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As of June 2009, the FDIC had about $42 billion in total resources; this includes money in its Deposit Insurance Fund, plus amounts set aside in the agency’s “contingent loss reserves,” funds earmarked for current and future losses. While the FDIC takes pains to tell the public that the agency is in no imminent financial danger and that it will not need to be bailed out by U.S. taxpayers, the agency in November 2009 adopted a new plan requiring all insured banks pre-pay (on Dec. 30, 2009) their estimated quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012.

FDIC Says Costs of Covering Failed Banks Is Taking a Toll

These quarterly premiums are the fees that banks pay in order to receive FDIC deposit insurance.  The FDIC asked for these $45 billion worth of early payments from its member institutions because the FDIC said it had under-estimated the cost of taking over failed banks, and needs to immediately replenish its available funds. In 2009, 140 banks collapsed in the U.S. However, some observers saw the FDIC request as a “gimmick” move to help the banking industry because the $45 billion would be treated as an asset on banks’ balance sheets (a prepaid expense, to be exact), and would not diminish banks’ capital or hamper their ability to lend money.

There are currently about 8,100 FDIC-insured financial institutions in America. In order for a bank to declare that it is FDIC insured, it must meet certain financial requirements imposed by the FDIC. Specifically, banks must maintain healthy, federally-mandated “capital ratios.” This refers to the amount of capital (or dollars) a bank must have set aside in reserves in order to guard against future, potential losses.

Banks Lend (or Not) Based in Part on Their Ability To Meet FDIC Rules

One key capital ratio for banks is called a “risk-based capital ratio.” It measures the capital a bank has (such as its common stock, preferred stock, and undistributed net income/profits) versus the amount of “risk-weighted” assets that bank has. These risk-weighted assets can be anything from corporate bonds and consumer loans (including mortgages, auto loans and leases, student loans, credit cards and personal lines of credit) to government notes and cash. The former – corporate bonds and consumer loans – all carry a risk rating of 100%, meaning they are highly risky since there’s no guarantee at all that they will be repaid. Meanwhile, government notes and cash are deemed risk-free.

If the notion of a loan being both an “asset” and something that is “risky” seems a little tricky, let me explain it briefly. A loan/credit line is called a “risk-weighted” asset because on the one hand, it is an asset, inasmuch as it represents a promise by a borrower to repay that loan/credit line (most often with interest). At the same, a loan is also considered a “risk-weighted” asset (emphasis on the word “risk”) because there’s always a chance, no matter how small or large, that the borrower will not repay a bank as agreed.

Banks Follow a 10-to-1 Rule

OK, now stay with me here. To get the highest stamp of approval from the FDIC, a bank’s capital must total 10% or more of its risk-weighted assets. Put another way, for every $10 that it loans, a bank must maintain $1 in capital reserves. For example, if a Bank A has $1 billion in capital, and that bank has made $10 billion in loans (or extended $10 billion in credit to its customers), then Bank A’s capital ratio is 1 to 10, or 10%. But if Bank B also has $1 billion in capital, and has made $20 billion in loans (or extended $20 billion in credit to its clients), then Bank B’s capital ratio is 1 to 20, or 5%. These are critical measures because the FDIC insists that member banks have a more than ample amount of capital on hand to deal with any financial scenario. Thus, the FDIC categorizes banks into five groups:

FDIC Classification of a Bank Capital Ratio

Well Capitalized                                        10% or higher

Adequately Capitalized                         8% or higher

Undercapitalized                                      Less than 8%

Significantly Undercapitalized           Less than 6%

Critically Undercapitalized                  Less than 2%

As you can see, the more credit a bank extends, the more capital it must be able to show the FDIC as proof of its financial strength – especially in the event of potential losses or other unforeseen circumstances. Without a healthy amount of capital, a bank runs into trouble with federal regulators. Once the FDIC labels a bank as “Undercapitalized,” it issues a warning to that institution, telling it to shore up its reserves. If the bank fails to perform, and its capital ratio falls below 6%, into “Significantly Undercapitalized” territory, the FDIC has the right to step in, change the company’s management, and insist that the bank take appropriate steps to remedy its capital shortfall. If a bank’s finances become so dire that its capital ratio drops to less than 2%, and it is deemed “Critically Undercapitalized,” that’s the point at which the FDIC declares the bank insolvent and can take over management of the institution. These illiquid banks are either run by the FDIC, as is currently the case with IndyMac, which failed in 2008, or the insolvent institutions get sold off by the FDIC to another bank.

