On Friday, the first unavoidable evidence that the credit crunch continues burst forth to center stage. The Office of Thrift Supervision (OTS) and the Federal Depositors Insurance Corporation (FDIC) were forced to take control of IndyMac Bancorp, Inc. IndyMac’s failure marks one of the largest bank failures in history, and is the largest bank failure since Continental Illinois National Bank and Trust Company failed in 1984. Moreover, the quasi-governmental lending/underwriting institutions for home loans - Federal Home Loan Mortgage Association (Freddie Mac) and the Federal National Mortgage Associatoin (Fannie Mae) - are under severe liquidity pressures and  the Treasury will come to the rescue of the institutions to the tune of $15 billion. If there were any doubts that the economy is precariously placed, the Fed and the Treasury running out of options (and time) in attempting to balance growth and liquidity, and the credit crisis danger still ever present, Friday should have eliminated them.

IndyMac has roughly $18 billion in deposits - ostensibly a large portion of which ($16B) are FDIC insured deposits in some form. Current estimates are that the bank’s failure may cost as much as $9B dollars from FDIC funds. The FDIC operates to protect the public against bank failure, and to prevent exactly what happened to IndyMac. IndyMac failed (oddly in part because of Sen. Charles Schumer making statements that the bank’s demise was at hand) because depositors withdrew their cash from the bank in a bank panic, thus, causing the bank to be insolvent. However, even without the Schumer-induced bank panic, IndyMac was badly hit by the mortgage lending meltdown (IndyMac’s origins beginning with Countrywide Financial) and had lost as much as a billion dollars in the mortgage meltdown. The mortgage losses combined with the bank panic caused the bank to become insolvent last Thursday evening, and the OTS was forced to take the bank into receivership immediately on Friday.

Is the IndyMac case isolated? Probably not, but I have significant faith that the banking system by and large will be able to weather what I expect is the final storm of credit issues. While Bank of America, Chase, and CitiBank, all suffered large losses in the mortgage markets - those banks were able to stay ahead of the surge of losses and refinanced their operations by raising funds, or by attracting additional capital. However, the IndyMac implosion should serve as reminder that the mortgage meltdown continues and that the US banking system remains under considerable strain as liquidity continues to be an issue for many institutions.

I suspect that there are significant numbers of banks that are invested in mortgage paper. The fact that IndyMac is the first to go doesn’t mean it’s the last to go. I suspect there are a smattering of banks that are suffering. I suspect that there are a string of middle-capitalized banks (perhaps 100 maybe 200 nationally) that will not be able to get out from under the paper they have on their books. These banks will ultimately wind up going into receivership, or trying to fund out their loans through the special Fed programs or through Freddie/Fannie swaps. If they will be able to is not yet known - but they are likely out there and the FDIC is probably watching for signs of weakness to ensure that another “savings and loan” crisis - where banks hid their financials from the Fed - doesn’t occur a second time. While the S&L crisis was going to be expensive - it was in part SO expensive because the bankers hid their numbers from the regulators. In this case, I suspect OTS and FDIC are watching the banks with high mortgage portfolios closely.

What is more disturbing to me is the crisis occurring in Freddie Mac and Fannie Mae. Those institutions are primarily responsible for securitizing home loans and making the secondary markets for mortgage-backed securities function. If the Fed is going to “bail them out” - then the underlying secondary markets and the overall ability of the market to securitize home loans may be bottoming out. I mean - we’re talking about the two largest lenders in the United States for mortgages. Fannie Mae and Freddie Mac either hold or back $5.3 trillion of mortgage debt. That’s about half the outstanding mortgages in the United States.

Federal officials again threw their support behind the government-sponsored enterprises; the Treasury pledged to expand its current line of credit to the two companies and the Federal Reserve said it will provide additional loans if needed.

Treasury Secretary Henry Paulson also said the government could, if needed, buy equity capital in the companies, whose stocks lost half their value last week. The Treasury’s moves would require congressional approval.

What the Government appears to be doing is figuring out who’s going to be in the lifeboat. The reality is - the Fed is near tapped at 90% capability. The Treasury is facing a double whammy in that borrowing costs are skyrocketing, while its demands for spending are also increasing. In short - they’re both running out of options to monetize the crisis and keep pumping in money. Today, it is obvious to me they decided they’re going to be saving Freddie and Fannie - but companies like Lehman may be on their own. Moreover, as banks fail - the FDIC will honor its responsibilities - but it may not go out of its way to ensure that depositors over 100K are taken care of and get their full value.

In short - its a mess… and its continung to unwind.