Some good reporting by Bloomberg today shows how the banking system is dependent on make-believe accounting to help prop it up.

It reports that the FDIC is planning to auction off a billion dollars in seized assets from failed banks. But other banks who partnered on these bad loans say the auction may push them into bankruptcy by forcing writedowns of those assets.

What’s wrong with this picture?

“These banks can’t believe that the regulator they pay to protect them is going to sell these loans to someone who can flip them and cause them serious losses,” said Robert Reynolds, a lawyer at Reynolds Reynolds & Duncan LLC in Tuscaloosa, Alabama, who represents 25 lenders that took part in financing the W Hotel. “Our banks just cannot believe they’re being treated in a way that ultimately hurts the FDIC’s insurance fund, because some of them are right on the edge.”
As Calculated Risk writes:
“This problem” is many small and regional banks are carrying loans above market value. The FDIC auction will establish market value, and that will probably lead to significant losses for many banks - and more bank failures.

It’s been policy to allow banks to paper over their losses and try to earn their way to health—see the mark-to-market changes of last spring. It’s never been clear to us from the reporting we’ve seen just how healthy the banks are, and how much of the rebound in their fortunes has been a mirage. They’re certainly not lending.

The sale of loans from failed banks in 2009 brought on average 43 percent of their book value, according to an FDIC summary. Non-performing loans, those on which the borrower has defaulted or there is little prospect of repayment, were sold for 26 percent of their book value on average.

The FDIC’s problem-bank list stands at 702, up by 150 in just three months, as Bloomberg notes.

Again, this is just one deal. But it has banks squawking that it could push them over the edge. Just how solvent is the banking industry really?

Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu.