Monday, October 5, 2009

Recovery? Don't Bank on It

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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As of Friday, 98 U.S. banks have failed this year and the FDIC Deposit Insurance fund is on the brink of insolvency. The fund now covers only 0.22% of U.S. bank deposits, whereas a 1.15% minimum is mandated by law. At the end of second quarter 416 banks were on the FDIC's troubled list (this number should be updated in about another month), so the steady drip of money leaking out of the fund could turn into a torrent. Commercial loan defaults are the current crisis hitting the system and this problem has just begun. While you may be surprised that this could be happening after Fed Chair Ben Bernanke has repeatedly told us that the banking system was saved last year, a government report released today indicated that the public had been lied to about just this very subject.

A special inspector general investigating the handling of the bank rescue program TARP in the fall of 2008 found that then Treasury Secretary Paulson and other officials falsely claimed that the first 9 institutions getting funds were sound. Paulson specifically stated, "These are healthy institutions ...". At the time, Merrill Lynch was actually collapsing. Citibank and Bank of America subsequently required significant additional funds to stay afloat. The report was criticized by Assistant Treasury Secretary Herbert Allison Jr., who now heads the bailout program for the government. Allison maintains that any critique of the announcements made a year ago should take into consideration the unprecedented circumstances facing financial regulators at the time. In other words, the government feels that it is justified in blatantly lying to the public if a crisis is taking place. Let me repeat that: the government feels that it is justified in blatantly lying to the public if a crisis is taking place. Let me follow that up by pointing out that there is both a credit and economic crisis still taking place.

The FDIC itself has given us more than enough reason to think the U.S. banking system has not actually been rescued. Other than the domino like collapse of smaller and midsized banks that is now occuring, the FDIC's figures state that in aggregate U.S banks lost $3.7 billion in the second quarter, even though almost every large U.S. bank reported major profits. Of course the major banks have received massive injections of government aid, while the smaller banks have not. This is a move afoot to try to inject TARP funds into smaller banks to prevent defaults on a mass scale.

At the risk of sounding like a broken record, what is taking place in the U.S. now is very similar to what took place in Japan in the 1990s. Japan had a banking system dominated by a small number of large institutions. The first 9 recipients of TARP funds controlled 75% of the assets in the U.S. banking system. In both cases, banks were allowed to become so large that a failure of even one of them endangered the entire financial system. Japan has propped up its banking system for two decades now and the cost has been an economy unable to grow unless there is government stimulus. Personally, I am waiting to see what the U.S. government is going to do to rev up the economy next quarter now that the Cash for Clunkers program has expired.

NEXT: Gold! Record High Knocking on Heaven's Door

Daryl Montgomery
Organizer,New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.


John C said...

Thanks for taking the time post your blog, I do find it interesting and informative. Does not the failure of all these banks give credence to those concerned about possible deflation?

New York Investing meetup said...

No, the failure of all these banks gives credence to INFLATION, not deflation. The correct definition of inflation is a currency losing its value. Bank failures mean more money printing and a lower U.S. dollar. A lower dollar means more inflation.

Vancouver Jay said...

Too bad the government investments we're useless. I wonder if this crisis could have been eliminated as a threat early on when the investments we're made. You should check out my Brick and Mortar Investments article. Maybe you'll find it interesting ;) Thanks for a great post though, nice reading.

Take care, Jay