FDIC Girds For Bank Failures

"Ninety percent of the banks haven't been paying in because the reserve ratio isn't low enough," he said. "Congress increased the number last year, but exempted older banks. We're restricted to income on Treasuries."

So the FDIC is going to be hitting up banks for more money at a time when many can least afford it. The goal for the DIF ratio is to be at 1.25 by 2009. "The number of problem banks is increasing, but still historically low," Barr said. "However, the assets are increasing."

A rise in bank failures exemplifies the burgeoning problem. Douglas National Bank in Missouri failed in January and the three banks that failed in 2007. The FDIC's Marino said that typically three to six banks fail each year, but there were no bank failures during 2005 and 2006, when banks were raking in fees for loans.

Last month, the FDIC issued a two-part Notice of Proposed Rulemaking, seeking comments related to the potential failure of large insured depository institutions. Marino has been working on this project for two years.

When a bank fails, the FDIC has to be able to look at all the accounts of a depositor and figure out how much is insured. "Banks do not know the insurance status of their customers, nor do they really care," Marino said. "What we're saying to larger institutions is that you're going to have to help us out."

Marino said banks with regulatory problems typically used to fail on a Friday, allowing the FDIC to step in and sort But with liquidity issues, failures can come at any time. Moreover, electronic banking leads to a lot of nightly processing, so it's usually not until 4 a.m. in the morning that the FDIC gets a glimpse of the balances.

The proposed rule the FDIC is considering would require the largest institutions to modify their deposit systems so that the FDIC could calculate deposit insurance coverage quickly in the event of failure.

Today's trouble in the banking sector has a long way to go before it rivals the Depression, when 4,000 banks failed. But the symptoms then were similar: banks were bogged down with foreclosures and left with unsalable assets. The banks struggled with liquidity issues, which the Federal Reserve did little to help.

Today's Fed is bending over backwards to create liquidity. Just last month when the Fed's own reports noted that banking reserves had gone into negative territory, the Fed stressed that by making short-term liquidity available through its term auction facility, the banks would have plenty of money. But that money is achieved through loans and not real capital.

Hussmann in September observed that reserves had fallen to their lowest level relative to non-current loans since the third quarter of 2002 and non-current loans experienced the largest uptick since the fourth quarter of 1990 -- representing the last two notable economic downturns.

"Recall that 1990 and 2002 were periods when recessions were already well underway," he wrote. "If we're already seeing these signs of credit stress at the peak of an economic expansion, the figures we observe in a recession are likely to be a lot worse."