Here's a story about a bank that failed, got rescued, was resuscitated, and made its private equity investors more than 100% on their money, all the while costing the FDIC around $5.9 billion.
It's not a story about a failed bank… although it is.
It's not a story about how smart the bank's private equity "rescuers" were… although it is.
It's not a story about how the FDIC is such a great savior of banks.
Or that that moral hazard exists manifestly because the FDIC is a tool (not as in a tool used to fix something) that lets banks run hog-wild… although it is.
This is a story about how nothing has changed and why another bank crisis is coming…
They "Save" You Money by Inflating Loss Estimates
Back in early 2009, BankUnited of Miami Lakes, Fla., was insolvent and going under. The FDIC – that's the Federal Deposit Insurance Corporation, which bails out depositors and whole banks when things go terribly wrong – tried to sell it.
BankUnited had stuffed itself with bad bets on option adjustable rate mortgages (ARMs). Those are mortgages that give borrowers the option to pay principal and/or interest every month – or not – and increase the total owed, which would later be subject to higher interest rates.
Nobody wanted to bid on the bank.
By May 2009, the FDIC was desperate. They figured closing the bank would cost them $6.4 billion. They called John Kanas, who was grilling outside his Long Island home.
John Kanas is a brilliant banker. In 30 years he built Melville, N.Y.-based North Fork Bank into a profitable machine. Kanas smartly sold it at the height of the market in 2006 to Capital One for $13.2 billion. Kanas made well over $200 million on the sale.
The FDIC knew Kanas and they knew he was working with billionaire Wilbur Ross of WL Ross and Company. The two were interested in getting into the distressed bank market. Kanas welcomed the call. They were ready to offer the FDIC a deal.
It was a sweetheart deal…
While the investors put up just over $900 million in capital, the FDIC kicked in $2.2 billion in cash, would reimburse 80% of any losses on the first $4 billion at risk, and would for the next 10 years cover 95% of all additional losses.
Of course the investor group didn't have to think about the terms, as those were their terms.
They had studied the sweetheart deal the FDIC made when it sold IndyMac Bank to another clever group of investors earlier in the crisis and knew how to deal.
Fast forward to 2011. With the help of the FDIC and their ongoing rescue of banks across the country, and with the extraordinary help of the Federal Reserve – which, in case you don't know, is the tool of private banks in the United States (that's "tool" as in they fix bank balance sheets, flooding them with free money and winks from Congress), BankUnited under John Kanas was flush enough to sell its shares to the public in an IPO that valued the bank at $2.7 billion, or triple what the privateers put up in capital.
Just last week the investor group, in the last of a series of secondary offerings, said goodbye to BankUnited (NYSE: BKU) and cashed out, having more than doubled their money.
The FDIC, on the other hand, took at least a $5.9 billion hit on the deal. Well, at least that's what they claim, which makes them look "smart" because they had projected a $6.4 billion loss if they actually closed the bank.
So, what does this story tell us? It tells us a lot.
About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.