On January 1 2009 the FDIC reported it had $17,276 million in the DIF and according to press releases for each failed bank, the estimated total costs for FDIC’s DIF during Q1 amounted to $2,146 million, leaving $14,997 million in the fund. However, according to the latest FDIC Quarterly report the fund counted $13,007 million at the start of Q2, – a difference of $1,990 million.
In other words, the estimated spending on failed banks during Q1 was $2,147 million, but the bill ended up around $4,137 million instead (and probably still counting).
This is why Q2 is even more interesting, since the estimated costs are $11,504 million, thus leaving only $833 million in the fund for supporting failing banks in the future. Moreover, the real total cost for the first quarter in 2009 was almost twice the estimates. If Q2 is even close to this figure, the FDIC’s DIF will (very) soon be out of funds.
However, we have detected that DIF costs/bank assets have steadily increased under the period of discussion.
We believe the main reason for this lies in a de facto relaxation of accounting standards, even before the FASB 157 amendment on March 15 earlier this year. Basically the relaxation allows banks to write-off the parts of their losses caused by the slowdown in the market - but it does this by allowing them to decide what a fair price in a ‘normal’ market would be.
Allowing banks to control how they mark-to-market their assets, will likely backfire and when they ultimately end up failing, imply greater closure costs for the FDIC. From the graph above one can infer that the average yearly DIF costs/bank assets have increased at an alarming rate to almost reach 31% in 2008 and 2009.
To review, banks have been granted a waiver by the government to essentially overstate the value of their assets, a convenience that wags refer to as "mark-to-fantasy" accounting. When the FDIC swoops in on a Friday afternoon and takes over a failed bank, they have to start with the bank's own estimates of asset values when assessing the possible losses. To put it bluntly, these are pie-in-the-sky estimates that will only ever disappoint.
Looking carefully at the numbers above, we see that the FDIC estimated $2,147 million in losses, but spent $4,137 million, resulting in losses that were 92% higher than expected (and counting). I don't know about you, but I happen to think that a 92% variance is a lot.
None of this is the least surprising to those who have been paying attention. It is another shell game, being conducted for the benefit of a very few at everyone's expense. It works like this:
- Allow banks to effectively lie about the value of their assets.
- Let them operate until it is beyond obvious that they need to be shut down.
- Act surprised when their losses are a lot higher than "expected."
Nobody who is paying attention is fooled in the slightest, but unfortunately, very few seem to be paying attention.
Moral Hazard
This is just one more example of where giving banks extra maneuvering room, by allowing them to overestimate the actual worth of their assets, has only made matters worse.
The alternative? Let the bondholders and shareholders of failed banks get completely wiped out. Let a large number of failed banks go out of business. It is a complete fabrication to suggest that we need anything more than a fraction of the existing banks and financial institutions. Certainly quite a few could go under, and we'd be none the worse for the wear. Then, if there's any additional exposure left in the remaining banks, have the problem assets be nationalized so that a healthy core remains.
At the most basic level, the FDIC itself is a very bad idea. While protecting depositors is a good thing, the FDIC also encourages bad banks to engage in risky behaviors, because there's no detectable reason for depositors to prefer one bank over the other. All pay essentially the same rate of interest, and all the monies are FDIC-insured. Bad banks that take on a lot of risk make huge profits compared to their more sedate competitors. Before you know it, perilously risky lending is the new normal.
And then the bad times hit, the bad banks are bailed out, and their safer competitors are left paying for their mistakes. And here we are, reaping the 'rewards' of this well-intentioned - but ultimately destructive - government program.
Lest you think that this moral hazard is some sort of passive by-product about which I am merely speculating, I offer you this account from March of 2009:
FDIC Criticizes Massachusetts Bank With No Bad Loans for Being Too Cautious
A Massachusetts bank that has defied the odds and remained free of bad loans amid the economic crisis is now being criticized by the Federal Deposit Insurance Corp. for the cautious business practices that caused its rare success.
The secret behind East Bridgewater Savings Bank's accomplishments is the careful approach of 62-year-old chief executive Joseph Petrucelli.
"We’re paranoid about credit quality," he told the Boston Business Journal.
That paranoia has allowed East Bridgewater Savings Bank to stand out among a flurry a failing banks, with no delinquent loans or foreclosures on its books, the Journal reported. East Bridgewater Savings didn’t even need to set aside in money in 2008 for anticipated loan losses.
But rather than reward Petrucelli's tactics, the FDIC recently criticized his bank for not lending enough, slapping it with a "needs to improve" rating under the Community Reinvestment Act, the Journal reported.
Can you imagine? Even as the credit crisis is savaging the land, the FDIC, lacking more urgent matters we guess, was busy slapping "needs to improve" ratings on the safest and soundest bank in the land.
We wonder if Citibank (C) got a "needs to improve" rating? But we doubt it - and that's the problem.
As an aside, we wonder if Sheila Bair, the current FDIC chairwoman, isn't already grasping for a rope tied to the wharf:
Friday August 14, 2009, 6:54 pm EDT
FDIC Chairman Sheila Bair said Congress would not go along with expanding the Federal Reserve's authority to regulate large financial companies or with giving a new consumer protection agency enforcement powers over banks.
Power to enforce rules for banks now belongs to Bair's agency and other bank regulators.
"There's a lot of resistance from a lot of different quarters to a lot of the things the administration has submitted," Bair told the AP on Thursday. "That is a reality the administration needs to deal with."
Given what we've reviewed here, that would be our preferred strategy too - find a side issue to create cover for the departure. Our appreciation for Ms. Bair's skills just bumped up a couple of notches.
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 their Blue 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 banks maintained 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).
Conclusion
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.
