The main purpose behind the FDIC is to insure bank deposits. To do so, it must have money available to pay off depositors.

That pool of capital is rapidly draining away. The deposit insurance fund fell to $10.4 billion at the end of the second quarter from $13.0 billion at the end of the first quarter. As a percentage of insured deposits, that is down to 0.22% from 0.27% at the end of the first quarter and 1.01% a year ago. Normal is about 1.20% of deposits. (See graph below from

The decline came despite a special assessment on the banks that brought in $9.1 billion in the quarter. Why? It is because of all the Friday night pizza parties Sheila Bair (head of the FDIC) has been holding. During the quarter, 24 insured institutions with combined assets of $26.4 billion failed, at a net cost to the FDIC of $11.6 billion. Keep in mind that the FDIC insures over 8,100 banks with assets of $9.3 trillion.

To you and me, $10.4 billion might sound like a lot of money, but relative to $9.3 trillion it is a drop in the bucket. Fortunately, the FDIC can borrow from the government (generally up to $100 billion, $500 billion under special circumstances) so your checking account is still safe.

Over time, the deposit insurance fund is going to have to be rebuilt. It has been done before — in the first quarter of 1993, at the tail end of the S&L crisis, when the fund got all the way down to 0.06% of insured assets.

This downcycle is not over yet. The pace of bank closures has picked up since the end of the second quarter, both in numbers and in the size of the institutions being shut down.

The number of problem banks is still growing. The FDIC listed 416 banks with $299.8 billion in assets as “problem banks” as of the end of the second quarter, up from 305 banks with $220.0 billion in assets at the end of March, and 252 and $159.4 billion in assets at New Year’s. While this is well below the peaks seen during the S&L crisis, both in terms of assets and number of institutions, it is up from almost nothing on both counts a few years ago.

This is going to act as a tax on all of the banks, from the huge and well capitalized like J.P. Morgan (JPM) down to the little community bank. The special assessments are not going to be all that special going forward, just part of the landscape. This is another one of the reasons I am cool towards the whole banking sector.

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