Crisis in the Making

Did you know that the Federal Deposit Insurance Corporation (FDIC) keeps a secret list of problem banks?

These are banks that are at risk of failing financially.

The list is maintained confidential.  So, it is impossible to know for certain if your bank is on it.  This is to keep trusting customers in the dark.  The last thing the FDIC wants is people pulling their deposits and triggering bank runs.

The idea is that by keeping the list confidential the FDIC can discreetly help the banks get their act together.  The goal is to prevent bank failures.

To qualify as a problem bank and be added to the secret list, a bank must score a CAMELS rating of 4 or 5 by FDIC examiners.  This nifty acronym represents the various criteria of a bank’s health that are evaluated by the FDIC.  Specifically, Capital, Assets, Management, Earnings, Liquidity, and Sensitivity.

Scores range from 1 to 5.  One is the best.  Five is the worst.

On May 29, the FDIC released its Quarterly Banking Profile for the first quarter of 2024.  Of note, was the addition of 11 banks to the FDIC’s problem banks list during the quarter.  That brought the total count from 52 to 63.

Maybe your bank is one of these problem banks.  Maybe it is not.  As of Q1 2024, these banks hold a combined total of $82.1 billion in assets.  This represents a $15.8 billion increase from Q4 2023.

At the same time, in Q1 2024, unrealized losses on available-for-sale and held-to-maturity securities increased by $39 billion to $517 billion.  This marked the ninth straight quarter of unusually high unrealized losses since the Federal Reserve began to hike interest rates in Q1 2022.

Burgeoning unrealized losses is a major problem.  We will have more on this in a moment.  But first, some context is needed.

Bank Failures

When the FDIC is unsuccessful at getting a bank off its confidential problem list, the bank is added to another list.  This list is also maintained by the FDIC.  However, this FDIC list is published and made available to the public.  It is a running list of every U.S. bank that has failed since October 1, 2000.

At the time of this writing, this FDIC list includes 569 bank failures.  On average, this comes to about 24 bank failures per year.  Of course, some years are worse than others.  While other years are better than some.

For example, no banks failed between October 24, 2020, and March 11, 2023 – a stretch of roughly 28 months.  But in 2010, there were 157 bank failures.  That amounts to a bank failure every 2.3 days, including weekends and holidays, for the entire year.

By comparison, at the time of this writing, only one bank has failed in 2024.  Republic First Bank (not to be confused with First Republic Bank) shuttered its doors on April 26.

Last year, 2023, only five banks failed.  These included Silicon Valley Bank, Signature Bank, First Republic Bank, Heartland Tri-State Bank, and Citizens Bank.  What’s notable about the FDIC’s list of 2023 bank failures is not so much the number, but the magnitude.

The largest bank failure in U.S. history was Washington Mutual Bank.  It bit the dust on September 25, 2008, with $307 billion in assets on the books.

After that comes First Republic, Silicon Valley Bank, and Signature Bank.  These banks, having had respective assets of $212 billion, $209 billion, and $110 billion, all disappeared from the face of the earth in 2023.

Confidence Games

If your bank makes it to the FDIC’s publicly available list it is too late for you to do anything.  The bank has already failed.  In theory, if you have deposits under $250,000 in a bank that fails you are protected by the FDIC.

But how safe is your money, really?

As part of its recent Quarterly Banking Profile, the FDIC reported its Deposit Insurance Fund (DIF) had a balance of $125.3 billion.  This comes to a reserve ratio of 1.17 percent of the total insured deposits.  What’s more, this reserve ratio is out of compliance with the FDIC’s own legal requirements.

The FDIC adopted a DIF Restoration Plan on September 15, 2020.  The goal of the plan is to return the reserve ratio to the statutory minimum of 1.35 percent by September 30, 2028.  A lot can happen between now and then.  And when it comes down to it, the statutory minimum reserve ratio of 1.35 percent is entirely inadequate.

By our estimation, insurance reserves of 1.17 percent (or even 1.35 percent) of potential obligations are not real insurance.  Rather, these reserves are fake insurance that pays for an extremely fragile trust.  They’re to preserve customer confidence…so people don’t all pull their deposits in a time of crisis.

In a real panic, FDIC reserves would be vaporized in less than a day.  Moreover, in instances where the majority of depositors have balances greater than $250,000, as was the case at SVB and Signature Bank, the FDIC’s fake insurance doesn’t cut it.  Still, confidence remains the name of the game.

Crisis in the Making

That confidence transfers from the FDIC to the Federal Reserve.  In a fiat money system, the quantity of credit that can be created out of this air is without limit.  The question, however, is a question of quality.

As excess credit is repeatedly issued by the Fed to bail out the banking system, the quality of that credit ultimately turns to toilet paper.  The actual break point, however, is unknown.

A primary driver of the increase in unrealized losses of $517 billion noted above was unrealized losses on residential mortgage-backed securities, resulting from higher mortgage rates.  Commercial real estate loans are also at risk.  Per the FDIC:

“Weak demand for office space is softening property values, and higher interest rates are affecting the credit quality and refinancing ability of office and other types of CRE loans. As a result, the noncurrent rate for non-owner occupied CRE loans is now at its highest level since fourth quarter 2013.”

The relationship between real estate and credit is fundamental to the health of the banking system.  When more money is owed on a property than the property is worth lenders are unable to recover losses should borrowers stop making payments, which, as stated by the FDIC, is exactly what’s happening.

As this goes on, and more and more banks are rendered insolvent as their liabilities exceed assets, the FDIC will be unable to insure all customer deposits at risk.

If you recall, the advent of quantitative easing in the U.S. in November 2008, involved purchases of mortgage-backed securities.  This served to bailout a banking system that was overloaded with non-performing mortgages.

When QE1 was first introduced the Fed’s balance sheet was about $800 billion.  Today it is about $7.3 trillion.

The current buildup of both non-performing residential and commercial real estate loans is a crisis in the making.  What will happen during a rash of bank failures?

Will the Fed standby as depositors are wiped out and risk a systemic collapse of the financial system?  Or will the Fed crank up the printing press and buy up all these bad loans?

Recent history points to the latter.  Thus, the quality of the dollar will be sacrificed once again.

[Editor’s note: It really is amazing how just a few simple contrary decisions can lead to life-changing wealth.  And right now, at this very moment, I’m preparing to make a contrary decision once again.  >> And I’d like to show you how you can too.]


MN Gordon
for Economic Prism

Return from Crisis in the Making to Economic Prism

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