The Risk Of A Run On The Banking System

by: Larry MacDonald August 28, 2008 | about stocks: FNM / FRE    
Larry MacDonald

Larry MacDonald

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“The risk of a full scale run on U.S. banks … is all too real,” states Nandu Narayanan in his July commentary. Narayanan has a PhD in finance from the Massachusetts Institute of Technology and is a hedge fund manager whose fund, CI Global Opportunities Fund, has gained over 75 per cent year-over-year thanks to short sales on U.S. financial stocks.

The Federal Deposit Insurance Commission [FDIC] currently has reserves of $53 billion (U.S.) to compensate bank customers for lost deposits in the event of a bank failure. About ten percent of these reserves will be needed to pay off depositors at failed Indymac, leaving at best no more than $50 billion in the FDIC kitty, remarks Narayanan.

According to FDIC estimates, total insured deposits in the U.S. banking system were $4.43 trillion at the end of the first quarter. “Thus the FDIC is operating with a cushion of no more than $50 billion to insure $4.43 trillion in deposits” at a time when dozens of regional and other banks are expected to go under. There is a risk depositors may become fearful for their deposits and start lining up to get their money out.

Moreover, another $2.42 trillion of bank deposits are uninsured by FDIC. These deposits are at even greater risk of fleeing the banking system, Narayanan believes.

Narayanan goes on. “Fannie Mae (FNM) and Freddie Mac (FRE) … are technically bankrupt when their assets are marked to market ….” Thanks to leverage ratios (total assets/equity) of anywhere from 20 to more than 80 times (depending on how one chooses to look at their off-balance sheet risks), their equity has been wiped out by asset impairments. They both have negative equity positions of more than $5 billion each, which could be disconcerting considering they jointly guarantee over S$4.7 trillion of mortgage securities, notes Narayanan in his monthly report.

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This article has 12 comments:

  •  
    Aug 28 09:21 AM
    So what is new? How long did it take for your guru to see what is happening. A run on the banks is possible, but you know the presses are ready and it would bring in all the central banks, the BIS. Anything is possible, but this is not probable for a while yet. The GPD numbers today will cheer the huns and spare the gates another day.
    Reply | Link to Comment
  •  
    Aug 28 11:13 AM
    A couple of months ago,a big run was very possible...now it would take a couple of large failures to re-spark those same fears..
    Reply | Link to Comment
  •  
    Aug 28 11:50 AM
    Come on Larry, you are rehashing quotes that are over a month old. Narayanan said that back in July. However, I am shocked...*SHOCKED*...... hear that a hedge fund manager that shorted the financial sector is trying up play up the possibilty of the worst case outcome in the entire spectrum of outcomes.
    Reply | Link to Comment
  •  
    Aug 28 02:47 PM
    FDIC capital on hand is not significant. The guarantee behind all these institutions is the Federal Govt.'s willingness to spend taxpayer money.

    Anyone betting against that is going to have to cover sooner or later.
    Reply | Link to Comment
  •  
    Aug 29 09:11 AM
    If there is a run on the banks, Larry Kudlow (CNBC) will have to change his mantra from "DRILL, DRILL,DRILL" to "PRINT, PRINT, PRINT"
    Reply | Link to Comment
  •  
    Aug 29 09:27 AM
    There will be 4 runs on banks today that will go unreported by any media outlet. My banks.
    My banks will see me withdraw 11 separate accounts before Labor Day. I will be taking physical delivery on gold and silver and not looking back until I deem it prudent.
    I have money diversified in the markets across many sectors, but I am unwilling to invest any more and I am unwilling to leave my bank accounts backed by "the US Govt..."
    Whatever decisions the rest of you make, I will not judge you on, as I hope you don't judge mine. I just need a good night's sleep.
    Reply | Link to Comment
  •  
    Aug 29 11:46 AM
    Kelly Lieberman - and could you tell me where will you be storing that gold ;>}
    Reply | Link to Comment
  •  
    Aug 29 01:13 PM
    Kelly Lieberman, if your apocalyptic scenario is correct then you may want to consider brass casings - instead of gold and silver.....Line out your fields of fire and stand guard. In the worst case, gold and silver have no value either......
    Reply | Link to Comment
  •  
    Aug 29 06:39 PM
    GatorTrader,
    Not really the worst case senario.... The worst case scenario is leaving your hard earned money in the bank as you watch bank after bank fail. That's just foolish.
    Reply | Link to Comment
  •  
    Aug 29 11:35 PM
    putting today in perspective with the savings and loan mess, we still seem to have only 100 banks today on the watch list versus 800 to 900 banks on the watch list then.
    Reply | Link to Comment
  •  
    Aug 31 09:30 PM
    Conveniently left unasked:
    What does the original and revised legislation governing FDIC Insurance say about the TIMELINESS of making insured depositors whole?
    I give Sheila Blair credit, she wisely cherry picks when to bring it up: only when she has 'good news' trumpeting FDIC’s ‘quick response’ in orchestrating the weekend/overnight movement of insured accounts to new bank ownership during a bank seizure. Journalists don’t ask and she doesn’t offer that FDIC has no legislated or regulatory timeline to make any insured account whole.
    Don’t ya love ‘Don’t Ask, Don’t Tell?
    Behind the scenes, Ms. Blair’s wisely beefing up FDIC staff and systems. I suspect she's also timing seizures around the capacity/workload of staff, and not on a strict interpretation of whether a bank has become insolvent. After all, only the FDIC decides insolvency.
    That all said, bank runs are a sociological mass reaction that can’t be forecasted using quantified measurements. It’s not like forecasting bank insolvencies based on data on reserves, etc. And the steps to cure the bank insolvency have no causal relation to steps to influence behavior of masses of people (depositors and the media) who could cascade a bank run.
    10% of banks could be insolvent but if it’s kept quite til the FDIC can address them in a methodical manner, there will be no bank runs.
    Flipside, a tipping point in technology-fueled rumors (like, hypothetically, via CalculatedRisk, the widely read blog, coupled with mega U-Tubing of images of bank-runs in effect) could case multiple bank runs in a rapid cascade even if only 1/100th of banks were actually insolvent.
    Reply | Link to Comment
  •  
    Aug 31 09:34 PM
    Conveniently left unsaid:
    Though the number of institutions involved in the S&L crisis dwarfs today's bank seizures, the number of institutions in existence and the scale in size makes for apples-to-oranges comparisons due to massive consolidation in the industry since 1989, as well as the recent inflated size of bank assets (now being viciously ‘corrected’ directly and indirectly by wholesale asset valuation deflation).
    Reply | Link to Comment
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