FDIC Insurance Fund Losses May Reach $500 Billion

(MoneyWatch)  The total hit to the FDIC's deposit insurance fund could reach -- wait for it -- $500 billion, says Chris Whalen in a forthcoming article in the Bank Credit Analyst (no link available). That far exceeds the agency's prediction this week of $100 billion in costs to the fund.

The financial industry wonk bases this forecast on his assumption that roughly 1,000 banks will fail and be acquired before the credit crisis finally abates. Really wreaking havoc is that estimated losses to the FDIC insurance fund for failed banks are running at 20-25 percent of these institutions' total assets. That's exceedingly high. By comparison, between 1980 and 1995, a period that included the Savings & Loan crisis and two major recessions, losses to the fund averaged 11 percent.

The potential capital drain from the DIF reflects, of course, the worsening credit environment for banks. Some more historical context: During the Great Depression, when thousands of banks shut down, institutions saw average loan losses topping five percent; in the latest downturn those losses could reach four percent, the analyst predicts. If the economy really deterirorates, aggregate losses to banks with at least $10 billion in assets could rise to as much as $800 billion, Whalen says.

Most of the bullish Wall Street recommendations on banks seems to discount the future cost of credit losses, but the latest data from the FDIC suggest that, at best, we face a few more quarters of credit reserve build and poor earnings performance.

And then there's Citigroup. The company's credit losses, which doubled to $16 billion in the first half of 2009 compared with last year's levels, are expected to top 25 percent of assets. Whalen says the company is headed for a "formal restructuring." It may not be alone, with at least one other mega-bank potentially needing a government transfusion. In fact, the banking industry may not start turning around until 2011.

The Great Mortgage Bust of 2007-08 will require a lengthy period of time to heal the wounds. Government ownership of banks, financial assets and real property may become a medium-term necessity as prices and demand are brought back into alignment.