The two hallmarks of the Great Depression were unemployment and bank failures. While the same economists who denied there was a recession for the first nine months of the economic contraction are now insisting that it is over and the recovery has begun, I am extremely dubious. Since the crisis became apparent, I believed that 2009 would be the equivalent of 1930, that being the year that everyone expected recovery to be waiting around the corner. But while there are some statistical green shoots, there are also numerous signs that the perceived recovery is illusory, and in fact, the economic situation is more dire now than it was 79 years ago.
In the first year of the Great Depression, unemployment reached 8.7 percent. The present unemployment rate is 9.4 percent. As I have shown previously in this column, bank failures in 2008 and 2009 are also worse than they were in 1930 and 1931 when measured in terms of bank deposits rather than the number of banks. Since that July column was published five weeks ago, 28 more banks have failed and driven the percentage of failed bank deposits up to one percent, which is more than I'd projected for all of 2009. At the current rate, bank failures over the last two years will equal 4.65 percent of total bank deposits, which is more than twice the two percent of failed deposits in 1930 and 1931.
Despite these widespread banking collapses, the American public has remained relatively quiescent, mostly because they believe their deposits are safely insured by the Federal Deposit Insurance Corporation. The problem is that the FDIC has now run out of money; the losses caused by the 81 bank failures this year has completely exhausted the Deposit Insurance Fund. At the beginning of 2008, the DIF had a balance of $52.8 billion. At the end of the year, during which 25 banks failed and caused $17.9 billion in FDIC-estimated losses, the fund was down to $17.3 billion.
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At this point, I should mention that some observers of the banking system are careful to point out that it's not correct to simply subtract estimated losses from the reported DIF balance because the FDIC brings in money every quarter through the insurance premiums it charges. This is true, but on the other hand, it's even more important to remember that estimated losses reported are merely estimates. An examination of the last five quarters shows that the net impact of a bank failure on the DIF balance is approximately twice the level of the estimated losses. For example, the $2.3 billion in estimated losses from the 21 bank failures reported during the first quarter further reduced the insurance fund by $4.3 billion, to $13 billion. What has happened since then can be seen in the chart below, which shows the FDIC's running fund balance with each of the subsequent 60 bank failures that occurred after March. The blue bars are based on estimated losses reported, while the red bars are based upon projected fund balance reductions, which over the last five quarters have been 1.94 times greater than the estimated losses.
While the FDIC does have the ability to borrow money from the U.S. Treasury, the chart shows that for the first time in its history, it has been forced to tap its $30 billion credit line. And while Congress can elect to intervene and bail out the FDIC as it bailed out the banks and other institutions, contrary to most depositors' assumptions, it is under no obligation to do so. An advisory opinion posted on the FDIC's own site makes it clear that the so-called federal guarantee is nothing more than non-binding reassurance made for the public's benefit.
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"[A] joint resolution of Congress (H.R. Con. Res. 290) adopted in March 1982, which reaffirmed that the United States pledges its full faith and credit behind the federal deposit insurance funds, may have served as a moral pledge on the part of Congress to support the deposit insurance funds should they ever need it, but, because of its status as a non-binding resolution, did not serve to create any legal liability on the part of the United States Government to support the funds. … it is our opinion that Title IX of CEBA merely represents an expression of the intent of Congress to support the FDIC's deposit insurance fund should the need arise.
If there is one thing that has been made clear by the response of the monetary and fiscal authorities to the economic crisis, it is that they will not lift a finger to help the general public. When they could have spent millions to prevent homeowners with mortgages from falling into default and foreclosure, they instead chose to spend billions to reduce the impact of the failed mortgages on the giant zombie banks. If one looks closely at the mechanisms underlying the Homeowner Stability Initiative, the Making Home Affordable plan and the Cash for Clunkers program, one will see that they are not designed to help the homeowner or the car buyer, but rather the banks that finance the purchases.
Given recent history, it would appear to be most unwise to assume that the federal government will do much more than permit the FDIC to borrow the additional $70 billion by which its credit line was increased in May, especially should depositors become aware of the increasingly fragile state of the banking system and begin to withdraw their funds from it. Banking holidays and other restrictions on the public's ability to access its money are probably more likely than an outright bailout, especially since a bailout will cost around $225 billion merely to maintain the status quo if Meredith Whitney's calculation of 300 bank failures is correct. In any case, the ability to ask permission to borrow from an unpredictable institution already $11.7 trillion in debt and expecting a further $9 trillion in deficits is not insurance nor can it reasonably be described as a guarantee of any kind.