The Fall of Georgia Banking … (Past performance does not necessarily indicate future performance)
The first three issues we dove into were all related to basic supply and demand. The major point of my argument surrounding the number of bank presidents, huge numbers of new banks, and “flipping” banks was this: When the supply of banks exceeds the demand for banks, banks will tend to go out of business or consolidate.
You see this all the time with all kinds of products and businesses. You even see this specifically with banks during the best of times as areas grow and mature. Branches close or are consolidated pretty regularly.
The next set of issues I’d like to deal with are a bit more complex, but truly set the stage for one of the biggest “bubbles” in the history of the world, and more specifically, Georgia. They are:
1. Explosive population growth and projections of continued growth
2. Unsustainable growth in debt, and
3. Sub-prime mortgages
The latter two were (and continue to be) national issues. The population growth was more specifically in Georgia, but we also saw it in places like Las Vegas, Phoenix, Florida coastal areas, and some other pockets around the country.
Growth in population is generally a wonderful economic driver. At one point Georgia was home to some of the fastest growing populations in the country. For years, counties like Coweta, Henry, Cobb, and Fulton experienced unprecedented and what seemed like endless growth. This shift was happening as the business environment got much better and more sophisticated in the Metro-Atlanta region. Georgia is also one of the best states for entrepreneurs and most businesses because of pro-business labor laws and a helpful tax code. When coupled with a generally good climate, lots of relatively cheap land and homes, and some good ole’ southern charm, Georgia and specifically Metro-Atlanta looked like a wonderful new place to call home.
All of this sounds great so far, doesn’t it? Why on earth would population growth be a “cause” of a banking melt-down? The answer is simple- people thought that it would continue, without interruption, forever.
Builders and banks especially believed this enormous myth. The faster the populations grew, the faster banks lent money to builders who built increasingly larger numbers of homes. They failed to realize that just like the much larger economy, population growth is generally cyclical unless you’re in a third world country. It might always be growing, but sometimes it grows faster than others, and there will almost always be some upper limit. When the growth in number of homes that banks were financing the construction of began to rapidly exceed the number of families moving into the area, there became a huge oversupply.
Banks were eventually forced to foreclose on a huge number of the new constructions. These were houses that had never been lived in and in many cases weren’t even finished. Because of the huge oversupply, banks were forced to write down values at a rapid rate.
Everyone also knows that homes have to sit on a piece of land. Banks were increasingly financing more and more land to be developed into subdivisions to support this huge, “infinite” population growth. It’s the land, especially, that has and will continue to bring down the community banks. This is where the largest write downs have been. Land, if it sells at all, is only selling for thirty to fifty cents on-the-dollar. That means for every dollar a bank had loaned on a piece of foreclosed land, it can only sell it if they’re willing to lose seventy cents on it.
What ultimately caused the housing boom and bust in Georgia, as with everywhere else, were subprime mortgages. There’s a twist to this story for community banks in Georgia however, and it’s very important. Most community banks don’t actually provide the funds for the mortgages that they make. The banks that have failed so far in Georgia actually held almost no “Sub-Prime Mortgages.”
The problem was the home ownership and building boom that those mortgages created. Community banks were the ones that generally financed the builder’s land purchase and construction costs. That builder would then sell the house to whoever could get the financing, and then pay off the community bank with the proceeds from the sale. The community bank didn’t care who bought the house, but they should have.
A large and growing number of the sales would never have happened under more “traditional” environments. Everyone is well aware of all the asinine practices that were going on in the mortgage market like stated income loans, Alt-A mortgages, 105% loans, etc. Had community bankers and regulators been more aware of these buyers, they might have been able to better slow down this clearly overheated market.
Finally, there was an unbelievable explosion in the level of debt for average households across the nation. Because everyone and their mother and sometimes even their dead grandmother could get a mortgage, there was a huge expansion of mortgage debt. Also, because home values were rising at an unprecedented rate and people were spending far more than they actually made, there was also an extremely big boom in home equity lines of credit. It is now well known that this level of debt creation could not be sustained. When home prices plummeted, home equity lines became worthless and the huge amount of debt outstanding relative to the new values of homes created a recipe for disaster for many banks. To summarize Warren Buffett: Debt is like gasoline in a car. It can make the car go 100mph in a heartbeat. But, when the car crashes, it’s also the gasoline that blows it up.
Through all this, a very important lesson was re-learned by many bankers: past performance does not necessarily indicate future performance. Populations will not grow endlessly, home values will not rise endlessly, people will not be able to sustain high levels of debt endlessly.
In the next couple of posts, I’ll be moving on from these more general issues that contributed to the Georgia debacle and diving headfirst into more complicated, but critical problems that brought down our banks.
