The effect of increasing bank failures on US economy

What does the continuing and increasing number of US bank failures mean to the American public and small and medium size business entities? Simply put, it is a big dampener, a depressant to those who want to strive and come out of the recession. One has to keep in mind that the medium and small enterprises and the labor of the common man contribute the major bulk of the GDP, not the handful of the big players!

With every failure of financial institutions, stock prices plunge, real estate market dampens, and the labor force which is already under pressure with one of the biggest job losses in recent history lose heart and give even much lower levels of output. The effect is a complicated chain reaction that is bound to leave a psychological scar even after the depression is over.

As it happened in the recent takeovers of financial institutions, bankruptcy cases and similar contingencies, not every thing is lost with every failure. The government steps in for rescue, of course at the expense of the taxpayers. So, ultimately, directly or indirectly, if the government has to do the carcass cleaning, why should it wait till the patients are mutilated? Symptoms are already known much before the financial breakdown. And if the government intervenes timely and take corrective measures, the news of the bank failures will not inflict psychological depression along with the financial depression. And it will not decelerate the rate at which the economy is recovering.

There were only 3 US bank failures in 2007, but it jumped to 25 in 2008, and the tally of the federally insured banks to fail this year rose to 72, the latest additions to the failed banks list being First State Bank, Community National Bank and Community First Bank. Interestingly, all the 72 failed banks were federally insured. The FDIC estimates the cost to the deposit insurance fund due to the failure of the three banks around $185 million.

The banks collapse because of the increasing job losses, sinking real estate/home prices and dwindling personal wealth that make it difficult for them to pay off debts. Bank failures and loan losses have sapped billions of dollars out of the deposit insurance fund making it at its worst since 1993, $13 billion as of the first quarter. The FDIC expects US bank failures to cost the insurance fund around $70 billion through 2013.

With the July 2008 seizure of IndyMac Bank, the insurance fund is estimated to have lost $10.7 billion. The largest US bank failure last year, Seattle-based thrift Washington Mutual Inc., which had about $307 billion in assets, fell in September 2008 and was acquired by JPMorgan Chase & Co. for $1.9 billion in a deal brokered by the FDIC.

A case worth considering is the performance of US stocks that opened higher on Thursday as a sharp fall in the number of US workers filing new claims for jobless benefits spurred optimism about the labor market and the pace of an economic recovery. It otherwise means, news of positive economic indicators immediately bring an improved economic performance, while negative indicators like increasing bank failures pull back an already beleaguered economy.