The Long-Term Implications of the Financial Meltdown

So what does all this mean for you? If you went through the ringer during the downturn, say you lost a good-paying job or maybe you even lost your home to foreclosure, you may have thought that those setbacks represented the single-biggest impact on you resulting from the financial crisis. If you believe that, however, you are sadly mistaken. Don’t get me wrong: Unemployment and foreclosure are major challenges, and they can have a host of far-reaching implications. But in the scheme of things, those are one-time obstacles. In truth, the single-biggest impact on you stemming from the financial crisis is that the credit environment has dramatically changed – mainly because the entire banking landscape has been forever altered. This new economic, banking and credit environment have the power to impact you, your family and your financial dealings for decades to come, likely for the rest of your life. You might miss that old job, or your previous home, but their loss will not impact your credit, or your ability to get a much-needed loan in a decade from now, let alone two or three decades into the future. The new credit environment, however, will continue to have reverberations for decades.

Banks Cutting Back on Lending Are Fighting for Survival

Considering the enormous upheaval the financial community has undergone, can you see why banks, credit card companies and others have become a lot pickier about to whom they lend money? They had to. It’s a matter of survival. Otherwise, making too many bad loans can mean the death of a financial institution – even a century old bank that was once seemingly rock solid. Look no further than the spectacular collapse of Washington Mutual in September 2008 and its takeover by Chase. WaMu was founded in 1889. For many decades, it was considered a great and mighty financial powerhouse. But with $307 billion in assets, and $188.3 billion in deposits at some 2,239 branches, WaMu went under in what is to date the single largest bank failure in U.S. history. In fact, as of October 2009, if you examined the biggest American bank failures ever, where insolvent banks had $1 billion or more in assets, you’ll find that 72% of those bank collapses (more than 7 out of 10!) occurred in 2008 or 2009. These bank failures have cost the FDIC billions of dollars and, some say, threatened the stability of the FDIC, the very institution that is supposed to back up banks.

In 1933, under the Glass-Steagall Act, President Franklin D. Roosevelt created the FDIC to provide deposit insurance to banks. The goal of this deposit insurance was to assure the public that money put into any FDIC member bank was safe, secure and “backed by the full faith and credit of the United States government.” So since Jan. 1, 1934, the FDIC has insured bank deposits in America. Back then FDIC insurance coverage guaranteed your deposits to the tune of $2,500 (a lot of money during the Great Depression). Before that time, if you had money in a bank, and that bank failed, your hard-earned savings was often completely wiped out.

FDIC-Insured Deposits Now Covered Up to $250,000

Fast forward 65-plus years later. If you currently have money sitting in a deposit account at a bank, and that bank is FDIC insured, then your money is protected up to $250,000. In 2008, during the height of the biggest financial crisis most of us have ever experienced, the FDIC raised the limits on insured accounts to $250,000 from $100,000. This $250,000 limit – per depositor, per account – will be in place until Jan. 1, 2014, at which time it is scheduled to go back to $100,000. The FDIC insures so-called deposit accounts, which include the following:

• Checking Accounts
• Savings Accounts
• Negotiable Order of Withdrawal Accounts (also called NOW accounts, which are savings accounts that allow you to write checks on them)
• Time Deposit Accounts, (including Certificates of Deposit or CDs)
• Negotiable Instruments (such as interest checks, outstanding cashier’s checks, or other items drawn on the accounts of the bank)

The good news for most people is that even if your bank goes out of business, if you’ve put your money in a FDIC-insured institution, you can rest assured that your money – up to the limits described – is perfectly safe. In fact, since the FDIC’s inception, not a single dime of insured deposits has ever been lost.

As of early 2010, both the American economy and the global economy appear to be stabilizing. But the U.S. banking sector nevertheless continues to struggle – and will likely do so for some time to come.

