Delay and Pray: Why the FDIC is Broke, by Dr. Gary North

“If it ain’t broke, don’t fix it.” — Burt Lance

“If it is broke, don’t admit it before you absolutely must, and then blame it on events that no one could have foreseen.” — [Gary North’s] universal law of bureaucracy

Burt Lance was briefly the head of the Office of Management and Budget under Jimmy Carter. He was a Good Old Boy from the banking world of Georgia. A William Safire piece, “Broken Lance,” created enough bad publicity to persuade Lance to retire in September 1977. The article won Safire a Pulitzer Price.

Lance’s aphorism, taken from the South, has been with us ever since.

I made up the second aphorism. It is based on my 40+ years of studying government bureaucracies.

The FDIC adheres to the second rule with remarkable tenacity. It closes no banks until Friday afternoon. This ensures that there will not be a run on the bank.


A bank run today is not the old-fashioned kind that we see every Christmas season when we watch “It’s a Wonderful Life.” That was a pre-FDIC bank run. A bank run took place in the Great Depression when depositors, who had been promised payment in currency on demand, exercised their contractual rights. The banks were unable to fulfill their contractual obligations because they had loaned out the
deposits. The deposits were short-term. The loans were longer-term.

Longest of all for banks were home mortgages: five years with 50% down. Longest of all were home loans made by Building & Loans, what we called Savings & Loans until the crisis of the mid-1980’s forced them to become banks.

“Borrowed short and lent long.” That was Jimmy Stewart’s problem in the movie.

Potter ran a solvent bank. He had not made long-term loans. The bank could cash in his short-term loans and pay its depositors. It could meet its contractual obligations.

Wicked, mean Potter!

In contrast was the lovable George Bailey. His institution had made long-term loans. It stayed solvent during a bank run only because (1) Bailey gave up his $2,000 honeymoon [savings] money (about $20,000 in today’s money); and (2) the bank run ended at 6 p.m. The bank run did not start up again the next day. That wasn’t the work of Clarence, the wingless angel. That was the work of Frank Capra’s screenwriters.

Over 6,000 small banks went bankrupt, 1930-33. The FDIC was created in 1934 to prevent that kind of bank run. Its presence calmed depositors, who knew that a government- chartered institution insured their accounts.

The FDIC eliminated the old-fashioned bank run. It replaced it with the modern bank run. This is the type of run we see every Friday afternoon.

This run does not involve depositors going to a suspect bank’s ATM and pulling out currency. No one uses that much currency in conventional markets — only in black markets, Latino men on the street corner markets, and gun shows.

Instead, they send a bank wire draft to make a deposit in a different bank. Or they write a check to a different bank and open an account.

When the money is deducted from the first bank, this reduced its liabilities. This must be balanced by an equal reduction of its assets. But a bank that is in trouble has illiquid assets. It must sell these at a loss. The net worth of the bank falls. The capitalized value of the bank falls. By law, the FDIC must intervene to shut down the bank when the solvency of the bank is threatened.

This law is not being obeyed. Why not?

“If it is broke, don’t admit it before you absolutely must, and then blame it on events that no one could have foreseen.”

Why does the FDIC wait until Friday afternoon to announce that a bank has been closed by the FDIC. To make the transfer of ownership legal by Monday morning, when it opens for business. “Under new management” means “you don’t have to send your money elsewhere.” This reduces fear.

If the FDIC closed a bank on Monday, before it had lined up a buyer, there would be a run on the bank all week. Depositors would shift their funds elsewhere. The FDIC would still be left holding the bag. The bag would have lots more IOUs to depositors by the end of the week. It is a bag filled with red ink.

The FDIC is liable for the deposits. The more pulled deposits, the lower the capitalized value of the bank. This means the FDIC is on the hook for more money. It wanted an outside bank to buy these liabilities and assets. If the liabilities must be covered by the FDIC, the FDIC must sell its assets.

It has less than $12 billion in assets remaining. It had $52.4 billion in 2007.

The following letter is posted on the FDIC’s web site. It is from an unidentified banker in Alabama. Here, we read the following:

If the public were to understand that the FDIC’s deposit insurance fund was at or near the point of depletion there would be a massive run on every bank in the country and the any remaining stability in the financial industry would be gone. This would likely result in the government having to take over more of these failed institutions and eventually having to guarantee all deposits thus resulting in a nationalized
banking system, which I 100% opposed.

If the FDIC posts a letter like this on its web site, then I conclude that the FDIC takes seriously this scenario.

The FDIC has a FAQ list on its site. The list does not include these questions, which I guess are not frequently asked:

How much money does the FDIC have in reserve?

How much money in commercial bank deposits does
this reserve base insure?

Where does the FDIC invest its assets?

Who insures these assets?

At the end of 2008, its annual report revealed that reserves were down to $17.2 billion (Fund balance — ending). That was down from $52.4 billion at the end of 2007.

Beginning in January 2009, 69 banks have failed. The list is here. [JWR Adds: Since Gary wrote this article last week, the tally of failed banks for 2009 has increased to 72.]

The general estimate is that the FDIC’s reserves are around $12 billion. They were at $13 billion in March. The ratio of FDIC reserves to banks assets covered was 0.27%, or 27 cents for every $100 in bank deposits.

