Once Upon A Mattress

During the Great Depression of the early 1930’s there were a tremendous number of bank failures. In response to this, the US Government established The Federal Deposit Insurance Corporation (FDIC) in 1933. The FDIC would guarantee checking and savings deposits for banks enrolled in the FDIC up to $100,000 per depositor. Each account at each bank is insured separately. IRAs are insured for up to $250,000.

Lesson 1: Never keep more than $100,000 in an account at one bank. That means if you put $100,000 and it accumulates interest, anything over the $100K amount is not covered.

If a bank goes insolvent, the FDIC has the option to pay each insured deposit (which is treated as a liability on the balance sheet) and then collect whatever it can by liquidating the bank’s assets (which includes loans) or help another bank assume the deposits and loans of the failed bank.

Believe it or not, bank failures are not unusual. In normal circumstances the depositors rarely ever feel the bite of a bank going kaput – they either collect or more often their account ends up whole at another bank. But this is George Bush’s America – and nothing, but nothing can be considered normal.

Could the FDIC handle a landslide of bank failures at once?

Basic Banking 101 – banks are not required to keep all the money you deposit with them in reserve. They only have to keep a portion, the rest is lent out for mortgages, car loans etc. This is in a nutshell how a bank operates and makes money. The FDIC also does not keep dollar-for-dollar matching reserves for every bank in the US. A combination of statistics, history, and economic factors determine the proper level of reserves the FDIC needs to set. In 2007, the FDIC held 1.2% of all deposits in reserve. That means for every $100 dollars held by member banks, the FDIC can cover $1.20 in losses. That was about $52 billion in reserve.

When Bear Stearns collapsed, the FDIC was asked to cover $400 billion in bad loans (not necessarily payout, but some complicated formula of insurance, coverage, write-offs etc) which is nearly 8 times greater than the FDIC reserve. That was ONE bank. What if Citibank, Wachovia and Bank of America all went into default at once? Could that mean the FDIC would literally run out of money? Is the agency established to protect bank bankruptcies capable of going bankrupt itself?

Here is the reality: The FDIC is that it has never supervised a bank failure which exceeded 175,000 accounts. A financial tsunami of many major bank failures will make Katrina look like a drizzle – I don’t think people will be saying, "Bernanke, you are doing a helluva job." Today some of the larger banks have more than 50 million depositors, which will make the FDIC's job nearly impossible.

Congress could act to prevent a complete meltdown – but the dominoes would be set and nothing would be able to prevent some sort of gigantic seismic event in the financial system. And anything Congress does to fund a bankrupt FDIC cannot be done in a vacuum.

Congress is funding a war right now to the tune of $12 billion a month. Hard to imagine it would cut funding to Iraq, since the weenies in Congress are petrified to look weak and are scared of the big bad president.

Congress (ok technically the Treasury) is paying the interest on debt incurred by the US Government for general operations – operations that have RUN at a deficit since George Bush took office. You want the US to shut down? And who is funding that deficit – one guess – c’mon. Yes, what if China decided saw this cataclysmic banking crisis looming on the horizon and decided to dump all its treasury holdings.

Lesson 2: The FDIC is NOT a government agency, it is a private corporation. It cannot print money.

In addition - according to the law, Congress cannot just give the FDIC money (see Lesson 2) to keep the insurer of banks solvent – it can only loan the FDIC money. Which of course means that money would have to be drawn from the markets, thus creating a cash crunch and raising interest rates as money becomes harder to secure for private industry.

OK things are looking bad -- No money, no China, no good leadership.

The FDIC is in deep doody since it cannot cover all the losses. But what about you -- the depositor? Just like in It’s A Wonderful Life, you will hightail it down to Wachovia and demanded your cash immediately – you are insured. The depositors have created a classic bank run.

It gets better.

While the law states the FDIC has to pay you, it only has to make you good “as soon as possible.” Depositor have a seat, Godot is on his way.

Some foreign banks and investment firms have recently said that they expect 150 or so US banks to fail in the near future. That number is high, but it was higher in the 1980’s. If things continue to march along this downward spiral – that 150 might be the low end. From 2004 to 2006 there were NO bank failures. But with the year-long mortgage crisis, oil prices skyrocketing to luxury good level, and the US debt increasing as it funds an endless and useless war – many banks will not be able to get cast from the capital markets to replace money that has been lost to bad credit.

It looks really bad – but it hasn’t reach the level of the John McCain Savings & Loan scandal of the 1980’s – whereas 1,000 banks failed in 1988-89. But the US government is trying real hard to get there. And if we elect McCain, he might just lead us down the bank meltdown road for a second time.

If banks begin to fall like dominoes, expect this recession to be one of the worst economic periods outside the 1931 depression, and expect to be a long long one.

As economist Nouriel Roubini said:

One has to realize that there is now a rising probability of a 'catastrophic' financial and economic outcome, i.e. a vicious circle where a deep recession makes the financial losses more severe and where, in turn, large and growing financial losses and a financial meltdown make the recession even more severe.

Lesson 3: FDIC insurance does not cover the contents of safe deposit boxes, insurance policies, annuities, stocks, bonds, mutual funds, and similar types of investments purchased through a financial institution, regardless of whether you own them directly, through a retirement plan, or through a trust.

Go buy a good mattress -- since we're fucked you might as well have it serve its two natural purposes.