The biggest bank closure of the year was announced last Thursday, when Bank United of Florida finally kicked the bucket.  Estimated cost to the FDIC: $4.9 billion. That’s a sizable chunk of total FDIC reserves. RBC estimates that more than 1,000 US banks will fail over the next 3 years. The question is: Who’s gonna get stuck with the bill?

As of Q4 ’08, The FDIC had around $18 billion in reserves. We can assume that their stash is significantly smaller now, especially after the $4.9b hit from Bank United. Part of the answer to the FDIC’s funding quandary comes from a recent increase in their credit line from Treasury, to $500 billion. That indicates that taxpayers are likely to get stuck with the bill.

But our government wants to at least maintain the appearance of banks funding the FDIC. So Friday night they announced significant rate increases on all banks, especially big ones. It appears that these new rules mean bigger banks, especially those who took on more risk, will pay higher fees as a percentage of insured assets. Here’s an excerpt from a Bloomberg piece on the change:

“Many small banks benefit from this, but there’s a lot of pain that others will suffer as a consequence,” said James Chessen, ABA’s chief economist. “It’s a zero-sum game and there’s unidentified consequences of changing this assessment base.”

This is a major shift from past policy, and at first it seems like a move in the right direction: You take on more risk, you pay a higher premium to insure it. But it’s not that simple. In the end, taxpayers still end up holding the bag, or a large portion of it. Because many of the same banks that are  facing higher fees are receiving trillions of taxpayer dollars in the form of bailouts and debt-guarantees.

So raising fees on the same banks we’re bailing out is a bit like taxing your kids’ allowance: “Here’s some money, now give me back a tiny fraction of it”. To make things worse, small responsible banks are also seeing increased fees, in order to pay for the failures of their riskier colleagues.

The FDIC is a flawed institution, another example of inefficient shuffling of money by bureaucrats. Banks who took too much risk must be allowed to fail. The alternative is a continuation of this moral-hazard nightmare. It’s a perfect recipe for stagflation.

Here’s what Sheila Bair had to say about the FDIC’s funding situation in a recent press release:

With the special assessment adopted today, the FDIC projects that the DIF will remain low but positive through 2009 and then begin to rise in 2010. However, Chairman Bair also cautioned that given the inherent uncertainty in these projections and the importance of maintaining a positive fund balance and reserve ratio, “it is probable that an additional special assessment will be necessary in the fourth quarter, although the amount of such a special assessment is uncertain.”

Bottom line to taxpayers: Prepare to hold the bag for the foreseeable future. Cause 2009 and 2010 are gonna be bad. 36 banks have closed so far this year. Major firms like RBC are estimating upwards of 1,000 bank closures over the next few years in the US alone. And the FDIC is opening satellite offices and hiring.

If we continue to back massive amounts of lousy bank debt and print money, the dollar and taxpayer will both suffer. We are giving up our role as the world’s economic leader in order to bail out some bad banks and their incompetent leaders. “It’s not worth it” does not begin to describe the ludicrous nature of the situation. Mortgaging our future, sacrificing the prosperity of future generations for temporary comfort. These phrases still don’t do justice to the situation.

Empires don’t fall in a day. But make no mistake, America is losing its position as leader of the world economy. It may take 20 years, or a hundred. It could be much quicker than that. It all depends on the whims of a relatively small group of politicians and financial power-players around the world.

On a side note, there were two smaller Illinois banks closed that closed on Friday. The estimated combined loss added up to less than half a billion:

There were also two Illinois banks closed tonight. Combined they were just a fraction of the Bank United loss: