Saturday, October 11th, 2008

Is the FDIC Trying to Tell Us Something?

Fri Jun 20, 2008 10:20am CDT • The Offshore A-Letter

By Eric Roseman

The Birth of the FDIC

The government created FDIC during the Great Depression. At the time, businesses were collapsing and bank failures riddled the economy. From 1920 to 1934, a total of 9,812 banks were suspended, closed, failed or merged, according to Colonial Statistics.

From March 6 to March 13, 1933, President Roosevelt declared a banking holiday. During that week, all financial institutions were closed and depositors could not access their funds. During the Great Depression, the Roosevelt administration also confiscated gold ownership.

The number of U.S. bank failures since the onset of the credit crisis last July is still under 100. But from 1988 to 1990, over 1,000 American banks failed, mostly because of the Savings & Loans crisis.

Considering the depth and longevity of this crisis, it’s probably fair to assume many more banks will succumb to failure or suspension, especially smaller banks. In fact, a few months ago, Fed Chairman, Ben Bernanke, warned that he expects a rash of smaller banks to fail because of weak capital ratios and bruised balance sheets.

Bernanke, of course, won’t bailout a small bank in Arkansas or other Mom and Pop banks in Middle America.

But the Fed did bailout Bear Stearns in a forced merger with J.P. Morgan Chase in March. They will also rescue other large U.S. banks if they pose systemic risk to the financial system. These include J.P. Morgan Chase, Citigroup, and Bank of America.

The Fed is desperately trying to help FDIC member banks rebuild their capital ratios and cut interest rates to 2% recently.

Low Rates Only Help So Much…

Low interest rates help boost lending margins for banks. When rates are low, spreads widen between short-term and long-term lending rates. However, the problem is most banks have pulled back from lending since the onset of the sub-prime debacle last summer.

Mortgage lending has collapsed. Consumer credit is especially difficult to secure, especially while these banks’ balance sheets are eroding. We’ve already seen enough massive write-downs and plunging capital ratios to be jaded by the numbers.

Indeed, 2008 marks the 75th anniversary of the FDIC.

Yet, I doubt this is a celebratory environment for an institution that serves to protect depositors. I’ve got a feeling the FDIC will be quite active over the next 12 months as smaller banks, including possibly some regional banks, head into bankruptcy.

The government’s safety net might offer peace of mind to some individuals, but for most depositors it’s a stop-gap none of us want to secure. As a precaution, park your cash and short-term emergency liquidity needs at J.P. Morgan Chase, Citigroup, Bank of America or 90-day Treasury bills. I’d avoid small institutions and the regional banks.

ERIC ROSEMAN, Investment Director

EDITOR’S NOTE: Over the last year, the Fed has: Bailed out institutions, cut rates to the bone, auctioned off liquidity willfully bought the sub-prime junk off several balance sheets that no one else wanted, and sacrificed the dollar’s value to try to stimulate the economy. So the question is: What will the Fed do next? The world will find out after next week’s Fed meeting. But we’re not waiting that long. Next Tuesday, Jack Crooks will host a FREE webinar to explain exactly how to profit off the Fed’s next big idea. Click here to join us absolutely FREE, next Tuesday June 24th at 12 NOON.