Bank Failures Surge in 2009

In 2009, 140 banks collapsed in the U.S. during the year. That compares to 25 bank failures in 2008 and just 3 bank collapses in 2007. The Federal Deposit Insurance Corp. maintains a “watch list” of problem banks, those with troubled finances. In the third quarter of 2009, that watch list contained 552 banks, the highest level in nearly 16 years; so experts predict that half or more of those banks could also fail.

Even if the economy were to miraculously bounce back to complete health overnight, it would not safeguard many financial institutions. “Banking industry performance is, as always, a lagging indicator,” FDIC Chairman Sheila Bair said in 2009, reminding the public that problems always take longer to work their way through the banking system.

The economic crisis that initially began when sub-prime mortgages started unraveling in 2006 and 2007, became a full-scale financial meltdown in 2008, and continues today to have a huge impact on the overall economy, as well as on you and me. At its core: the crisis was about debt. Or “leverage” as they call it on Wall Street. Call it what you want: the simple fact is too many individuals and far too many institutions borrowed way more than they could afford to repay.

A Nation of Debtors

People racked up credit card debt. They bought expensive cars. And, of course, they stretched for that loftiest of goals embodied in the American dream: a home. During the height of the real estate boom, it was common for cab drivers, teachers and others earning $40,000 or so to take out mortgages for $400,000 or more. As long as real estate values kept escalating, the party continued. When the credit cards got maxed out, people simply used the equity in their homes as collateral to get cash from banks. Voila! The credit card bills were paid once again. Consumers could go back to spending. The banks were satisfied because they were getting repaid, and the economy was humming along nicely. Everyone was happy.

But you know the old saying: “What goes up must come down.” So it was with real estate. Starting around early 2007, house prices stopped rising, and people were no longer able to use their homes as piggy banks. All of a sudden when those credit card bills crept up, they couldn’t be paid off by tapping a home equity loan or a home equity line of credit. The first people to be hit were so-called “sub-prime” borrowers, those with less-than-perfect credit ratings. They saw the interest rates on their adjustable-rate mortgages shoot up, often causing their mortgage payments to skyrocket. Scores of borrowers struggled to keep up, but they simply couldn’t. Most had absolutely no savings. Plus, millions of people began receiving pink slips, as corporate America went through a wave of layoffs that endures to this day. Without a job and with no cash reserves, how can you pay your house note and other bills? So many cash-strapped homeowners went 30 days past due on their mortgages. Then those 30-day delinquencies turned into 60 or 90 days. Soon, a cascade of foreclosures rippled through the housing market.

Who Is To Blame for The Financial Crisis?

Needless to say, the consumer was not solely to blame in this whole mess. The financial community definitely played a critical role in creating the problem, and allowing it to persist. Banks were way too lax in extending credit, often making the riskiest loans to borrowers with the worst credit. Banks, brokerages and other investors also made the mistake of buying investments called mortgage-backed securities. These were essentially thousands, or hundreds of thousands of mortgages, all packaged together as one big investment. In the heyday of the real estate boom, mortgage-backed securities were big money makers. After all, their value was tied to the worth of rising home properties. Once the real estate crash happened, however, these investments went belly up. Finally, lenders, regulators and credit rating agencies such as Moody’s and Standard & Poor’s all should have been sounding the alarm bells about rising debt and credit delinquencies. Instead, they failed to accurately envision the very real possibility that a massive wave of consumers – including those with poor and good credit – might not be able to handle their overall crushing level of debt. But that’s precisely what happened in 2007 and 2008.

Once homeowners began defaulting on their mortgages, and fewer people paid their credit card bills, student loans and other debts, banks started to feel the sting. The money that banks had relied upon – the money that consumers borrowed and were supposed to repay – simply wasn’t there. Before long, the financial crisis spread from individuals to institutions. In the financial world, it’s common for banks to lend money to each other at low interest rates. Usually, these are very short term loans; they typically get repaid as quickly as 24-hours, or about as long as one month. But by 2008, banks became leery of lending to each other, for two primary reasons. First, banks wanted to hoard their cash to protect themselves against future losses. Second, and most important, banks were terrified of making big loans in an uncertain environment. They feared that other banking institutions might fail to honor their debts, just like consumers did. Adding to the fear and worry, nobody knew exactly how many bad loans banks had made, or how many investments they had in toxic sub-prime mortgage debt. So just like that, the credit markets came to a grinding halt. Nobody was lending money to anybody. Period.

