Expect to See the FDIC Go Deeper into Debt

| About: Zions Bancorporation (ZION)

Profits might be surging at banks with big trading divisions, but lending remains stuck in the mud. In the third quarter, lending by U.S. banks dipped $210.4 billion, or 2.8 percent, representing the largest drop off in 25 years.

Partly as a result, the Federal Deposit Insurance Corporation (FDIC), which insures consumer deposits in the event of a financial institution bankruptcy, swung $8.2 billion into the red in the same quarter. But even as the number of problem banks increased by one third, to 552, banks overall posted earnings of $2.8 billion vs. a loss in the previous quarter of $4.3 billion.

What is more, house prices, which have risen modestly for the past two quarters, are now 10 percent above the relative level they were in the 1990’s, according to historical price-to-rent ratio data based on the Case-Shiller Index, which tracks U.S. home values.

The other day I pointed out how Zions Bancorporation (NASDAQ:ZION) may have been getting a little ahead of itself by asking preferred shareholders to convert their holdings into common stock. Since then, the value of its common shares has declined 8 percent in value. Indeed, Zions is a classic example of one of the many financial institutions that needs to keep raising capital in order to fill the massive hole of debt that has been created by four consecutive quarters of losses. Without a strong lending environment, the bank cannot make money — it’s as simple as that.

That’s why the earnings surplus the FDIC reported last quarter is so misleading. Pretty much the only reason for the $2.8 billion number reported above is that a relatively small number of investment banks — whose trading departments are chasing a rapidly-expanding asset price bubble — have been making money as investors have fled the bond markets in search of yield.

If conditions remain the same for the next two quarters, you can expect to see the FDIC go deeper into debt, an increasing number of big banks swallowing their smaller rivals, while home prices will begin to become priced out of the range of most consumers’ pockets. In the end, that scenario won’t even bode well for the big banks and their trading divisions.