According to various news sources (here), Kansas Bankers Surety (KBS, about which refer here), a unit of Berkshire Hathaway, is exiting the business of privately insuring bank deposits beyond the $100,000 limit of the Federal Deposit Insurance Corporation. The September 10, 2008 Wall Street Journal reported (here) that the company is notifying about 1,500 banks in more than 30 states that it will no longer offer bank deposit guaranty bonds.

 

The part of this story that interests me (and, I am guessing, most other people, too) is the Journal’s statement that, according to sources, the order to stop insuring bank deposits came directly from Warren Buffett himself, although a spokesman for the company declined to comment on the report.

 

The Journal article also shed a little bit of light on what might have precipitated the decision. The article reports that KBS insured some deposits of Columbian Bank & Trust Company of Topeka, Kansas which failed on August 19, 2008 (about which refer here), which at the time of its failure had 610 accounts representing approximately $46 million potentially exceeding government insurance limits.

 

It is unclear from news reports what KBS’s exposure is in connection with the Columbian Bank failure. However, Columbian Bank is one of eleven banks to have failed already this year, and concerns about further failures loom. As the Journal article stated, the decision for KBS to withdraw from bank deposit guaranty bonds is "an indicator of how many in the industry are worried about future bank failures."

 

The prospect of future losses could have been a precipitating factor in KBS’s pullback. But I am guessing that Buffett himself needed little persuading to exit this business. He has a long-standing and very public antipathy for the banking business. As he wrote in one of his annual letters to Berkshire’s shareholders (here):

 

The banking business is no favorite of ours. When assets are twenty times equity – a common ratio in this industry – mistakes that involve only a small portion of assets can destroy a major portion of equity. And mistakes have been the rule rather than the exception at many major banks. Most have resulted from a managerial failing that we described last year when discussing the "institutional imperative:" the tendency of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so. In their lending, many bankers played follow-the-leader with lemming-like zeal; now they are experiencing a lemming-like fate.

 

Some readers may wonder about these comments in light of Berkshire’s substantial investment in Wells Fargo. Specifically, as of December 31, 2007, Berkshire owned 303,407,068 Wells Fargo shares, representing 9.2% of the shares outstanding, at today’s price worth more than $10 billion. Buffett commented on his willingness to invest in Wells Fargo at the time he made his first significant investment in the company, notwithstanding his general antipathy for banks, citing the quality of Wells Fargo’s management and its culture.

 

However, at the same time Buffett lauded Wells Fargo’s virtues, he also acknowledged its vulnerabilities:

 

Of course, ownership of a bank – or about any other business – is far from riskless. California banks face the specific risk of a major earthquake, which might wreak enough havoc on borrowers to in turn destroy the banks lending to them. A second risk is systemic – the possibility of a business contraction or financial panic so severe that it would endanger almost every highly-leveraged institution, no matter how intelligently run. Finally, the market’s major fear of the moment is that West Coast real estate values will tumble because of overbuilding and deliver huge losses to banks that have financed the expansion. Because it is a leading real estate lender, Wells Fargo is thought to be particularly vulnerable.

 

Readers may be interested to know when Buffett wrote these statements. Both Buffett’s remarks about the lemming-like qualities of banking managers and the potential problems of systemic risk and overbuilding on the West Coast appeared in Buffett’s 1990 letter to Berkshire shareholders. Reading his 1990 remarks some eighteen years later does suggest that history seems destined to repeat, at least when it comes to banking. From the 1990 shareholders’ letter is also clear that part of the reason Buffett was willing to invest in Wells Fargo then was that, due to terrible banking results at the time, bank stocks were beaten down and Wells Fargo was a relative bargain.

 

There have been numerous reports that we are now facting the worst set of conditions for the banking industry since that prior period. Although Buffett was then able to make a favorable investment in Wells Fargo, he undoubtedly recalls what happened to others in the banking industry in the late 80’s and early 90’s. The current conditions are similar to those from which Buffett profited in the past. He undoubtedly has aspirations of repeating that performance this time around, but at the same time he has no interest in footing the bill for depositors’ losses in excess of FDIC insurance.

 

If Buffett thinks this movie looks like a remake of old familiar classic, his actions suggest that he is pretty sure he know what is going to happen in the next scene.

 

From the Archives: Buffett is not the only one who memory runs back to the earlier era of failed banks. Many of us oldsters in the D&O business earned our spurs during the S&L crisis and era of failed banks in the early 80s and 90s. If we are indeed headed into another period of significant bank failures, many of the themes from that earlier time may again be relevant, including some venerable D&O insurance coverage issues, as I noted on a recent post, here.

 

Back to the Future: Comparisons back to the earlier era of failed banks seems to be the order of the day. According to a September 11, 2008 press release (here) from Navigant Consulting, the subprime-related litigation filed in federal court in the last 18 months already exceeds the amount of litigation filed in the S&L crisis.

 

The press release states "the number of subprime-related cases filed in federal courts through the second quarter of 2008 has topped the 559 savings-and-loan (S&L) lawsuits of the early 1990s, until now viewed by many as the high-water mark in terms of litigation fallout from a major financial crisis."

 

The release specifically cites the "rising tide of bank failures" as one potential source from which future litigation could emerge.

 

The Navigant data is interesting, but it would be even more helpful if the company had specified how it collected its data and what it was "counting" as subprime litigation. I know from my own efforts to track the subprime securities litigation that deciding what to count and what to exclude is an extremely challenging task. It would enhance the Navigant reports if the company were to provide a little more specificity about exactly what the company’s "count" actually represents.

 

Special thanks to the several readers who sent me links about the Navigant report.

 

The Hits Just Keep on Coming: In my prior post (here) commenting on the government takeover of and litigation involving Fannie Mae, I noted that the company’s huge loss of market capitalization would translate to significant losses throughout the marketplace and that in the weeks and months ahead we would find out where those losses landed. Along those lines, Progressive Corp. today announced (here) a monthly loss for August 2008 of over $135 million, based on large part on the write-down of the company’s holdings in Fannie Mae and Freddie Mac securities.

 

The company reported that during August, its holdings of Fannie and Freddie preferred stock declined $271.4 million and its holdings of the two companies’ common stock declined $6.8 million. The company also reported that following the government’s recent takeover, its holdings in Fannie and Freddie preferred stock declined an additional $171.3 million, which loss will be reported in the company’s September monthly results.

 

For those keeping score at home, that means that the value of Progressive’s holdings in Fannie and Freddie’s preferred securities declined a total $442.7 million in August and September. Even for a company the size of Progressive (the company had YE 2007 assets of nearly $19 billion), that is significant.

 

Progressive is far from the only company that will be reporting these kinds of results in the weeks and months ahead. Indeed, and to bring this blog post full circle, I note in that regard that a September 11, 2008 CFO.com article entitled "Fannie-Freddie Bailout  Losses Hit Banks" (here)  reports that a number of banks have issued warnings about the hits they must take to their balance sheet because of Fannie and Freddie’s collapse.