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 When Colonial Bank failed on Friday, the 77th bank to fail this year, very few people noted that it was the largest bank failure of 2009. Even fewer people noted that the cost of cleaning it up required more capital resources than the FDIC had.
   The total losses of Friday's five bank failures, according to the FDIC, would be $3.67 Billion. The problem is that the FDIC had less than $650 million in its Deposit Insurance Fund at the time.

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 Back on May 22, the FDIC decided to impose a special levy on solvent banks in order to replenish its DIF. The smaller, more prudent banks of America screamed about how unfair it was that they were being asked to bail out a few irresponsible banks, but their complaints went unheeded.
  The special levy won't be collected until September 30, which brings us back to the depleted DIF.

 Ah. Now we have a reasonable explanation for why the FDIC has been dragging its feet and not shutting down the numerous banks that are already bankrupt, yet still operating.

It can't afford to.

 Dragging its feet? The FDIC has closed down more than twice as many banks as last year, and the year is far from over.

 Believe it or not, there are two major banks practically begging to be shut down right now, but the FDIC has shown no rush to do it.
  For instance, Guaranty Bank, the second-largest bank in Texas, had this to say in a recent filing with the SEC.

 Based on these adjustments, the Bank’s core capital ratio stood at negative 5.78% as of March 31, 2009. The Bank’s total risk based capital ratio as of March 31, 2009 stood at negative 5.52%. Both of these ratios result in the Bank being considered critically under-capitalized under regulatory prompt corrective action standards.

In light of these developments, the Company believes that it is probable that it will not be able to continue as a going concern.

 Normally that sort of language is made by regulators, not by the banks themselves. In case you still didn't understand it, critically under-capitalized means bankrupt.

 The same thing can be said for Corus Bank, where 2/3rd of its loans are non-performing.

 [T]he Bank reported negative equity capital as of June 30, 2009. As such, the Bank expects to be notified by the OCC that it is "critically undercapitalized" within the meaning of PCA capital requirements.

Under the FDI Act, depository institutions that are "critically undercapitalized" must be placed into conservatorship or receivership within 90 days of becoming critically undercapitalized...

 Fortunately 90 days from the filing brings us to September 30.

 One thing the FDIC learned from the S&L Crisis is that the longer they waited, the bigger the taxpayer losses became. Thus this foot-dragging by the FDIC may allow it to put off an embarrassing taxpayer bailout for a while, but it also ultimately pushes up the bill that the taxpayer will have to pay.
  It's penny-wise, pound-foolish.

 This element can already be seen in the FDIC bailouts that have already happened.

 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.

 The ultimate bill was nearly twice the original FDIC estimates, 92% greater. (So the $3.67 Billion bill for last Friday will probably end up costing something north of $6 Billion). Why is this happening?

 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.

 Once again, the relaxation of the accounting standards for banks has come back to bite us. Banks are lying to themselves and to the regulators. Once the lies can no longer be covered up, the total bill turns out to be far higher than anyone is estimating.

 It's interesting to note that insured deposits recently declined for the first time in at least a decade (probably more). It undermines the idea that the American consumer is saving money as fast as he/she can. Instead, the America/consumer is either paying down debt or defaulting on it.

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 Possibly, just maybe, the public doesn't want their savings tied up in a failed bank while the FDIC finds a way to pay up on its guarantees. Or maybe the American consumer just doesn't have any money to put in there. Either way that means that the capital base for banks will get thinner and more unstable, which will lead to more bank failures.

[Update: A lot of people are noting that the FDIC has a nearly unlimited line of credit with the Treasury. This is true. Thus you can expect federal government bailouts of the FDIC for as long as it takes to clean up the banking system.
  However, that doesn't mean the title of this diary is incorrect, as some claim. Getting a bailout is a benchmark of failure, not a way to erase the past. Once you've spent all your money from a system that is supposed to be self-supporting, then you can broke by definition. A bailout doesn't change that.
  It's the same logic that applies to Social Security. At some point it will stop being self-supporting because it can't keep up with the Baby Boomers. Most people call that "broke".]

Originally posted to gjohnsit on Tue Aug 18, 2009 at 12:42 PM PDT.

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