During 2008/2009, the Federal Deposit Insurance Corporation (known as the FDIC) was staring down the barrel of a financial crisis like no one had ever seen.
Ten failed banks in the five years prior. But the Great Recession forced the FDIC to shut down nearly 500 banks. The chaos in between – the billions won and lost – became the stuff of Wall Street legend.
When you try to picture the FDIC or Federal Reserve, what comes to mind? For most of my early life, I imagined giant, lifeless, concrete office buildings. Even the plants outside were gray instead of green. And the people inside were essentially robots in gray suits. Zero chit-chat by the water fountain and a whole lot of number crunching in poor lighting.
I’ve been to the FDIC’s headquarters in Washington D.C. and the Federal Reserve’s in New York City. I’ve had colleagues that have worked at both.
Frankly, the description I gave isn’t far off except during a crisis. These bureaucrats normally take months to formulate one liquidity measure for a single regional bank in Cincinnati. But in a financial emergency, decisions impacting billions of people – and trillions of dollars – must be made almost overnight.
The FDIC and Federal Reserve don’t try to handle this all on their own. When the going gets too tough, they call for help just like anyone else. And those on the receiving end have an advantage money can’t buy.
By Invitation Only
During the Great Recession, hundreds of billions of distressed assets were dumped on the FDIC almost overnight. They aren’t the type you can sell in your Schwab brokerage account. It included all types of real estate in all stages of construction, derivatives, equity in private companies, illiquid private credit, and much more.
Selling these assets quickly wasn’t just about protecting depositors. Or even ensuring the FDIC remained solvent. No, if this didn’t happen fast and the right way, the entire system was at risk.
There was no time for the usual three-hour lunches or months of deliberating the pros and cons of every decision. So, they called the people who can solve any financial problem fast – for the right price: Wall Street.
That’s when investment firms realized if they were in “the club” or not. In last month’s edition of the High-Yield Advisor, I explained how two companies you’ve probably never heard of received “SOS” calls from the FDIC. And how it changed their futures forever. They teamed up to take down a loan portfolio that was originally worth $4.7 billion. They paid about half of that.
Corus, once a top Chicago bank, decided to go “all-in” on condos in southern Florida just before the financial crisis of 2008. I don’t need to tell you how that worked out.
I’d forgive you for thinking the Wall Street companies called by the FDIC were getting “free” money. They renovated more than 40 real estate projects with their own dollars, managed another $400 million in construction work, sold more than 3,100 apartment units, and had to deal with the 6,000 mostly unsold condos. And don’t forget those were in one of the most saturated, least desirable real estate markets in the U.S. at the time.
The investment managers in this transaction were private, so the exact return they achieved was never made public. A managing director of the top company involved did give us a hint in a press release at the time:
We believe that this collaboration has produced a very favorable outcome for our investors, partners, and the FDIC.
One of the investment managers is now public, and we’ve already invested in one of their highest-yielding securities.
Bureaucrats Are People Too
People working at the FDIC and Federal Reserve aren’t that different than you and I. The staff at these agencies want to be there for kids’ doctor appointments and hate working past 5 p.m. Otherwise, they would have worked on Wall Street.
When a crisis develops, they don’t have all the answers. They pretend like they do, but they are winging it like the rest of us. And they don’t get paid big bonuses if they solve the problem faster or get taxpayers a better return. There is no incentive.
That’s one of many reasons you can’t depend on the Federal Reserve, FDIC, or any other “regulator” to protect your portfolio or the broader markets. This reality influences what we do here at Wide Moat Research in two ways.
First, we never make investments that depend on predicting their next moves. I’ll let you in on a little secret: Not even the Federal Reserve knows exactly when they’ll cut rates or by how much. So, how would anyone else? They don’t.
Now, we can still make reliable guesses about where rates might be over longer periods. That’s based on macroeconomic data, like population growth and savings rates, that are easier to predict. But we never “bet” on a specific FDIC or Federal Reserve policy. Instead, we make more durable recommendations.
Whether the Fed cuts rates in the next meeting or the one after that doesn’t stress us out. We won’t be four coffees deep waiting to see if it is for 0.25% or 0.5%. Our recommendations stand on their own legs – any tailwind from the likes of the Federal Reserve is just icing on the cake.
Second, we study which players on Wall Street have the most lucrative relationships with these government agencies (the Federal Reserve is technically a private company, but it was created by Congress in 1913 and is held accountable by elected representatives).
In less than two decades, we’ve had the Great Recession of 2008/2009, the pandemic stock market crash of 2020, and the regional banking crisis of 2023. Each time, the government called for help and paid a pretty penny for those services.
JPMorgan (JPM) “never lets a crisis go waste” and profited from all three. It now earns $1 out of every $5 in profits earned by the entire banking industry. Many other specialty Wall Street firms have made tens of billions in profits bailing out the likes of the FDIC. We’ve included several in recent editions of the High-Yield Advisor and the Intelligent Options Advisor. Some companies can boost earnings by 100% or more thanks to special opportunities thanks to the regulators.
There is no reason to fear the inevitable. A recession or banking crisis is always around the corner. We select companies designed to not only withstand tough times but grow their market share and acquire weaker competitors at distressed prices. And we know which asset managers get the call when the FDIC or Federal Reserve needs a bailout.
Regards,
Stephen Hester
Chief Analyst, Wide Moat Research