Another Pending Crash?

Two articles from Bloomberg caught my eye this afternoon.

The first, which is the source of the above graphic, indicates that there may be a massive swell in US bank failures in the near future. According to the article:

• "More than 150 publicly traded U.S. lenders own nonperforming loans that equal 5% or more of their holdings, a level that former regulators say can wipe out a bank’s equity and threaten its survival. The number of banks exceeding the threshold more than doubled in the year through June, according to data compiled by Bloomberg, as real estate and credit-card defaults surged. Almost 300 reported 3% or more of their loans were nonperforming, a term for commercial and consumer debt that has stopped collecting interest or will no longer be paid in full."
• "Also left out were the 19 lenders that underwent the Treasury’s stress tests in May; they were deemed “too big to fail” and told by regulators that government capital was available to keep them in business."
• "Excluding the stress-test list, banks with nonperformers above 5 percent had combined deposits of $193 billion, according to Bloomberg data. That’s almost 15 times the size of the FDIC’s deposit insurance fund at the end of the first quarter."

One thing the article fails to mention is why a ratio as low as 5% is such a problem. Unless I am mistaken, it is because of the way our banking systems' fractional reserve lending works. By law, banks must keep the ratio of outstanding loans to assets at 10:1, or to put it another way, for every dollar the bank has in deposits, they can loan out $9. That means that a "well capitalized" bank will have only 10% of its outstanding loans on hand.

In the other article, the chief portfolio strategist for bear markets at Federated David Tice claims that US stocks are "dramatically overpriced."

According to his numbers, the recent bull market pushed the S&P 500s' price-to-earnings ratio to the highest it's been since December 2004. To put an exclamation point on his findings, the article goes on to say:

Tice said he’s the most confident ever that the stocks will fall beneath their March lows. A drop to 400, a 61 percent plunge from yesterday’s close, is likely within a year, he said.

What would our economy look like if the S&P 500 dropped to 400? Would we even have an economy left? Would we even have a functioning government?