Via ZeroHedge, comes a smoking gun release today from the FDIC. I mentioned last week that the FDIC, which is essentially broke (and by the FDIC, I mean, of course, the DIF - the Deposit Insurance Fund which insures customer deposits up to $250,000), was discussing a plan to re-fund itself by borrowing from its member banks. Today's FDIC press release confirms just that. "But wait, Kid Dynamite," you might say, "the release says that the FDIC will have banks prepay 3 years worth of fees." Yes - that's the same as borrowing from the banks.



Sadly, the FDIC wants to go this route, instead of using a special assessment on the banks, because, in their own words:

"Furthermore, any additional special assessment or immediate, large increase in assessment rates would impose a burden on an industry that is struggling to maintain positive earnings overall."

In plain English, that's like saying "everyone wants to pretend that the banks are solvent, but if we make them actually pay us extra money, it will make it harder to cover up the fact that the banks are insolvent." Thus, we wave a magic wand, and even though the FDIC is asking the banks for 3 years worth of money today, the banks will be able to recognize the cost over 3 years. Since when do we treat insurance as a depreciating asset? It's not like when you buy an airplane and recognize the cost over 20 years! There is a simple, unarguable fact: if Citibank pays the FDIC $1B TODAY (I'm making this number up) in fees for the next 3 years, Citibank has $1B less in cash today. Not $333MM less in cash - $1B less in cash.



The FDIC's release today is a must read - it contains some serious and scary truths about our national financial situation, despite what the press and the administration have been telling us over the past six months.



Take, for example, this gem:

"Staff’s current projection of $100 billion in failure costs from 2009 through 2013 is higher than staff’s projection in May of $70 billion over the same period. Projected failures have increased due to further deterioration in the condition of insured institutions, as reflected in the increasing number of problem institutions. Asset quality problems among insured institutions are not expected to abate in the near-term."

In plain speak: While you read headlines every day about the end of the recession, improvement among all metrics, green shoots, and how great it is to have 9.7% unemployment and over 500k in new jobless claims weekly, the fact of the matter is that in the last 4 months, the estimate for losses from bank failures over the next 4 years has increased by 43%! And guess what - asset quality problems are not expected to abate!



The FDIC also reminds us of their previous time frame for restoring the Deposit Insurance Fund:

"In October 2008, the Board adopted a Restoration Plan to return the Deposit Insurance Fund (DIF or the Fund) to its statutorily mandated minimum reserve ratio of 1.15 percent within five years. In February 2009, given the extraordinary circumstances facing the banking industry, the Board amended its Restoration Plan to allow the Fund seven years to return to 1.15 percent. In May 2009, Congress amended the statute governing establishment and implementation of the Restoration Plan to allow the FDIC up to eight years to return the DIF reserve ratio back to 1.15 percent, absent extraordinary circumstances."

So, last year, the FDIC hoped to replenish the DIF within 5 years. As reality hit, they adjusted this estimate to a 7 year time frame in February. Then, in May, despite an epidemic spread of green shoots in the media, the FDIC again extended the estimate of time needed until the DIF was replenished to 8 years.

There is another terrifying tidbit in the FDIC's release that's easy to gloss over:

"At the beginning of this crisis, in June 2008, total assets held by the DIF were approximately $55 billion, and consisted almost entirely of cash and marketable securities (i.e., liquid assets). As the crisis has unfolded, the liquid assets of the DIF have been used to protect depositors of failed institutions and have been exchanged for less liquid claims against the assets in failed institutions. As of June 30, 2009, while total assets of the DIF had increased to almost $65 billion, cash and marketable securities had fallen to about $22 billion. The pace of resolutions continues to put downward pressure on cash balances. While the less liquid assets in the DIF have value that will eventually be converted to cash when sold, the FDIC’s immediate need is for more liquid assets to fund near-term failures."

This is the doozy - the FDIC has been exchanging cash for trash - as banks fail, the FDIC takes assets (as they've admitted above: illiquid, presumably low quality paper - perhaps MBS that will turn out worthless?) and gives the failed banks cash to protect depositors. The last sentence of the quote above presumes that in the end, if they wait long enough, these illiquid assets will have value. The problem is, the FDIC needs cash now, and these assets simply cannot be sold for what we're pretending they are worth right now. If you've been following the crisis, you should realize that this is no different from what the banks the FDIC has NOT yet seized have been hoping - that their trash assets will eventually recover. Everyone is sitting around extending and pretending, delaying and praying, refusing to mark to market, and keeping their fingers crossed that in the end, these assets will be worth what we pretend they are worth. What happens if they're wrong?



Obviously, I'm adamantly against continued attempts to hide the health of the banking industry. The FDIC doesn't want to impose special fees on the banks because it's a tough time for the banks, so they concoct a plan to cook the books -they admit this! They acknowledge that the "prepayment" plan doesn't really change the balance of the fund!

"Although the FDIC’s immediate liquidity needs would be resolved by the inflow of approximately $45 billion in cash from the prepaid assessments, it would not initially affect the DIF balance. The DIF would initially account for the amount collected as both an asset (cash) and an offsetting liability (deferred revenue)."

When you pull forward revenue, you're not improving the long term health of the insurance fund- you're taking money now, and giving up money later.



We need to have another round of special assessments on the banks to shore up the DIF, write trash assets down to realistic levels, seize the bad banks, take the pain, and then we'll be able to move on unencumbered by a never ending pile of bad debt. As we stand now, failed banks have passed their problems on to the other banks, since the FDIC has inherited fantasy assets which are clogging up the balance sheet of its fund.

(This post originally appeared at the author's blog)