As we write this, the 95th bank to fail this year, Georgia Bank, has now closed their doors. This particular closure will hit the dwindling FDIC fund for an additional $892 million. Although customers are not likely to see significant disruptions to their accounts and financial management this is a worrying sign for the economy as a whole. You need to understand the banking industry and why they are still in a precarious position. This article will help you understand and identify your nearest Zombie bank.
[VIDEO] What Are Zombie Banks?
Zombie Banks are the Living Dead
Zombie banks are banks that appear to be healthy and appropriately capitalized right now but will be viewed as insolvent in the future once investors know the true value of their assets. In other words, zombie banks are banks that are going about their day-to-day business as if everything is okay today but will be forced to close their doors in the future when everyone realizes they don’t have as much money as they thought they did.
You see, a healthy—or solvent—bank is a bank that has enough money to lend to new borrowers while covering its liabilities to shareholders and lenders.
Conversely, an unhealthy—or insolvent—bank is a bank that does not have enough money to lend to new borrowers or to cover its liabilities to shareholders and lenders.
To understand what makes a bank a zombie bank, you need to understand a bank’s balance sheet.
On one side of the balance sheet, you will find the bank’s assets. On the other side of the balance sheet, you will find the bank’s liabilities and the owner’s equity in the bank.
The reason it is called a balance sheet is the two sides of the sheet should balance—i.e. the bank’s assets should be equal to the sum of the bank’s liabilities and the owner’s equity in the bank (Assets = Liabilities + Owner’s Equity).
Here’s the problem when it comes to a zombie bank’s balance sheet… nobody knows what the assets are worth.
Sure, it’s easy to tell how much a bank’s cash is worth, but it is virtually impossible in the midst of the credit crisis to know how much a bank’s asset-backed securities and other mortgage-based assets are worth. They may be worth 75 cents on the dollar, or they may be worth 25 cents on the dollar.
At this point, each bank has come up with some sort of valuation for their asset-backed securities, but if the banks have valued their securities to high, they may find they don’t have enough assets to cover their liabilities in the future—which would make them insolvent and force them to close their doors. And if that happens, the shareholders in those banks will most likely lose everything.
Be careful…the bank you buy stock in may be a zombie.
Image courtesy jerekeys.