The Real "Secret" Crisis That Could Overwhelm the American Economy at Any Moment

by Adam Lass, Editor, WaveStrength Options Weekly

Sorry to start off the week on a down note, but reading through the latest FDIC Quarterly Banking Report, and there are some figures here that you simply have to be made aware of.

This report is possibly the least-biased look at the banking industry one can find, as it is primarily read only by the folks in that biz (and bureaucrats in Washington). This latest edition covers the last quarter of 2008, and the numbers are gory beyond belief...

First off, the industry as whole lost some $26 billion last quarter, its first such quarterly loss since 1990. To give you a sense of scale, it took all of 2008 for GM (GM:NYSE), Ford (F:NYSE), and Chrysler to lose $52.6 billion.

And as long as we are speaking of full-year earnings, the bankers did manage to squeeze out some $16.1 billion, a figure that said auto execs would kill for. However, the trend indicates that the banks are headed down the same dark alley Detroit has already gotten lost in: This year’s take is 84% lower than 2007’s $100 billion!

How Did It Get This Bad?

I could go into chapter and verse as to how they managed to fritter away so much of what is, in essence, your money. I could describe how non-current loans spiked 23.7% in the last quarter of 2008 and are now somewhere in the vicinity of $44 billion.

I could tell you about their $9.2 billion in trading losses. I could mention that quarterly net charges are matching the all-time high. I could point out the $16.5 billion increase in cash set aside against disaster, cash that is for all other purposes frozen and useless.

This report is rife with generally alarming statistics like these. Keep in mind that this is supposed to be a conservative trade... these are real banks we are speaking of here, the kind where regular folks deposit their paychecks. (In other words, not the high-stakes Ponzi schemes known as “investment banks.”)

These guys handle what is in essence the lifeblood of the real economy: our paychecks and savings. When these guys are in the soup, all of America – you, me, our parents, our kids and our grandkids – are in the soup up to our necks too.

The Real Threat…

But these are mere generalizations. There is a very specific set of numbers that I must draw your attention to. I spoke earlier of the dramatic increase in cash set aside against further disaster. Because I want to get this absolutely right, I will simply quote from the report:

Total reserves increased by $16.5 billion (10.5 percent) in the fourth quarter. Insured institutions added $31.5 billion more in loss provisions to reserves than they took out in charge-offs, but the impact of purchase accounting from a few large mergers in the quarter limited the overall growth in industry reserves.

The growth in reserves, coupled with a decline in industry loan balances, caused the industry’s ratio of reserves to total loans to increase during the quarter from 1.96 percent to 2.20 percent, a 14-year high.

However, the increase in reserves did not keep pace with the sharp rise in non-current loans, and the industry’s ratio of reserves to non-current loans fell from 83.9 percent to 75.0 percent. This is the lowest level for the “coverage ratio” since the third quarter of 1992.

We Are Completely Unprepared for What’s Coming

That’s right: For all the screaming by analysts like me and Justice, for all the prodding by Washington bureaucrats who have suddenly decided to actually regulate this vital sector, indeed for all the admittedly painful efforts on the part of the banks to protect themselves from this tsunami of defaulted loans, American banks are actually in more danger of failing now.

In fact, the risk of complete systemic collapse is the highest it’s been in more than a decade:

• In 2005 and 2006, no banks failed whatsoever.
• In 2007, three American banks shut their doors.
• In the first three quarters of 2008, we saw 13 institutions close down.
• In the final quarter of 2008 alone, 12 thrift houses went belly up.
• By the end of 2008, failures and assistance transactions were at a 15-year high.
• And so far in just the first two months of 2009, another 14 bit the dust.

This trend is not arithmetic. Rather, it is a horrifying geometric progression that we are completely unprepared as a nation to cope with.

Again I quote from the report:

Estimated insured deposits (including U.S. branches of foreign banks) increased by 4.7 percent during the fourth quarter of 2008, up from a 1.8 percent increase in the previous quarter. For all of 2008, insured deposits increased by 10.9 percent, up from a 3.3 percent increase in 2007.

Hedging Against Disaster… or Creating One?

This is the sudden increase in savings that has Wall Street tied in knots. When no one knows if they are the next guy or gal to get a pink slip, they stop spending and start squirreling away cash as their own personal hedge against disaster. And when folks hunker down like this, spending falls off a cliff. 2008 Q4 was the worst consumer figure in 26 years, while December and January durable goods orders fell 4.6% and 5.2% respectively, the tail end of a six-month slump (a 17-year record) that has dropped us to levels unseen since December 2002.

But here’s the big wiener:

Despite this dramatic increase in the risk the Deposit Insurance Fund (DIF) is covering, that fund actually decreased by $15.7 billion during the fourth quarter to $18.9 billion. In fact, for all of 2008, the DIF balance fell by $33.5 billion – some 64%, primarily because of $40.2 billion in loss provisions.

This latest figure is the lowest reserve ratio for a combined bank and thrift insurance fund since June 30, 1993.

Forget about Wall Street. Forget about Detroit.

This is the big one folks, the real crisis that no one wants to talk about.

Sincerely yours,

Adam

P.S. When you realize the risk to your bank deposits, it kind of “recasts” the risk of staying in the market, now doesn’t it? Now I am not advising you to dump your kid’s college fund into a short play on Citi, or some such. But I certainly do feel that you ought to be actively defending your net worth with a healthy dose of put options against guys like Lockheed and 3M.