Next Step: Zombie Banks

More fodder for a coming “zombie bank” financial sector: The TARP banks are lending less. Among banks that have received any form of federal assistance this year, lending contracted 0.8% during March, the Treasury announced yesterday. Amazingly, this is the Treasury’s first study of lending activity among the 500 financials that used the Capital Purchase Program.

The FDIC has restricted interest rate levels at banks it deems to be “not well capitalized.” Banks around the country are trying to attract new investment with high-yielding checking and savings accounts. But if your bank is struggling, it won’t be allowed to follow suit. The FDIC wants the banking sector to stop jettisoning failed institutions… even if it means the survivors are left scraping by. Letting banks set rates as they please could be… risky! Gasp! What if the stupid ones fail?

“It seems Mr. Market believes the financial crisis is behind us,’ observes Chris Mayer. Indeed, the financial sector has more than doubled since its March lows.

“Though it may be hard to imagine a return to those March lows for bank stocks, this credit crisis is, in the words of James Grant, ‘the story of unimagined things.’ First, consider that bank failures are sure to rise.

“As Grant pointed out in his newsletter, Grant’s Interest Rate Observer, 36 banks have failed this year, at a cost to the FDIC of $10.6 billion. If that pace should continue, we’ll have 179 failed banks, the most since 1992. That seems reasonable, especially as this crisis is much bigger than the blip of the early 1990s.

“In dollars, the costs to the FDIC would top $27 billion, the most since at least 1990. The FDIC, too, is low on funds and will need refueling. Such funds come out of the hide of the banks covered by the FDIC. And so amid bank failures, the banks still standing have the prospect of higher FDIC assessments hanging over their profit-and-loss statements.

“What these might be is anybody’s guess, but as Grant points out, delinquencies are on the rise and more losses are coming. In the first quarter, credit card delinquencies shot up nearly 15% from the fourth quarter. For commercial loans, delinquencies were up 21%. This latter category of loans is bigger than subprime. Credit card debt is only slightly behind subprime. So both categories have the potential to spell new (and large) disasters for banks.”