The FDIC is nearly out of cash, the victim of almost a hundred bank failures this year and a few particularly large ones last year. Now, that shouldn’t be too big of a problem (it may be a symptom of a problem) in and of itself; after all, the FDIC is a government agency, and the Federal government is still solvent. As Sheila Blair put it in the dark days of March:
To be sure, we won’t run out of money. We’re 100 percent backed by the full faith and credit of the United States Government. No depositor has ever lost a penny on an insured deposit. And that is not going to change.
The only detail to be worked out is exactly how the FDIC plans on funding the shortfall to its fund:
Senior regulators say they are seriously considering a plan to have the nation’s healthy banks lend billions of dollars to rescue the insurance fund that protects bank depositors. That would enable the fund, which is rapidly running out of money because of a wave of bank failures, to continue to rescue the sickest banks.
It is important to include the adverb “seriously,” because otherwise you might be tempted to think “yeah, I’m sure they talked about it between the sixth and seventh beer while watching the Redskins-Rams disaster.”
The plan, to put it in plain language, makes no sense.
Why would the FDIC borrow at all? The FDIC – the Federal Deposit Insurance Corporation – is funded by a levy charged to all banks. When the insurance fund runs low, the banks have a supplemental levy. It is the banks’ obligation to keep the FDIC fund topped up.
If the fear were that the FDIC needed money suddenly, before a levy on the banking industry could be processed, not only can the FDIC borrow directly from the Treasury, home of the lowest dollar-denominated cost of capital going, the banks from whom the FDIC would be borrowing are already themselves wards of the Treasury. Why would anyone possibly want to create a middleman?
One of Taunter’s Tips is that when you see a government action that makes no damn sense for the government, don’t assume it is being done for the government’s benefit. Sometimes the people who serve in the government have very different incentives from the government as a whole:
The Federal Deposit Insurance Corporation, which oversees the fund, is said to be reluctant to use its authority to borrow from the Treasury.
Under the law, the F.D.I.C. would not need permission from the Treasury to tap into a credit line of up to $100 billion. But such a step is said to be unpalatable to Sheila C. Bair, the agency chairwoman whose relations with the Treasury secretary, Timothy F. Geithner, have been strained.
The FDIC is not going to borrow directly from the Treasury because Sheila Blair does not want to be beholden to Tim Geithner. Way to serve the national interest, Sheila. Oh, and there’s one other party who really likes the idea of the FDIC borrowing from the banks: the banks.
When the FDIC assesses a levy to the banks, it directly hits the banks’ cash and equity. The banks don’t like having their equity hit when they have been running around telling the world that everything is fine and they are ready to begin paying people again. When the FDIC borrows from the banks, the lending banks get an asset in exchange for their cash – a government bond. The interest and ultimately the principal is repaid by the banking industry as a whole, but it allows the banks to float their needs for a period of time.
Furthermore, the lending banks will be the banks deemed “healthy.” Once the deposit insurance fund gets in the habit of borrowing from these banks, it damn well cannot take a hard line with them – even if the banks no longer seem so healthy. Not only does the FDIC rely on the bank, it has something even more valuable in DC invested: credibility. If Sheila Blair borrows from First National Bank of Health, and FNBH fails, she’s going to look like a fool. It would be worse than going to Tim Geithner for money. So Sheila is going to do absolutely everything she can to keep FNBH in operation. Consider this TBTF insurance; participation is a mechanism for any bank to get itself regulatory cover.
Over the past year we have seen a steady trend in the direction of the socialization of risk and the privatization of reward. Some of this was a deliberate policy choice: Summers & Co. decided that they did not want the banks to fail, and with that off the table, the only way to return to normal economic times was to funnel profits to them until they were well-capitalized. But a great deal of it was simply a change in perspective. As the bailout went on and expanded and metastasized, the constraints to any individual act of tunneling diminished; why not make friends with the people you regulate, when no one outside the family is willing to do anything and everyone inside the family expects it?
We can have all the regulatory and institutional systems we want; if the people in power refuse to act for the public good, the public good will not be served. We have always been somewhere in the middle of the corruption world – far dirtier than the small nations of northern Europe, but cleaner than the global South. Each of these little chips drags us farther from where we ought to be.
HAVE WE LANDED IN BRAZIL?
(The country created by Terry Gilliam.)
Let’s see if I understand this – last year, banks collapsed massively, so Treasury Secretary Paulson said we needed to funnel over massive amounts of money (nearly a trillion was his guess-timate at the time) to save the economy.
The economy tanked anyway. (Would have been worse without TARP, I guess. Certainly no bonuses would have been paid to bankers.)
Now banks are continuing to fail in rather alarming numbers, and the FDIC insurance fund is nearly tapped out.