The FDIC keeps its [so-called] reserves in short-term U.S. Treasury debt. So, every time it sells T-bills, the government must find a buyer, presumably in the private sector. The FDIC has access to money only by moving T-bills out of the government sector and into the private sector.

If there are no buyers, the Federal Reserve will buy the T-bills. So, the Federal Reserve System is the ultimate insurer of the banking system. How can it do this? By creating money out of nothing.


The FDIC has an incentive to delay the announcement of another bank failure. If the bank can somehow dig its way out of its crisis, the FDIC conserves its reserves.

In March of 2009 Senator Dodd introduced a bill into the Senate, S. 541. If passed, it will grant the FDIC a $500 billion line of credit. It has not been debated in the Senate or the House. Why not? Publicity.

“If it is broke, don’t admit it before you absolutely must, and then blame it on events that no one could have foreseen.”

The FDIC is delaying the announcement of its takeover of three regional banks whose liabilities could deplete the FDIC’s reserves. Karl Denninger posted a revealing report on his site on August 2. It considered the situation facing these three banks. Two of them have reported negative Tier-1 Ratios. This means that they have a negative ratio of assets versus liabilities. They are legally bankrupt.

The third bank needs a $500 million infusion of private capital, plus another $500 million from the Federal government. If this bank goes under, it will be the sixth largest bank failure, by assets, in U.S. history.

It has $20 billion in assets. How much money might the FDIC be forced to raise by selling its own assets if this bank goes under? In the case of Florida’s BankUnited, which had $12.8 billion in assets, the FDIC had to pony up almost $5 billion. That was a loss of 40% of assets, Denninger points out. Yet the bank showed nothing like this loss until it was shut down. Neither did IndyMac.

The FDIC has not closed any of the three banks. By law, it must take Protective Corrective Action, Denninger says. It hasn’t.

These three banks are regional banks, not small local banks whose losses the FDIC can afford to absorb without much publicity on a Friday afternoon.



Why did the other busted banks suffer such enormous percentage losses when the banks’ accountants revealed nothing like this? Denninger offers a cogent explanation.

An enormous number of banks are holding loans at or close to “par” that really aren’t. They’re holding mortgages at massively-inflated values, even on defaulted properties, and this is why you
are not seeing more foreclosure sales – that is, why inventory is being held back. If they sell it the accountants will force recognition of the loss, which will render them instantly insolvent, but so long as they “extend and pretend” they are marking these loans way, way above recovery value. The upshot of this is that these firms’ balance sheet claims on asset values are massively inflated, regulators know it, and
they’re intentionally ignoring it.

If this is true, which I think it is, then the continuing crisis in housing will pressure the banks even more. The suggestion that the crisis is over ignores the looming losses from defaults on re-sets of Alt-A mortgages and Option ARM mortgages. Over he next two years, they will rival the losses inflicted on lenders by subprime mortgages. The chart is here.

Denninger’s conclusion seems sensible to me.

The claim of banking sector health and “successful rescue by Treasury and The Fed” is in fact false. No such thing has occurred. What’s going on here is nothing more or less than intentional false claims of asset “valuation”, which is repeatedly exposed when the FDIC is finally forced to seize institutions, exposing the lies. Then, suddenly, 20, 30, even 40% losses on alleged “asset books” come out into the
light and the taxpayer eats them.

The banks are allowed to carry these dead and dying assets on their books at par value. This is par for the course — the government’s course.

[Like Denninger], I believe the FDIC is broke and knows it; that under the law they should have seized these three banks (and many dozens more, including some really big ones) some time ago, but doing so will force them to tap the Treasury “emergency” credit line. They’re well-aware that this could instill quite a bit of panic in the public (never mind Congress!); as such they, along with [the Office of Thrift Supervision] OTS and [Office of the Comptroller of the Currency] OCC are conspiring to (once again) hide the truth and pray for an economic recovery before they are forced to act as the law demanded months or even years ago!

This policy of delay and pray is pushing up the stock market. He pointed out that insider sales by corporate executives are higher today than an any time since late 2007. They know what is going on inside their own firms.


When banks refuse to sell empty foreclosed houses, the houses deteriorate. The bankers delay and pray, hoping the housing market will turn back up. They don’t want to list these properties as losses. They are allowed to delay such a listing until the properties are sold.

Empty houses deteriorate fast: weather, squatters, and vandals. This is why private property insurance firms revoke property damage insurance after 30 days of vacancy.

These capital losses are mounting, thereby lowering the value of the loans’ collateral. These are hidden losses. The lenders’ books do not record these losses.

The longer banks delay sales of foreclosed houses, the greater the capital losses for these banks.

The longer the FDIC refuses to close these banks and get these properties sold, the larger the losses the FDIC will suffer when it finally closes the banks.

The longer these empty houses are not sold, the longer this sword of Damocles hangs over the residential real estate market. This delays the recovery: too much inventory.

This “shadow inventory” is not reported to any official institution. No one knows how large it is nationally. All that investors know is that it is large, and it will get larger.

Delay and pray will fail. But no government official will lose his or her job when the day of reckoning comes.

Delay and pray will therefore continue.

“If it is broke, don’t admit it before you absolutely must, and then blame it on events that no one could have foreseen.”