Reporting on the parlous state of the US financial system has become a daily ritual for the business media, with good reason: things keep getting worse. The banks keep getting worse, the Fed’s getting worried about inflation, and credit and growth, US house prices keep dropping, but at a slower rate and new home sales looked a bit better. That was, until economists realised the goodish figures for June had been revised downwards.

While the health of mortgage giants, Fannie Mae and Freddie Mac absorb much of the attention from markets, the condition of the country’s banks has worsened and the key regulator, the Federal Deposit Insurance Commission (the one that comes in to pick up the pieces after a collapse) says its problem list of banks jumped to the highest level in five years. The FDIC said now has 117 banks on that list at the end of June (they were not named) up from 90 in the March quarter and 61 in the June quarter of 2007.

And as FDIC chairman Sheila Bair told a Washington press conference overnight, the forecast ain’t good: “Quite frankly, the results were pretty dismal, and we don’t see a return to the high earnings levels of previous years any time soon.”

US shareholders taking a battering. Shareholders are suffering, not only from weak share prices, but from reduced or non-existent dividends. The FDIC said just over half of the more than 4,000 banks that paid a quarterly dividend last year reported paying out a smaller amount, or no dividend whatsoever, during the June quarter of this year, a real sign of the depths of the problems the sector finds itself in.

US banks are trying to rebuild capital, hence their cutting back on lending, and that’s why the slowing rate of decline in US house prices shouldn’t be seen as a positive, yet.

It’s no wonder the recent Fed survey of senior loan officers revealed a majority of banks were cutting lending for all types of business, and would continue to do so for the rest of this year and into 2009. Simply put, the banks have little money to lend and what they have is being rationed.

In case that’s not enough … the latest Federal Open Market Committee meeting minutes from three weeks ago, released overnight, show that the Fed’s key policy making body agree that the next move in US interest rates will be up, but not yet.

The Fed remains split between inflation hawks and moderates, with many on the Committee still worried about the credit crunch and why it won’t go away. None of the members were worried about growth recovering and causing problems for inflation: its just that inflation remains persistent.

“Although members generally anticipated that the next policy move would likely be a tightening, the timing and extent of any change in policy stance would depend on evolving economic and financial developments,” minutes of the Aug. 5 meeting said.

The Fed left the Federal Funds rate steady on 2% for the second meeting in a row and not many in the markets expect that to change by the end of 2008.

A burgeoning inflation problem? The US consumer price index hit an annual rate of 5.6% in July, while the produce price Index rose at an annual 9.6% rate in the same month. The Fed’s preferred benchmark, the 12-month change in the personal consumption expenditures price index, minus food and energy, has been 2% or more since early 2004.

If US inflation remains elevated for the rest of this year then the potential for a sharper set of rate rises in 2009 will be higher, just at a time when most forecasts have the US economy drifting closer to the shoals of outright recession.

House prices still heading south. The latest S&P Case/Schiller Home Price Index showed that the fall in US house prices was still happening, but the rate of decline was slowing.

But it is still falling, and although several metro areas had rises in the month, others had horrible falls, such as Las Vegas. The positives from the report were fleeting.

The Index showed that US home prices fell a record 15.4% in the second quarter compared with the same quarter of 2007 and the index is now down 18.2% from its peak in the same quarter of 2006.

In the month of June the pace of the decline slowed a tiny bit compared with what happened in May: the 10-city index declined 16.9% year-on-year and the 20-city index was down 15.8%. There is now an 11.2 month supply of existing homes on the market and that’s a big hurdle to be overcome before prices can stabilise and rebound.