Home > bailout, FDIC, financial crisis > Smoke and Mirrors at the FDIC

Smoke and Mirrors at the FDIC

September 30, 2009

” ‘Sheila Bair would take bamboo shoots under her nails before going to Tim Geithner and the Treasury for help,’ said Camden R. Fine, president of the Independent Community Bankers.” — New York Times, Sept 22, 2009

We learn today from the New York Times that the FDIC — the independent government agency that insures your bank accounts — is effectively insolvent. It is going to ask insured banks to prepay three years worth of deposit insurance premiums in order to raise $45 billion to replenish the FDIC insurance fund.

What makes this interesting is that the FDIC is backed by the “full faith and credit” of the US government. In other words, as long as the US government is solvent, your bank accounts are safe. There was no need for Sheila Bair, the head of the FDIC, to ask banks for funds. The notion that the banks will rescue the FDIC is pure theatrics.

There is apparently no interest cost to the loans (details are here), so to the extent the banks forego interest one could say they are subsidizing the FDIC. However,  the notion that this borrowing is not public debt is ludicrous, and it is exactly the sort of accounting fiction that helped cause the crisis. Because the Treasury backstops the FDIC,  prepaid assessments from the banks represent public debt, even if it is off the official balance sheet.

I can’t resist including one other quote from the New York Times article: “Borrowing from healthy banks, instead of the Treasury, has the advantage of keeping this in the familyIt is much better for perceptions than having the fund borrow from somewhere else.” Karen M. Thomas, executive vice president of government relations at the Independent Community Bankers of America. (emphasis added)

Categories: bailout, FDIC, financial crisis
  1. Patrick Conway KSM '76
    October 23, 2009 at 2:27 pm

    The FDIC proposal to collect three years of deposit insurance premiums, in advance, from the banking industry, is a brilliant idea. The banking industry provides the FDIC’s revenues through premiums and this plan will also mean that some banks and thrifts which no doubt will fail in the next three years will have provided some of the funds to pay off the depositors when those institutions fail.

  2. E.J. Donaghey, EMP 50
    October 25, 2009 at 3:35 pm

    Thankfully the FDIC has to maintain a solvent fund. And the member banks must contribute back to the FDIC to ensure solvency. This ensures the financial institutions pay the fund first, before the government has to be called upon.

  3. Robert McDonald
    October 26, 2009 at 11:03 am

    Patrick and E.J., thank you for the feedback. I would ask you to consider this question: suppose that you replaced “FDIC” with “State Farm” (or the insurer of your choice) and “banks” with “homeowners”. Would you feel the same? Would you prepay three years of your homeowners insurance and feel that this was a reasonable response to your insurance company’s inability to meet its current obligations?

    This is an accounting fiction designed to give the appearance that a bankrupt entity — the FDIC — is not bankrupt. This raises at least two issues. First, it is exactly the kind of accounting fiction that pervaded the crisis. Cant’ we start telling the truth, please?

    Second, as my co-blogger Debbie Lucas has pointed out, this accounting fiction could lead to complacency about a serious structural problem. We need policy discussions that start from the (true) premise that the FDIC is bankrupt. We could discuss how to restructure deposit insurance and the FDIC to increase the chance of future solvency.

    The FDIC’s move was applauded by the bankers. Is it any wonder? They’ve just managed to maintain the status quo by cheating on the accounting.

  4. Patrick Conway KSM '76
    October 30, 2009 at 1:18 pm

    The hypothetical substitution of “State Farm” and “homeowner”, for “FDIC” and “bank”, of course, is not even closely relevant or analogous. For one, while “State Farm” may insure the “homeowner”, the “FDIC does not insure “banks”. The FDIC insures depositors, up to the limit of deposit insurance. For another, a homeowner might sell his/her home in the 3 year time frame, thereby not needing the insurance at all. The number of times that a bank has surrendeered or lost its FDIC certificate (except through merger or failure) is infintesimal. And, of course, depositors can (and should) review their deposits (and other business relationships) with their banks on a regular basis.

    There is no “accounting fiction” going on, either. The FDIC has been accounting for its actions properly, unlike, say, Enron or WorldCom, where there was clearly pervasive “accounting fiction” going on. It is true that the DIF (Deposit Insurance Fund) is insolvent. It is also true that, under current law, there is a methodology to address such times as these and the FDIC has made a proposal to do so. It is also true that the FDIC, at least once before, had a similar situation – during the banking crisis of the late 1980’s and early 1990’s. And, the FDIC was able to solve the funding issues of the deposit insurance fund. The problems with the savigns and loans during the 1980’s, of course, are a whole other set of issues.

    There clearly are structural issues within the banking and financial sectors. Since at least the early 1980’s, there have been issues of concentration; “too big to fail” – remember Continental Illinois National Bank and Trust Company of Chicago; the elimination of the Glass-Steagall Act; and the profliferation of various financial instrucments of which no one seems to know or understane the risks involved. Regulators have allowed the concentration by allowing mergers to occur. Sadly, politicians of both parties since at least the Reagan administration have been loathe to seek solutions. We have heard testimony from a former Chairman of the Federal Reserve Board in which he acknowledged that he relied, incorrectly, on thinking that management had the interests of shareholders at heart. We have had a least one former recent Chairman of the FDIC and the head of another federal banking agency do their best to dismantle any effective supervisory role for their agencies. The disappearing act of the SEC during much of the past two decades is another issue.

    We also can’t rely on the leadership of the American Bankers Association, the Community Bankers Associatin or the major financial institutions to provide possible solutions for these systemic problems. They have failed us numerous times (and their senior leaders have frequently gotten rich along the way). Watching/listening to CNBC or the other so-called financial news media is frequently hazardous to everyone’s financial health.

    There are a number of legislative proposals currently afoot which, perhaps, may help address some of these and other relevant issues. Let’s hope so.

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