Common Cents & Big Banks on August 14, 2020

This past week, my daughter asked if we could watch the movie “The Big Short” at the house. Although I lived through the crisis, have read Michael Lewis’ classic book twice, and had previously seen the movie on at least two occasions, I was more than happy to do so. Anything to cast her proverbial interest net wider than musical theater! Besides, my new books hadn’t yet arrived in the mail.

Watching a movie with the ladies in my house can be an exercise in patience, which isn’t one of my stronger traits. My daughter has a tendency to ask questions and talk throughout, and my wife meticulously follows every line of dialogue. So, you can imagine, with Annie asking questions and Beth hanging on every word, there is a lot of pausing, stopping, and rewinding when watching a movie at mi casa. It is not unusual for a, say, 90-minute show to go well into a second hour when the three of us are together.

If I am lying, I am dying.

Most of you are probably familiar with the story, so I won’t belabor the plot. Suffice it to say, the movie is about the events leading up the housing market collapse and financial system crisis in 2008. Unless you are a centipede, you don’t have enough fingers to point at all the guilty parties and cast blame. It was a system-wide mess, from top to bottom, and the banking industry suffered a black-eye (arguably still does) from it.

One of the questions Annie asked, and there were many, was about bank failures. Why didn’t the government just let the bad guys fail? Indeed, a lot of people wondered that at the time and still wonder it today. Why in the world does the US taxpayer have to ‘bail out’ financial institutions that have been careless, capricious, greedy, stupid, fraudulent, or what have you? It is a fair question in 2020, just as it was in 2008.

What I am about to write will probably make a few people angry: simply put, some banks are too big to fail. There, I have said it. Despite my capitalist nature and libertarian leanings, when push comes to shove, when the dust settles, and when the smoke clears, that is just the way it is. It is nothing more than math, really.

The largest bank in the United States is JPMorgan Chase (JPM). According to Schedule RC-O (Other Data for Deposit Insurance and FICO Assessments (Form Type – 031)) of its 2Q 2020 ‘Call Report,’ the bank had a total of $2.133 trillion in deposits. Of these $370.414 billion were ‘allowable exclusions’ from FDIC insurance calculations, or basically ‘foreign deposits.’ That means the bank had an estimated $1.762 trillion in domestic deposits as of June 30, 2020.

Now, how would you react if I told you $988.354 billion is uninsured? Doesn’t carry FDIC backing? Close to $1 trillion? I mean, what would happen to those deposits if JPMorgan Chase were truly to fail, which isn’t likely by the way?

Obviously, much would depend on the liquidation of the company’s assets. Intuitively, this would be some number of cents on the dollar, otherwise the company wouldn’t be going bankrupt. Senior secured debt holders get/claim their money first, and then come depositors. While it is impossible to predict what the end math would be in this very unlikely scenario, the shortfall would be probably be in the hundreds of billions of dollars.

However, that might even be the biggest issue or problem. Seriously.

According to the most recent FDIC data I could fine, the balance in the ‘Deposit Insurance Fund’ is around $113 billion. The amount of insured deposits in the banking system is, get this, $8.169 trillion. As such, the FDIC has a coverage ratio of around 1.39%. Those are just insured deposits. There are another $6.137 trillion which aren’t insured.

So, going back to JPMorgan, if $988.354 billion of its $1.762 trillion in domestic deposits is uninsured, that means the FDIC is on the proverbial hook for the remaining $774.083 billion. This could be a bigger problem than the uninsured amount, right? After all, if the government is ‘covering’ close to $800 billion in liabilities (and deposits are liabilities), there might be enough generated in the liquidation process to pay off uninsured depositors. Of course, this assumes adherence to traditional bankruptcy procedures.

But something doesn’t add up, does it? If the FDIC fund has a balance of $113 billion and JPM has $774 billion in insured deposits, from where does the necessary $660 billion come? It is a real nightmare scenario, because I suppose there are really only a few levers: 1) raise the funds from the rest of the banking system; 2) jump the line in the capital structure and seize assets in front of secured debt holders and uninsured depositors, or; 3) get a healthier bank to take it over.

The first option is a doozy. Take $660 billion in capital from the rest of the banking system to cover JPMorgan’s insured deposits? That would be more than 32% of the current ‘residual’ in the US commercial banking system (assets less liabilities on the Fed’s most recent H.8 report). Since banks extend credit based on their capital base, reducing the overall system’s capital by roughly a third would, um, have a negative impact on the banking system’s ability to extend credit. Frankly, it would be catastrophic.

If you assume a relatively conservative capital ratio of 15%, $660 billion in capital equates into potentially $4.4 trillion in credit. Unless the Federal Reserve, and other powers that be, significantly relax capital requirements, the banking system would be on hold for an extended period of time. But who really wants significantly relaxed capital requirements?

That leaves the second option. In all likelihood, in this extremely unlikely scenario, the FDIC would jump the line and take the company’s liquidated assets before other claims. This, then, leaves that $988 billion in uninsured assets ‘in the lurch.’ What will be the shortfall? $300 billion? $400 billion? More? I can’t tell you for certain, but it would/could/should be a pretty hefty sum. The best part? All of that money would just sort of vanish. Poof.

Do you think that might have a detrimental impact on those companies and individuals whose money it had been? Think there are significant multiplier effects with that sum of cash? How does that impact their balance sheets? Their ability to conduct business? To cover their own debts? Then there is the pesky old rule of law thing, you know? When the FDIC is on the hook for the insurance and uses its role of ‘receiver’ in the process to cover its obligation?

Here is what the FDIC, itself, says is the source of funding:


“What is the source of funding used by the FDIC to pay insured depositors of a failed bank?

The FDIC’s deposit insurance fund consists of premiums already paid by insured banks and interest earnings on its investment portfolio of U.S. Treasury securities. No federal or state tax revenues are involved.”


In the end, no matter how you slice it, dice it, or carve it up, the failure of a major money-center bank would put an enormous strain on the US financial system, causing major credit and liquidity crunches. Major. It is one thing for the FDIC to let Centennial Bank in Ogden, Utah, fail and pay off insured depositors directly. It is even another to entice/cajole/force a larger, healthier bank to ‘acquire’ a failing one, as happened numerous times during the financial crisis (which just so happens to be the third option). Forcing another bank to buy a distressed JPMorgan? Pray tell, what firm would have the ability to do that? What combination of banks could do that without, as a former boss of mine would say, “swallowing themselves”? None. Besides, if the solution to the problem of a bank being too big to fail is to make other big banks even bigger, what is the purpose in that?

With all of this in mind, how do I think I responded when my daughter asked during the movie if some banks are too big to fail? With all of what I have put you through today? Not a chance.  I simply told her: “Yeah, Boo, a few. More than idealists would like, but not as many as most would imagine. Trust me, you wouldn’t want them to fail.” Sure, I would have added more, but my wife had hit the pause button on the movie and was giving us the ‘evil eye’ to quit talking.

Such as it is watching movies at my house.


Take care, and have a great weekend.

John Norris

Chief Economist


As always, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as those of our investment committee, are subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the reset of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.