US bank backstop could need rescue of its own!

Boston.com

IndyMac collapse and mounting failures could sap FDIC reserve
By Bloomberg News | September 25, 2008

Deborah Horn tugs on the handle of the glass-paned entrance of the IndyMac Bancorp Inc. branch in Manhattan Beach, Calif. The door won't budge. The weekend is approaching, and Horn, 44, the sole breadwinner in a family of three, needs cash.

A small notice taped to the window on this Friday afternoon in mid-July tells her why she's been locked out. IndyMac has failed, the single-spaced, letter-size paper says; the bank is now in the hands of the Federal Deposit Insurance Corp.

Inside, an FDIC examiner is talking to six IndyMac employees. "I don't know when I'm going to be able to get my money," Horn says. "I'm a single mom. This is the money I live on."

Don't worry about Horn. She'll be all right, as will most of Pasadena, Calif.-based IndyMac's 200,000-plus customers. That's because the FDIC, created in 1934, insures all accounts up to $100,000 at its member banks, and it has never failed to honor a claim. The people to worry about are US taxpayers.

The IndyMac debacle is taking a large bite out of FDIC reserves, and if scores of other banks fail in the year ahead, the fund will be depleted. Taxpayers will have to step in.

Americans have gotten used to the idea that bank failures were as rare as a category 5 hurricane. No banks went bust in 2005 or 2006. Seven collapsed in 2007 as the credit crisis began to exact a toll. So far in 2008, 12 more, with total assets of $42 billion, have fallen - that's the worst wave of bank failures since 1992.

IndyMac, which had $32 billion in assets when it went into receivership, is the most expensive bank failure the FDIC has ever covered. And that record may not stand for long.

By the end of 2009, about 100 US banks with collective assets of more than $800 billion will fail, predicts Christopher Whalen, managing director of Institutional Risk Analytics, a Torrance, Calif.-based firm that sells its analysis of FDIC data to investors.

"It's not going to be Armageddon," says Mark Vaughan, an economist at the Federal Reserve Bank of Richmond, Va. "But it's going to be bad."

The FDIC knows which banks are at risk; it has a watch list with 117 institutions. The agency won't disclose their names because doing so could cause depositors to panic.

It won't take many more failures before the FDIC itself runs out of money. The agency had $45.2 billion in its coffers as of June 30, far short of the $200 billion Whalen says it will need to pay claims by the end of next year. The US Treasury will almost certainly come to the rescue.

Emergency federal funding of the FDIC could swell the cost of government rescues of failed financial institutions to more than $400 billion - not including the $700 billion Wall Street bailout now under discussion.

The subprime crisis - which started in the suburbs of California and Florida and migrated through the alchemy of securitization to Wall Street investment banks - has come almost full circle, spreading its toxins to the very lenders who first extended those teaser-rate, no-document mortgages to homeowners.

In 2006, IndyMac was the largest provider of mortgages that didn't require borrowers to provide proof of income. US lenders, in their embrace of subprime lending, committed the same analytical fallacy as their Wall Street counterparts. When it came to assessing risk, they relied on the recent past to predict the near future.

They were blinded by years of rising home prices and low mortgage default rates.

The FDIC fell into the same trap. As recently as March, an FDIC memo estimated the cost to cover bank collapses in 2008 would be just $1 billion, dropping to $450 million in 2009. It wasn't even close. The IndyMac failure alone will cost the FDIC $8.9 billion.

FDIC chairman Sheila Bair says depositors shouldn't fret about their banks. "We do have a handful with some significant challenges," she says. "Overall, banks are quite safe."