The Credit Crunch Reaches a Tipping Point

It was one thing for a consumer credit crunch to take place, as it did during the summer and fall of 2007, when it was terribly difficult to get a mortgage loan. But when the credit crunch spread in 2008 to banks being unwilling or unable to make loans to each other, well that was another story. That corporate credit crunch proved to be too much stress on the system. The spread of the credit crunch to the corporate market – where even banks themselves couldn’t get a loan – marked a critical tipping point and the height of the financial crisis. In January 2008, Countrywide Financial Corp. just managed to avert complete disaster, by selling itself for $4 billion in stock to Bank of America. Without that deal, many feared that Countrywide, which had been suffering under the weight of bad mortgage loans, would have certainly collapsed.

Wall Street Implodes

Before long, however, the fallout from the credit crunch and soured mortgage loans could not be contained. There was carnage on Wall Street, as centuries-old institutions failed or got bought out – some of them seemingly overnight. In a matter of months, three of America’s top five investment firms went under. Bear Stearns collapsed in March 2008, and was sold to JP Morgan Chase for the bargain-basement price of just $2 a share, a deal that valued Bear Stearns at less than $240 million. (That $2 per share price was later raised to $10 a share. But even that was small potatoes, since earlier in 2008 Bear Stearns’ stock had traded at $80 a share, and Bear Stearns had been worth $20 billion). Then in September 2008, two other major events rocked Wall Street. Lehman Brothers went bankrupt, after federal authorities refused to rescue the company. Soon after, Bank of America purchased the once-mighty brokerage house Merrill Lynch for about $50 billion in stock – less than half what Merrill was worth the prior year.

The U.S. Government Steps In to Prevent a Systemic Banking Failure

At the peak of the crisis, when it appeared the entire financial system was on the verge of collapsing, the U.S. government got actively involved, stepping in with massive efforts to provide stability. Banks were allowed to borrow money easily, and at cheap rates, directly from the government. The government took over mortgage companies Fannie Mae and Freddie Mac, as well as insurance giant American International Group Inc. (AIG). Also, the government began more closely scrutinizing the health of banks and other financial institutions. This led the federal Office of Thrift Supervision in September 2008 to shut down the 119-year-old Washington Mutual Inc., which had been America’s largest savings and loan. Once again, JP Morgan Chase was a shrewd buyer, snapping up WaMu’s banking assets for a mere $1.9 billion. By October 2008, Congress passed a gigantic $700 billion financial rescue package, officially called the Emergency Economic Stabilization Act of 2008, to bail out Wall Street and to encourage banks to start making loans again. If all this wasn’t enough, the U.S. Federal Reserve and other government entities also launched coordinated fiscal and policy actions with governments around the globe to stop the growing financial crisis from being felt worldwide. Commenting on the government’s unprecedented role in shoring up some financial institutions, former Federal Reserve Chairman Alan Greenspan said in an ABC interview: “This is a once in a half-century, probably once-in-a-century type of event.”

The Credit Crunch Rages On … Squeezing Individuals and Businesses Alike

Despite Greenspan’s proclamation, the financial crisis rages on. In late October 2009, commercial lender CIT Group Inc. became one of the latest high-profile casualties of the credit crunch. CIT had been one of America’s biggest providers of loans to small and medium-sized businesses. But the 101-year-old company was forced into Chapter 11 bankruptcy – the fifth largest bankruptcy in U.S. history – after CIT’s own lenders refused to extend it more credit and CIT’s financing evaporated. Unfortunately, CIT Group wasn’t alone in its woes. In November 2009, another lender to small businesses, Advanta, also filed for Chapter 11 bankruptcy protection. Commenting on the company’s unsuccessful efforts to survive the credit crunch, Advanta CEO Dennis Alter said in a statement: “The economic debacle over the last two years devastated Advanta’s small business customers and Advanta itself.”

Unfortunately, there were more than 1.4 million consumer and business bankruptcy filings in 2009. So the bankruptcy problem and the credit crunch is expected to last for years to come.