So we are now considering the notion of borrowing money from banks (who pay a fee to stock this fund anyway), instead of using an established line of credit at Treasury, to bail out other banks.
Why borrow from banks? What’s wrong with increasing the levy on banks, which brings with it the suggestion that risky banking practices might be costly to banks, rather than profit centers?
Puzzling, all of it. Having the FDIC borrow from banks to insure the deposits of other banks is an idea that seems perfect for the WTF category of ideas.
All things being equal, I sure as hell trust Sheila Bair more than Little Timmy G.
Anyway, this is all a result of Obama’s early decision to coddle the bankers instead of taking decisive action. There is no way the public will support another banker bailout even though we all know they’re broke. So instead, you get shenanigans like this. It’s just moving (our) money around, and the only people getting rich are the folks that caused the problem in the 1st place.
What I think will happen is this: Eventually, the system will seize up again. Either by some catastrophic event or simple inertia. We’ll have another sudden ‘credit crunch’. But this time, Obama will be have to address the real problem. The only way he’ll be able to shake money loose from the public will be BIG penalties on the banking cartel. The big boys will finally have to take their medicine. Namely, Citi, Golden Sacks and JP Morgan will have to be declared insolvent and broken up. THAT is what Sheila Bair should be doing. Hopefully, the 1930s banking restrictions will be re-implemented and updated.
Therefore, I completely agree with: “if the people in power refuse to act for the public good, the public good will not be served.” The proof in the pudding will be when the next banking “crisis” hits and the Obama administration’s actions afterword.
We don’t “all know” the banks are broke; the banks are trading as though they were in perfect health, so at least some people are willing to invest on the basis that the problems are ancient history.
“We don’t “all know” the banks are broke”
Then they had better learn elementary arithmetic. When liabilities exceed assets, I don’t know what else to call it. Further, there is substantial evidence that it is the ‘plunge protection team’ that is propping up bank shares. Insider selling has never been higher. Would you recommend buying C, GS or JPM at this time?
I did not say that I was one of these people.
I would observe that one asset that does not appear on a balance sheet but is very real is the government’s willingness to inject whatever capital might be required to provide value to the shareholders.
To take the most extreme example, consider AIG; the government has injected $180bn+ into the company, but has left a public stub outstanding. That public stub does not trade on any sort of analysis of the enterprise value of the company; it trades on the assumption that the government will do something to prevent AIG from filing Chapter 11, and that something will have some value to the common shareholders.
And I didn’t say you did. Relax!
Good argument, but it leaves out a central fact; banks invent cash money out of thin air by the process of making loans. Making loans to the banks’ customers – via the FDIC – is a good thing, not a Monty Python good thing.
Why not allow the banks to create free money to support their customers?
http://economic-undertow.blogspot.com/2009/09/more-fdic-follies.html
And here I thought we were supposed to be reducing bank leverage, not increasing it…
As for the criticism in the attached post that I would prefer to tax taxpayers’ grandchildren, no, I would prefer to tax bank equity holders; I propose the Treasury merely as a short-term funding source in the event that a temporary run put the FDIC in danger. I would expect that borrowing to be repaid promptly with a special assessment on the banks.
Bank failures and depositor risk is less abstract than the (added) leverage which is comparatively small.
In the same perfect world where there are sufficient funds in the FDIC account to bail depositors, there would be fewer bank failures in the first place. Up to now, the (customers of) the solvent banks are paying the bailouts @ the failures of the insolvent; (the FDIC can be faulted for part of the added cost but that is beside the point of this discussion).
The bank equtiy holders are likely beyond the reach of the FDIC, the depositors are on the hook, the banks themselves are just conduits. If a bank is in good enough shape – through extending leverage and collecting interest – they have the resources to pay the extra assessment. What of the other banks that aren’t in good shape? Eventually they fail and require depositor bailouts in turn. After awhile, the straws on the backs add up.
As for the Treasury being a ‘temporary funding source’ in the even of some exigency: what you are suggesting is cojectural and out of context of the Bair proposal. A serious run and the entire administration will jump in with both feet.
You are observant, not many others have caught the rivalry between Bair & Geithner. Bair wanted to be the Treasury Secretary. She’s competent whereas Geithner is a worthless Goldman- Sachs sock puppet.
Get rid of Geither, make Bair the SecTreas and put Volcker in charge of economic policy and you’ve got a deal! FDIC can raid the Treasury.
While you are at it, get rid of Bernanke.
Having said that, if push comes to shove, Bair will bite the bullet and take Treasury cash rather than allow a depositor to lose their account. I can’t say the same thing about Geithner, Bernanke, Summers or any of the others.
OT: Oh, before I forget, you should take a look over at Naked Capitalism today and check out professor Black’s post on “exiting” businesses. (He didn’t call them that. I just like your term better.) fyi