Commentary on the FDIC Bank Failure Report (05 March 2010)

Apologies on not updating for the last two-plus weeks. We have a large project which we're in the throes of wrapping up, so quite a bit of other things fell off the table, FDIC reports being one of them.

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The last two weeks' closures were relatively unremarkable, except for their small-ish size - none were larger than $1 billion. Even the least recoverable bank, Rainier Community Bank, wasn't all that bad: it was 'only' 48.25 cents on the dollar. Below average, yes, but not a bell-ringer, as the tenth worst failure by recoverable value - Century Bank FSB - was 40.72 cents on the dollar. Rainier's board of directors needed to fritter away another 8 cents per asset dollar to make our prestigious Ten Nastiest Bank Closures.

Oh well, maybe next time.

It is presently fashionable to blame the U.S. for the ongoing Depression, and we are only too happy to join in: the U.S. banking system has, for the past decade, exported rot and decay to the rest of the world, in the form of securities and derivatives, passed off by the credit rating agencies as somehow AAA debt. In 2007 the domestic became so unutterably septic that even the U.S. banks couldn't handle it anymore, and so the system broke down. Left to its own devices, the banking system would have imploded, taken down the U.S. economy and Government, knocked the stuffing out of the world economy, and then that would have been that.

That obviously did not happen, and now that same rot and decay is not only still extant in the world economy, but the U.S. is attempted to restart the exportation of more, so as to stave off domestic economic collapse. Both issues have severe implications for the rest of the world: first, if said securities and derivatives are not expurgated from the economy, they will with age become even more poisonous than they are now; and second, if the U.S. managed to force-feed more toxic assets to the rest of the world, there will be just that much more poison in the system.

What that means for the person on the ground, trying to make his or her way through this Depression, is rather grim. The greatest Keynesian-Fisherian nightmare is mass liquidation; which is to say, everything must go. We posit that the Keynesians presently holding the purse-strings in the central banks of the world are only forestalling the inevitable, and thereby making the future situation worse, in exchange for papering over the present. When the papering-over fails, as we suspect it will, then more of the baby will be thrown out with the bathwater; or, more good assets (e.g. precious metals, tools, bicycles, et cetera) might collapse in value with those assets which have none to begin with (e.g. AAA rated debt, designer clothing, suburbia, et cetera). This facet will make investing one's financial resources very difficult; indeed, down not so much might become the new high return.

Since the ongoing Depression was fomented in the U.S., we suspect that the next big leg down will also come from the U.S. When - not if - this next drop occurs, we suspect that the FDIC will be caught flat-footed and flat broke. That situation might already be in place, and the economy is not crashing fast enough to reveal the tenuous position of the FDIC, but whatever the case, going into the future, having large and vital amounts of cash sitting on deposit at banks will become a riskier proposition. Put another way, a bank account will change from being an asset, to a liability, for the average person.

Some banks will be better off than other. Some might even be perfectly solvent and capable of performing adequately, and be able to defend their depositors' money. Tying back into our earlier comment, it is highly possible that these rare, healthy banks will be destroyed along with the bad banks, either by hapless Government intervention, or panicked bank runs, or both.

The Curse of Reverse Banking

Banking is the great octane booster of the engines of economy. It can make many people feel rich. Albert deposits $100 in the First National Bank. Bertrand borrows $100 from the First National Bank and deposits the funds in the Second National Bank. Clyde borrows $100 from the Second National Bank ... and so on ad infinitum. Everyone has $100 in their bank accounts at the same time! There is a lot more spendable funds now than if Albert had just kept his $100 under the mattress. A whole lot more. Whee!

This sort of dementia has been going on for a couple hundred years and has reached a fevered pitch in the last ten or so. How could this go on so long without it all crashing down like the house of cards that it is? That is the marvel of economic growth. As long as the economy, and consequently income, keeps growing in the aggregate, there will be plenty of funds to keep all those plates spinning.

When banking goes into reverse though, it is deadly. Sufficient losses on loans cause banks to become unprofitable. Unprofitable banks have to pull the loss out of their equity and shrink lending, because loans cannot exceed a regulated ratio of bank equity. Roughly $10 of lending has to be cut for every $1 of losses. When lending is cut, borrowers have to pay back loans (if they can) instead of rolling them over. When they can't pay the loans back, the banks have further losses, and must restrict lending even more.

It gets worse. When borrowers have to pay back loans they have to cut other spending. If their income is falling, this causes their spending to fall disproportionately. One person's spending is another's income, so income tends to fall. When income falls, debt becomes harder to pay back, and many borrowers default, causing more loan losses for banks, and more restrictions on lending.

Around and around this destruction goes, and where it stops nobody knows. The entire World's economy is wildly indebted. Households, businesses, and governments have never been so in debt as they are now. What goes up, must come down. The bottom could be shockingly low.