March 9, 2009

$500 billion FDIC bailout forebodes massive failures

Late last week, the U.S. Senate proposed to allow the FDIC to borrow as much as $500 billion from the Treasury Department. While the mainstream media obsesses over the seemingly never-ending stream of colossal bailouts pouring out of Washington, another — arguably more important angle — is going relatively unnoticed: Massive bank failures are on the way.

Bailout increases normal FDIC fund by 1000%

First, let’s put the dollar amount in perspective. Historically, the FDIC fund has maintained a reserve around one percent of all insured deposits. At the start of 2008, that was $52.4 billion. But one year and 25 bank failures later, the fund held $18.9 billion, down 64%. As of February this year, another 14 banks had failed, draining another $1.7 billion from the insurance fund. Three more banks have already failed in March, whose hits to the FDIC have not yet been calculated.

Currently, the FDIC’s deposit fund is at just 0.4% of banking industry assets. That’s barely a third of the 1.15% statutory minimum. So the FDIC desperately needs cash…and a lot more than the $15 billion in special assessments they just tagged on their insured institutions (for just this year alone).

How big is the problem?

It almost seems the FDIC’s insolvency is inevitable. At least that’s what the FDIC’s chief Sheila Bair is worried about.

Last month Bernanke sent a letter alerting Congress to the imminent dangers if the FDIC wasn’t given a “mechanism that would allow the FDIC to respond expeditiously to emergency situations that may involve substantial risk to the financial system.” In case you aren’t nuanced in the language of “Fed speak,” what Bernanke is saying is, “Look out. Something’s coming. Are you hearing me??? Are you listening? Something big is going to happen.”

At the current rate, the FDIC will seize over 100 banks by the end of the year. Some prominent research firms in the financial industry predict that the banking crisis will claim 1,500 banks before it’s all over. RBC Capital Markets recently upped their expectations for bank failures earlier this month, warning that they anticipate 1.000 institutions could fail over the next three to five years, up from their earlier forecast of only 300.

More than 1,900 financial institutions went under during 1987-1991, peaking with the failure of 534 banks in 1989.

Institutions on the FDIC’s  “problem list” grew to 252 lenders in the quarter ended December 31. Back in Summer 2008, there were only 90 so-called troubled banks. But nowhere on the list was IndyMac, Washington Mutual, nor Wachovia.

Reality Check: The FDIC doesn’t know which banks are going to fail this quarter or the next. All they know is that massive failures are on the way.

Some people speculate that either Citi or BofA are next. If either one failed, that would slam the fund for around $500 billion according to some estimates. When IndyMac failed, it cost the fund $9 billion and the bank had $31 billion in assets.

The five biggest U.S. bank holding companies — Bank of America, Citi, JPMorgan Chase, Wells Fargo and Wachovia (now owned by Wells) — had domestic deposits ranging between $271 billion and $701 billion at the end of the second quarter of 2008.

“It’s the biggest banks that need the bailout,” says Walker Todd, a former Fed official, lawyer and economic historian. “And those hold the vast majority of the estimated $4.54 trillion in FDIC insured deposits.”

Bottom Line: Whether it’s one big bank or hundreds of smaller ones, the shockwaves hammering the financial industry are far from over. By the end of the year, there will be far fewer bank brands covered by this publication. And it could be a long time — if ever — before we ever see the 8,000+ banks that the U.S. once had.

Key Questions: If the amount of insured accounts is fixed at $250,000, what will the affect be of making FDIC premiums permanently larger? What is the right amount for the FDIC to hold in reserve? Is it more than the historical 1%±?

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Previous related stories from The Financial Brand:

• WaMu seized, deposits go to JP Morgan
• Are you safe? Here’s 20 things you had better know
• Big bank brands, big consumer contradictions
• Secretive bailout banks fail transparency test

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