FDIC pre-announces bank failure crisis part deux

http://www.marketwatch.com/story/fdic-tells-banks-to-recognize-loan-losses-promptly-2009-08-03

SAN FRANCISCO (MarketWatch) -- The Federal Deposit Insurance Corp. said late Monday that banks should recognize losses on home loans promptly and warned that failure to do so could delay efforts to mitigate the financial impact.

Institutions must analyze the collectibility of the loans they hold for investment at least every quarter, the FDIC said in a statement on its Web site.

Banks then have to keep an appropriate allowance for loan and lease losses, covering estimated credit losses on individually evaluated loans that are deemed to be impaired, and on groups of loans with similar risk characteristics, the regulator said.

I have speculated that the banks are still technically insolvent, and bank stock prices are effectively call options that don't expire. This further establishes my hypothesis. If we are to get a correction in to Q3 earnings, this may be the catalyst to do it.

The following was a response in a forum:

The problem with this analysis is the same as when the bankers used flawed reasoning to make the loans in the first place. The bankers/investors/brokers etc all made an implicit assumption that real estate values would continue to go up indefinitely, thereby protecting their investment from default. They didn't factor in the cascading effect that massive defaults would have.

This analysis (in the OP) similarly figures that all the "bad paper" out there is permanently "bad", and that the current (rough) climate for employment and resale of foreclosed property will continue indefinitely.

If and when the economy starts to recover, the amount of loans that can be considered "bad" will drop, and property values will eventually increase again. That means banks holding those properties are going to gain significant value back.

This still doesn't solve short term insolvency issue. And the faulty assumptions bankers used you mentioned in the boom and bust can be applied to your statement that when the economy starts to recover property values will increase again. The problem is that right now they are still dropping, and you are assuming there will be some kind of price recovery. The price recovery you are talking about will not happen in the short term, if at all, and the amount of price recovery needed to make the toilet paper worth anything is very large. We lost a generation worth of housing gains in a matter of a couple years, I can speculate we will not reach that level for a very long time, if ever in our lifetime (in real terms).