The FDIC Is Broke - Now What?
This blog post is the most recent Martenson Report which I am now making available for wider distribution. I believe this needs to be read and understood by as many people as possible.
- With the most recent bank failures, the FDIC is out of funds.
- The FDIC is levying a one-time fee on member banks to cover the shortfall, but it will not be enough and it punishes the prudent.
- The FDIC has been suspiciously slow at shutting down banks that have admittedly already failed.
- Banks have been allowed to overestimate the actual worth of their assets using "mark-to-fantasy" accounting.
- Hundreds of banks are likely already mortally wounded and set to fail.
- The FDIC means well, but creates a moral hazard the effects of which now haunt us.
- Take prudent action: Choose only high-rated banks, and keep cash out of the bank.
Five more banks failed this week, resulting in a long weekend for the FDIC (see below). The largest of these, by far, was Colonial Bank, which will cost the FDIC some $2.8 billion. And that's assuming that their loss estimates pan out as expected and that the $15 billion in shaky assets on which the FDIC will share future losses do not turn into larger-than-expected losses.
SAN FRANCISCO (MarketWatch) -- Colonial BancGroup Inc. became the largest bank failure this year after the Federal Deposit Insurance Corporation seized the struggling Alabama-based lender Friday and sold it to BB&T Corp.
The Colonial BancGroup deal will knock roughly $2.8 billion off a pool of money, known as the Deposit Insurance Fund, which the FDIC maintains to guarantee bank customer deposits.
The FDIC and BB&T will share losses on $15 billion of Colonial's assets. Loss-sharing deals have become common since the financial crisis struck last year, as the FDIC tries to encourage more stable banks to take over failing institutions.
Here is the list of failed banks for the weekend of August 15/16, 2009:
Let's add up the estimated costs to the Deposit Insurance Fund (DIF), which is the FDIC pool of money toward which banks pay a premium and out of which all bank failure costs are covered.
Union Bank: The FDIC estimates that the cost to the Deposit Insurance Fund (DIF) will be $61 million. (Source)
Community Bank of AZ: The FDIC estimates that the cost to the Deposit Insurance Fund (DIF) will be $25.5 million. (Source)
Community Bank of NV: The cost to the FDIC's Deposit Insurance Fund is estimated to be $781.5 million. (Source)
Colonial Bank: The FDIC estimates that the cost to the Deposit Insurance Fund (DIF) will be $2.8 billion. (Source)
All together, that adds up to $3.67 billion dollars in new costs to the Deposit Insurance Fund. The problem is that this turns out to be $3 billion more than currently exists in the Deposit Insurance Fund:
The incredible shrinking balance of the DIF is best viewed on a chart comparing it to total insured deposits:
With this latest series of bank closings, the DIF ratio is now solidly in negative territory. Interestingly, we might also note that insured deposits have declined for the first time since at least 1999, which is as far back as I have found data.
I suspect this deposit decline reflects the fact that people who are out of work are drawing down their savings, but I lack the data to confirm it at this time. Regardless of the cause, declining deposits are a significant threat to the banking system, which is only ever stable and happy when it is continuously growing.
Okay, so the FDIC is out of money. Now what?
What this means
To begin with, one thing we can be completely certain about is that the FDIC is going to need a lot more money, and soon. While there is a bolus coming in on September 30th from the special FDIC levy, I doubt that it will last more than 2-3 months, given the accelerating rate of failures and the number of banks that have already failed but are still operating.
I assume that the Treasury or the Fed will need to step in by year's end to provide additional funding. Hopefully the US Treasury can continue to find adequate market demand for its ever-growing debt sales. If not? Then the FDIC will be one of many demands upon an insufficient pool of funding. And who knows how that will play out?
I also fear that this drama is just getting started. Like an asset bubble, a banking crisis has a trajectory and pace all its own. In the chart below from Calculated Risk, we can see that the S&L crisis that began in 1980/81 took eight years to peak and another four to subside.
While it's possible that this banking crisis will be shallower and shorter than the S&L crisis, I consider it very unlikely. Assuming that this crisis began in 2007/08 and that it, too, will take eight years to peak, we might expect the FDIC to find itself increasingly busy through 2019, with a peak in 2015.
Too bad the FDIC is completely out of money already, even as this crisis is just beginning.
So how do I protect myself?
My immediate concern, should the FDIC find itself short of cash, is that it will simply turn from dragging its feet on closing banks to dragging its feet on paying out depositor claims. This means that if you have money in a failed bank, it could be tied up for quite some time.
Here's the advice I gave last year when I wrote about the FDIC:
- Do not keep more than $100k in any one bank account (okay, no genius insight there…)
- Always keep 1-2 months worth of basic living expenses, in cash, out of the bank but in a safe place. This way, if the banks close down, the ATMs aren’t working, and checks won’t clear, you’ll still be able to go on with things as the crisis gets resolved. And don’t worry; you won’t be losing much in the way of interest payments on that cash.
- Be prepared to run, not walk, down to the bank to remove your funds if the bank looks like it’s going down. Being one step ahead of the legal machinery could save you a lot of anxiety, if not your money. Here I would keep a sharp eye on the bank's stock price, because that will give you the earliest possible warning. The FDIC is notorious (and for good reason) for keeping mum about a troubled bank prior to seizing the assets.
- All banks are NOT created equal. Only keep your money in a Blue Ribbon bank (as rated by Veribanc in theirBlue Ribbon Report ) or in one that is rated “B+” or higher by TheStreet.com. If need be, separate your holdings across several banks to assure your risk is not overly concentrated. Also, just ask around – some banks play a riskier game than their local brethren, and knowing who’s who could be a real life saver.
Another great place to check on your bank is to see if it appears on this unofficial list of troubled banksmaintained at Calculated Risk. If my banks were on that list (I use several, all highly rated, to spread the risk), I would switch to a different (highly rated, naturally) bank.
You might also want to read my prior report on the FDIC, because it covers the legal language from the FDI Act, which unequivocally states that depositors may only be paid from money that exists within the insurance fund (which is now depleted).
The FDIC Deposit Insurance Fund (DIF), carefully built up over decades, has been completely depleted in the first two years of this crisis. While there's a special levy on the way on September 30th that will help the FDIC continue to operate for a while longer, those funds will prove insufficient to last the year. Funds will have to be found outside of the usual and customary system of assessing a premium on bank assets.
Adding to the FDIC money woes are the already-bankrupt but not-yet-seized banks that are waiting in the wings, the mark-to-fantasy accounting gimmick used by banks to understate the true extent of losses by nearly 100%, and past losses from already-seized banks running out to be much worse than anticipated.
This banking crisis has a long way to go. And if history is any guide, it may not peak for another 5-6 years.
The FDI Act provides for no additional source of funding to repay depositors other than funds located in the depleted DIF. The FDIC will need to have that fund restocked by the Treasury or some other source later this year. Smaller banks are already quite miffed about having been asked to pay higher premiums to pay for the all-too-predictable mistakes of their larger brethren.
Because of the potential funding problems for the FDIC, I continue to advise that it is prudent to keep some money out of the banking system entirely, avoid troubled banks, and be ready to rapidly withdraw funds from any bank that appears troubled.
Stay calm, be ready, there's more to come.
Check your bank HERE!
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