Banking crisis ready to rumble

The US Banking System Is in Trouble
(August 22 - John Mauldin)


Yet another crisis confronts us, as we will have to deal with the aftermath of a rather large number of bank failures over the next year, which is likely to overwhelm the ability of the FDIC to insure your bank deposits. Today we look at the banking system, the FDIC, and Freddie and Fannie. It's not pretty, but as realists we must know what we are facing.

A few weeks ago when I was in Maine, I met Chris Whalen. Chris is the managing director of a service called Institutional Risk Analytics, whose primary business is analyzing the health of banks and financial institutions.

And what he sees is not pretty. There is a crisis brewing. He expects 100 banks to fail between now and July of 2009. Most of them will be small, but there will be a few large banks. The total assets of those banks he estimates to be $850 billion (not a typo!). Those are the assets the FDIC is going to have to cover when they take over the banks.

Chris thinks a more conservative number for planning purposes would be 20-25% potential losses, and you hope it does not get there.

If we take the worst case presented in this excellent summary, 25% of $850 billion is more than $210 billion. After dealing with the IndyMac failure, the FDIC will have at most $40 billion but more probably $30 billion in the kitty. This means the US Federal Government will be authorizing another $100 to $150 billion just to keep the FDIC solvent.

My view? This is overly optimistic. I see total bank losses as feeding off of each other, leading to a total recapitalization need in the neighborhood of $1 trillion. Couple this to a probable $800 billion in Fannie and Freddie losses, and we’re talking about an amount that is in the vicinity of the entire yearly income of the US government. Who will lend all that money, and under what terms? If the answer is “foreign central banks,” then we have to ask ourselves why we would willingly sell a large chunk of our country to foreign agents simply to save a few banks and a couple of reckless GSEs.

This is a companion discussion topic for the original entry at