Thursday, March 17, 2011

FDIC Bill for Loan Losses at Failed Banks to Reach $30 Billion

The good news is that the FDIC payments to those organizations and institutions buying failed banks during the present crisis are smaller than the regulatory officials anticipated. The FDIC has paid out $8.89 billion to “cover losses” at 165 banking institutions that have failed during the recent financial crisis. (See Wall Street Journal article:

The reason for this good news, I believe, is the monetary policy followed by the Federal Reserve over the past three years, now captured in the quaint symbol QE2. Excess reserves pumped into the banking system by the Fed now total around $1.3 trillion.

I have argued for at least a year-and-a-half now, that the Federal Reserve is pumping all these reserves into the banking system to help the FDIC close banks in an orderly manner. The basic premise is that if the Fed can provide sufficient “liquidity” to the financial markets in order to maintain the value of financial assets it wil give the FDIC breathing room to close banks as rapidly as they can without causing major disruptions to the many other troubled banks in the system.

The Federal Reserve has argued that it has pumped all these reserves into the banking system to help stimulate the economy. The economic recovery has almost reached its two-year anniversary, although there is general dissatisfaction with the speed of the recovery, and looks likely to extend beyond this milestone.

However, the recovery seems to have taken place without the Fed’s help except for the argument that there have not been further disruptions to the recovery due to major cumulative banking failures. Certainly, one cannot argue that the Fed’s actions have provided banks with the incentives to increase their lending activity for they have not. Commercial banks are still sitting on the money.

This is exactly my point! The policy of the Federal Reserve has been to support the FDIC and allow the FDIC to close insolvent banks in an orderly manner.

Thus, the monetary policy followed by the Federal Reserve over the past three years has succeeded.

Added evidence that the policy of the Federal Reserve has been successful is that reported above: the FDIC payments to those acquiring banks have been “smaller than FDIC officials anticipated.” Without the market liquidity, results would have been much worse.

The Wall Street Journal even reports: “Some executives at U. S. banks that bought failed institutions using the FDIC lifeline agreed that losses on the troubled loans aren’t piling up as high or as fast as they previously anticipated.”

The bad news?

“FDIC officials expect to make an additional $21.5 billion in payments from 2011 to 2014. More than half of that total is predicted for this year, followed by an estimated $6 billion in loss-share reimbursements in 2012, according to the agency.”

According to my calculations, $21.5 billion is almost two-and-one-half times the $8.89 billion the FDIC has already paid out during this cycle of bank failures!

This would bring the total of FDIC payments up to more than $30 billion!

It also seems to mean that we have a lot of bank failures that still have to be resolved!

The banking system now has less than 8,000 banks in it. Over the past year or so, I have argued that this number will drop to less than 4,000 by 2015.

I see nothing inconsistent between my forecast about the number of banks that will be in the banking system and the estimates made by the FDIC, itself, concerning the amount of payments it will need to make to those that acquire banks to cover loan losses.

Bottom line: there are still a massive amount of bad loans that still reside on the balance sheets of commercial banks!

Consequently, there are still a lot of commercial banks that need to be closed!

And, what does this mean for the Fed and QE2? The Fed claimed on Tuesday that the economic recovery is picking up. However, QE2 will need to continue, as planned, through June. Also, the Fed will maintain its interest rate targets at current levels for “an extended period”. NO CHANGE IN MONETARY POLICY!

If I am correct the Fed will only change its monetary policy when it…and the FDIC…believe that problems connected with bank closings have receded sufficiently so that more normal operations can be resumed.

Since the Fed…and the FDIC…have never claimed that the excessively loose monetary policy over the past few years has been to assist the regulatory closing of commercial banks, any statements about changing policy will not be worded in a way that ties the policy with the closing of banks.

Maybe it has been just as well for us…that we have not really known how bad off the banking system has been. But, so much for openness and transparency.

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