the number may be higher this year. It stands at 26 as of March 6. The FDIC's insurance fund also had a deficit of $20.9 billion at the end of the year.

"This whole thing is a mess waiting to happen across the country," said Geoffrey Miller, a professor of securities law at New York University and director of the Center for the Study of Central Banks and Financial Institutions.

"Unlike the subprime mortgage problems, which hit mostly bigger financial institutions, the commercial real estate crisis is going to hit mostly smaller and regional banks," Miller said. "It was common for them to make these loans and buy participations. It's a systemic problem that the FDIC has to deal with."