On October 4th,2009 I wrote that the FDIC had laid out over $55 Billion in insurance funds to cover bank loses, and that I felt the FDIC would go red in January or February of 2010, just based on the math and the rate of bank failures, coupled with the number of banks that were still in trouble. My concern was the bigger banks still in trouble like Citi. In December 2009, one of the major shareholders of Citi, Kuwait Investment Fund sold their stake in Citi. There is also a lot of money moving in the EU after the announcement that Greece is essentially bankrupt. In my October article, I personally thought that the FDIC might go red sooner than January or February, “much sooner” is what I said exactly.
While many readers commented that I may be too pessimistic about the situation, it actually turned out to be worse than even I thought. Bank failures for 2009 set a record and FDIC went red in December 2009. As losses have mounted on loans made for commercial property and development, the growing bank failures have sapped billions of dollars out of the deposit insurance fund, and its deficit stood at $20.7 billion as of March 31.
282 banks have failed since the beginning of 2008. 400 of the remaining 800 “troubled” banks may be in trouble. George G. Kaufman is the John F. Smith Professor of Finance and Economics at Loyola University Chicago and a consultant at the Federal Reserve Bank of Chicago has this to say about it. “ Bank (depository institutions) failures are widely perceived to have greater adverse effects on the economy and thus are considered more important than the failure of other types of business firms. In part, bank failures are viewed to be more damaging than other failures because of a fear that they may spread in domino fashion throughout the banking system, felling solvent as well as insolvent banks. Thus, the failure of an individual bank introduces the possibility of system wide failures or systemic risk. This perception is widespread. It appears to exist in almost every country at almost every point in time regardless of the existing economic or political structure. As a result, bank failures have been and continue to be a major public policy concern in all countries and a major reason that banks are regulated more rigorously than other firms. Unfortunately, whether bank failures are or are not in fact more important than other failures, and I will argue in this paper that they are not, the prudential regulations imposed to prevent or mitigate the impact of such failures are frequently inefficient and counterproductive.
A little background: Most failed banks are essentially sold to other banks and some go into receivership. The common maneuver here is to transfer the assets and liabilities to another bank with some level of guarantee from the FDIC to help support those liabilities. This is typically done on a Friday evening and causes the bank to be closed perhaps the next day (Saturday) and then the bank opens, business as usual, on Monday. So far, there has been little panic or problems with this modus operandi.
Now however, the FDIC is finding it more and more difficult to find banks that want to help out. That is, the banks that formerly had wanted to purchase other banks have done so and are not interested in buying any more banks. To put it bluntly, the FDIC is running out of buyers. Often times they are literally coming down to the wire to get all the transactions and contracts, etc. pertaining to the purchase completed in time to seamlessly make the transition, as it is taking longer and longer to secure a buyer. A recent example is Ideal Federal Savings Bank of Baltimore Maryland with $6.3 M in assets, but will cost the FDIC $2.1M because the FDIC could not find a buyer.
The number of bank failures is expected to peak this year and be slightly higher than the 140 that fell in 2009. That was the highest annual tally since 1992, at the height of the savings and loan crisis. The 2009 failures cost the insurance fund more than $30 billion. Twenty-five banks failed in 2008, the year the financial crisis struck with force, and only three succumbed in 2007.
The number of banks on the FDIC’s confidential “problem” list has jumped to 775 in the first quarter of 2010 from 702 three months earlier, even as the industry as a whole had its best quarter in two years. A majority of institutions posted profit gains in the January-March quarter. But many small and midsized banks are likely to continue to suffer distress in the coming months and years, especially from soured loans for office buildings and development projects.
The FDIC expects the cost of resolving failed banks to grow to about $100 billion over the next four years. The agency mandated last year that banks prepay about $45 billion in premiums, for 2010 through 2012, to replenish the insurance fund. While depositors’ money — insured up to $250,000 per account — is not at risk, with the FDIC backed by the government, the concern is competition and more importantly the loss of local community banks that invest locally.
James Wesley Rawles at survivalblog.com suggests we should be forewarned: 1.) The pace of bank failures in the U.S. is likely to increase. 2.) The number of banks that will have to be directly bailed out (rather than conglomerated with little fuss) will increase. 3.) The risk of bank runs will also increase. The point at which bank runs occur is difficult to predict, since it is based upon subtle psychological tipping points.
What is really disconcerting about these facts is that there are several other facts that just don’t jive with the reality of what is going on. Fact One- The FED is sitting on the largest excess cash reserves in its history (over $1 trillion). Fact Two- collectively corporate America is sitting on their largest cash reserves. Fact Three- banks are recalling record numbers of credit lines from small businesses that ARE NOT in default and have no adverse issues. So while overall the economy is the main cause of the failures, there also seems to be some hidden agendas working as well. It will be very interesting to read the independent examiner’s report concerning the WAMU closure last year. Maybe we can find a “smoking gun” from this report that would indicate if there is some hidden agenda in the FDIC’s aggressive actions. All I know is that there will be little hope of recovery if the “Big Five” are the only ones standing when the “Fat Lady” sings.