FDIC Adds Twenty-Seven More Banks to “Troubled” List

On August 26, the Federal Deposit Insurance Corporation increased the number of banks it considers in danger of failure from 90 to 117 and responded indirectly to concerns about its ability to insure money on deposit at retail banking institutions. The FDIC is considering increasing the fee it charges retail banks to insure their deposits to 14 cents for every 100 dollars of insured deposit money this October. A serious fight from the banking industry is expected since banks are already struggling to survive. The fee increase could not come at a worse time for them, and yet without functional FDIC deposit insurance, bank runs become all too likely all over again.

In the immediate aftermath of the recent failure of IndyMac Bank in California, FDIC officials were all over the media assuring a skittish public that the situation was well in hand and that the number of banks on the troubled list is actually lower than it was in the 1990s. What was not said, possibly because it defeated the whole point of going on TV to reassure the public, was that the size and scope of the banks currently facing failure is far beyond anything the FDIC has had to face since the Depression.

IndyMac was the third largest bank failure in history, and it is but one of a large number of major regional banks that are currently struggling to stay above water. Earnings at banks and thrifts declined a whopping 86% from April to June and are currently down to $4.96 billion from $36.8 billion only a year earlier. At the same time, the credit crisis appears to be spreading to lending products that were not really of concern only six months to a year ago. Credit cards, auto loans, and other types of retail consumer debt are beginning to go into default a higher and higher rates, and already institutions are experiencing a rapid increase in late payments.

Small business credit lines, which insure the smooth operation of daily life in many cities, are already getting much tighter as underwriting departments react to a steady drop in the value of business capital due to the housing crisis. While it is true that more homes sold this July than expected, the drop in housing values for June was the largest on record. Many of those sales were “short sales” on foreclosures.

As home prices continue to plummet, both personal and small business customers have fewer and fewer options for securing needed credit. Already many homeowners are “upside down” on their mortgages; that is, they own more on their homes than their homes are currently worth. When this happens to customers who have home equity lines at retail banks, the lines are frozen and credit is no longer available.

Sadly, many customers are tapping their unsecured credit cards to fill the gap and are consequently having a harder and harder time managing those payments now too. The high cost of gasoline and the rise in foreclosures has also resulted in an increase in voluntary defaults on auto loans. Banks don’t really want or need a wave of people calling in to “give back” their SUVs right now since, with gasoline still closer to $4 a gallon than $3, those vehicles are incredibly hard to sell at any price.

Many analysts fear a second huge waive of defaults on credit cards, HELOCs, and auto loans that will hit banks harder than they can stand to be hit right now. The FDIC currently provides up to $100,000 per customer in insurance for checking and savings accounts and up to $200,000 for married couples, per financial institution. However, much of that promise depends on the FDIC never having to actually deliver on that promise in a truly huge way.

Even in the wake of the single IndyMac failure, some multinational banks were refusing to cash checks issued by the FDIC on IndyMac acccounts, putting extensive holds on the deposited items or refusing them altogether, hoping to shuffle these customers off to another bank before anything went to court. It’s hard to imagine the chaos that might be caused by multiple simultaneous bank failures, so we don’t see a lot of open discussion about that possibility.

That lack of discussion doesn’t mean the possibility isn’t out there, it just means the topic of simultaneous multiple bank failures has become “the elephant in the living room.” Banks, federal regulators, and some customers see the danger quite clearly, but no one knows quite what to do about it. Add to that the concern about not causing panic and you have a truly uncomfortable situation for all concerned.

The financial crisis that has gripped the U.S. since last November as the subprime loan mess began to hit full force has been like that all along: a series of choices between difficult options both of which might have major negative consequences. For example, when the Fed cut the interest rate for the funds banks lend each other daily from from 5.25% to 2% over the course of less than a year, it probably saved credit markets from freezing up completely. On the other hand, it almost certainly fueled inflation, which is now at record levels.

If the FDIC draws undue attention to itself by increasing the fee it charges retail banks to insure their customers’ deposits, it will almost surely provoke the very reaction it wants to avoid: runs on the most troubled banks. If the FDIC does not increase this fee, it risks having inadequate resources to actually provide the money for the insured deposits should more banks fail. That’s a devil versus the deep blue sea sort of decision, and right now, there’s really no avoiding it.

The year 2009 promises to be as difficult, if not more difficult, for retail banks and the Federal Reserve as the year 2008 was. At the bottom of the whole mess is a lot of American consumer debt, a huge tremendous amount of debt, much of it probably bad debt, that no one is quite sure how to manage. The economy can’t recover without spending, people can’t spend without credit, and banks really can’t afford to extend any more credit given the current economic conditions.

That’s a recipe for disaster (for the banks at least), but in the long run, if it provokes a broader discussion of debt and the American consumer lifestyle, it might not be such a bad thing. This mess didn’t create itself: a lot of bad decisions at the level of individual people and banks themselves got us into this. I don’t think we can really get out of it without a long, hard discussion of those bad decisions and how to avoid them in the American’s economic future.

In the meantime, if you still have unsecured credit available to you, you may want to pay it down or off as soon as possible. Already major banks are slashing credit limits even on good customers in anticipation of further problems. If you have $5000 charged on a card with a $10,000 limit and your limit is reduced suddenly to $5100, your credit score instantly plummets, making it harder for you to get a mortgage or conventional secured loan.

All of which puts the banks into one of those lose/lose situations too: reduce unsecured lending and banks reduce credit card losses but also credit card profits, right at a time when profit is dropping like an SUV off a Minneapolis bridge.

One last thought: if you’re losing your house, now might not be the best time to sleep under a bridge either.

3 comments to FDIC Adds Twenty-Seven More Banks to “Troubled” List

  • jumper

    waive = wave

  • Thomas C. Inskip

    A big bang before elections would bring all financial engineering toxic trash problems “to the table.”

    Then, with political demands, the FBI would employ twenty times as many agents on “economic crimes.”

    We could start large vegetable farms in Mid-Western states to hold economic problem people.

  • Evelyn Black

    Hi Tom,

    It would make the election interesting, wouldn’t it? I do like the idea of resurrecting FDRs public works projects to employ people–that would have the dual benefit of putting cash money into people’s pockets again and repairing infrastructure.

    I don’t think we’ll see anything like that unless we do have a ‘big bang’ though. Thank you for your comments.

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