'Too Big to Fail' Cause of Current Community Bank Failures

| About: SPDR S&P (KBE)

We all know there are problems within the banking sector from lack of lending, whether it is demand or banks' unwillingness to lend is a matter of debate, and continuing credit losses. Banks are continuing to set aside more money for potential credit losses which indicates the road to recovery is still not clear yet. Not to mention the building commercial real estate issue which has yet to fully rear its ugly head, but recent numbers show commercial real estate delinquencies are up 585% over last year at this time.

However, what 's not receiving much publicity are bank closures by the FDIC, which we post every Friday night when the report is issued in our piece called Friday Night Fun at the FDIC. One would think that seizures by the FDIC would have abated by now with the massive bank bailouts which have cost us an estimated $3 trillion and has a projected cost of $23 trillion if things get really bad again.

Last year the US saw 25 banks closed through brokered deals by the FDIC with the most notable being Washington Mutual and Indy Mac. After those two closures we heard bits and pieces of other closures, but the news of closures began to dissipate in the early part of 2009. I suspect the media assumed that most banks worth saving had already been saved or they are carelessly overlooking the continuing problem.

I understand the “too big to fail” theory, but I disagreed with it in 1999 as much as I do today. In fact the greatest betrayal of our government and what is directly responsible for our current troubles was the dissolution of the Glass-Steagall Act which kept banks and investment firms separated in order to control risk. Because of the too big to fail theory those banks were saved first and very little rescue went out to smaller institutions.

As a result we have seen a tremendous increase in bank closures over the past 7 months. In fact, the closure rate is alarmingly high and accelerating every month. To date we have had 69, exhibit 1-1, banks fail in 2009 which is 276% more banks than last year and at the current rate it will double by the end of the year. Keeping in mind that in July alone we have had 24 banks closed by the FDIC which is almost 100% of all of last year's closures, all were merged into new entities. (click on chart to enlarge)

Exhibit 1-1

Bank Failures

This should trouble you as it has an impact to the availability of credit in smaller communities. Even though most banks are merged with others having less competition could mean less credit if the new owner tightens lending standards or practices. This could also mean fewer jobs as many branches do get closed in these brokered deals mostly because of overlap or poor profit margins.

Most of the banks failing are “hot money” banks who dealt in brokered CDs which offer higher paying yields than traditional brick and mortar bank CDs. Since the bank pays more interest on these CDs they must make higher risk loans to keep profitability intact. Most acquiring banks, especially lately, had declined these brokered CDs leaving the FDIC on the hook for repayment from the asset sales or to make whole if not enough money was raised through liquidation of remaining assets. This costs you, the tax payer, money eventually and this is why the FDIC raised its premiums earlier this year.

Costs of Closures

Not only is the pace of closures accelerating, but the cost of the closures is also increasing at a much higher rate than you might think. Last year the loss of Washington Mutual was nothing to the FDIC, but who knows what guarantees or funding the Fed offered that we do not know about, but other closures did cost a significant amount of money to the FDIC totaling some $14.9 billion for 2008. We calculated the cost to the FDIC according to the higher end of their estimates and included all loss-sharing agreements.

During 2008 we had a real crisis with major institutions failing, but we have been told that this year things are much better and our banking system is safe. That may be true for firms such as JP Morgan (NYSE:JPM) and Goldman Sachs (NYSE:GS), but the truth of the matter is we have had bank failures almost every week this year. The banks are smaller, most are below $3 billion, but the net result is astonishing with the total projected costs reaching $13.5 billion, there were not even calculations of estimates in some of the FDIC press releases so we still do not have a real number. See exhibit 1-2 for a chart () of the cost of bank failures

Exhibit 1-2

Failure Cost

How can things be getting better when the banks are failing at an astonishing rate and the cost of the failures are going to surpass 2008 when we just crossed the half way point in the year? The fact that the media is not reporting on this is obscene and a disservice to the American people. The major media outlets are more interested in hearing the latest Obama speech or picking out the sparse pieces of good news proclaiming that the recession and the crisis is over all while ignoring this information.

These same pundits are also claiming we are in a new bull market and everything is just fine, but there is no mention of bank closures, none. Worse yet, we watched as many TV personalities pointed to a 3 month rise in the durable goods orders as bullish, but then turned around and said that the last report was too volatile, it is truly baffling that anyone takes these people seriously anymore.

The Bottom Line

The crisis is still here. It has just been buried by the very same people you may trust on the TV. Anyone looking at these numbers, plus other evidence of the true health of the economy would not be calling for a bull market with another 20%+ to run.

You should be questioning everything from the falling dollar, which is the real reason for the bull rally besides an oversold situation, the lack of coverage of bank failures, the 35% reduced earnings expectations which were easily beat, with no top line earnings growth, unemployment is a lagging indicator, it is not in this case, and the record number of insiders selling their stock. Like it or not, this time it is different than almost any other time in history because we do not lose major players like Lehman, Bear Stearns and Washington Mutual in an average recession.

Without questioning these things you are simply sticking your head in the sand and pretending that everything is OK, when we still have significant problems that remain unresolved. It is imperative that you do research before committing your capital to the equity markets and look at what is really going on otherwise you will get burned. If you want to hope everything is fine that is fine by me because, if the truth be known, I hope everything gets better soon as well, but do not hang your financial future on hope, that’s just crazy talk.

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