Crisis Coverage: FDIC Rumors

It appears today's market activity and the news regarding Merrill, Lehman and AIG has spiked an interest in my earlier post about the safety of financial institutions.  I read on the tape today that one economist was emphasizing bank failures and the possibility of the FDIC running out of the reserves used to insure deposits up to $100,000.  Let us examine this possibility from a rational perspective:

The FDIC has roughly $45 billion on hand to make depositors whole.  There are roughly $4.5 trillion of FDIC insured deposits for a reserve ratio of just 1.01%, down from a more typical ratio north of 1.2%.  Of course, this is what you would expect during a recession, the fund pays out more than it takes in.

Let's examine the nation's banks as a whole.  As of the end of the second quarter, the banks collectively absorbed losses equal to 1.3% of assets and remained profitable.  There are currently 2% of loans considered "delinquent" which means payments were missed.  Some of these will turn into losses in future quarters, but not all at once and not in entirety.  Remember, when a loan goes bad, it is usually not a 100% loss, particularly when it comes to home loans.  Losses are probably in the 20% range, so if 2% of loans go bad, it should result in about 0.4% of losses to assets.  Credit card lending experiences higher losses.  Between the different forms of loans, losses end up in the 1-2% range.  Those banks in serious trouble like Washington Mutual have managed their loan books extremely poorly- but those banks are few.  In fact, over 82% of banks were profitable last quarter despite writing off bad loans!

Also consider that the system's banks have equity capital of 10.2%.  That means 10% of assets must be 100% losses before the bank is out of capital and the FDIC must step in (usually they step in before it gets that bad).  This is why the FDIC's fund is adequate and you should not worry.  But what if it isn't enough, should I take my money as cash now and hide it?  In short no.  First, if large numbers of people tried to take funds at once, the system would indeed collapse making confidence a central tenet of modern banking.  Authorities will do whatever it takes to ensure confidence in regular old banks (Bear, Lehman, Fannie and Freddie are not regular old banks).  That means there is no way the Fed, the Treasury and Congress will allow the FDIC to fail sending the country into the dark ages.  Would you feel better if the FDIC had a 3% cushion instead?  A few strokes of the pen and the government could lend $100 billion to the FDIC for such a purpose.  In short, no one in a position of authority would let the FDIC run out of funds. 

Of course, if you have uninsured or large deposits at any one bank (usually more than $100,000) first check to see if the accounts are titled properly to offer full protection. Use the FDIC's interactive calculator to see if you are covered. If not, you should move enough to make sure you are protected, but there is no need to stuff the mattress with cash.