The Risk Of A Run On The Banking System

Includes: FMCC, FNMA
by: Larry MacDonald

“The risk of a full scale run on U.S. banks … is all too real,” states Nandu Narayanan in his July commentary. Narayanan has a PhD in finance from the Massachusetts Institute of Technology and is a hedge fund manager whose fund, CI Global Opportunities Fund, has gained over 75 per cent year-over-year thanks to short sales on U.S. financial stocks.

The Federal Deposit Insurance Commission [FDIC] currently has reserves of $53 billion (U.S.) to compensate bank customers for lost deposits in the event of a bank failure. About ten percent of these reserves will be needed to pay off depositors at failed Indymac, leaving at best no more than $50 billion in the FDIC kitty, remarks Narayanan.

According to FDIC estimates, total insured deposits in the U.S. banking system were $4.43 trillion at the end of the first quarter. “Thus the FDIC is operating with a cushion of no more than $50 billion to insure $4.43 trillion in deposits” at a time when dozens of regional and other banks are expected to go under. There is a risk depositors may become fearful for their deposits and start lining up to get their money out.

Moreover, another $2.42 trillion of bank deposits are uninsured by FDIC. These deposits are at even greater risk of fleeing the banking system, Narayanan believes.

Narayanan goes on. “Fannie Mae (FNM) and Freddie Mac (FRE) … are technically bankrupt when their assets are marked to market ….” Thanks to leverage ratios (total assets/equity) of anywhere from 20 to more than 80 times (depending on how one chooses to look at their off-balance sheet risks), their equity has been wiped out by asset impairments. They both have negative equity positions of more than $5 billion each, which could be disconcerting considering they jointly guarantee over S$4.7 trillion of mortgage securities, notes Narayanan in his monthly report.