Don’t worry about the FDIC

By Felix Salmon
August 28, 2009
Rolfe Winkler has a good, detailed snapshot of what's going on at the FDIC. But I'm not nearly as worried about the state of the US deposit-insurance fund as he is. As I've said before, the FDIC can't run out of money. Conceptually, it has simply been faced with a choice up until now -- do you raise money from banks, in deposit insurance premiums, before banks start going bust and need an FDIC bailout, or after? Congress made the decision that is should be the latter, when they barred the FDIC from charging such premiums between 1996 and 2006.

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Rolfe Winkler has a good, detailed snapshot of what’s going on at the FDIC. But I’m not nearly as worried about the state of the US deposit-insurance fund as he is. As I’ve said before, the FDIC can’t run out of money. Conceptually, it has simply been faced with a choice up until now — do you raise money from banks, in deposit insurance premiums, before banks start going bust and need an FDIC bailout, or after? Congress made the decision that is should be the latter, when they barred the FDIC from charging such premiums between 1996 and 2006.

That’s really not much of a problem. As Rolfe shows, now that banks are failing in large numbers, the FDIC is charging insurance premiums again, and will certainly continue to do so until any money it borrows from Treasury is paid back. Its credit line, of up to $500 billion, is more than enough to cope with the bank failures coming down the pike, which means that the only real question is how much of that credit line it will have to draw down, and how long it will take to pay it back.

Rolfe is right that “the deposit insurance fund is tiny compared with the total amount of deposits that are insured” — but it doesn’t need to be anything but tiny, because if push comes to shove, there’s essentially unlimited liquidity just sitting there for the asking. It’s the government which is insuring deposits: the FDIC is simply the entity created by the government to administer the deposit-insurance program, and the size of the fund is a way of keeping score and making sure that over the long term the US banking system pays at least as much in insurance premiums as the FDIC spends in bailing out failed banks.

What’s more, even if the 2006-7 vintage of loans will continue to underperform for years, that doesn’t mean, as Rolfe seems to think it means, that there will be a large number of FDIC bank bailouts for years as well. Banks are inherently profitable institutions, and with interest rates at zero they’re inherently very profitable institutions. Loan losses can and will to a large degree be covered by operating profits, and/or the raising of new capital. Remember that depositors are at the very top of the capital structure: not just stockholders but bondholders too need to be wiped out before the FDIC takes any losses. Look at the recent rally in the prices of both bank stocks and bank bonds: it means (a) that the market is pricing in a much lower risk of failure at such institutions, and (b) that it’s much easier for those banks to raise new money if they need to.

So yes, the FDIC insurance fund might go for a little while with a negative balance. But that’s nothing to lose any sleep over. The FDIC deficit, unlike the national debt, is sure to be paid off, in full, over time. And insofar as the government needs to loan money to the FDIC, it will end up making a small profit on that loan. If only the same could be said for most other government spending!

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Comments
14 comments so far

Making the assumption that dozens of more banks will fail and the FDIC fund will become depleted, in the event the FDIC Fund chooses to draw down on its line of credit with the U.S. Treasury, where does the U.S. Treasury derive its funds from? The bond market? From foreign investors. So, given that the line of credit is derived from more Federal debt, the FDIC backstop comes from the backstop of foreigners willing to lend the U.S. money. To say that the FDIC can increase the fees banks pay to support the FDIC fund is fine, but there is a limited supply of capital available. If you take it out of one pigeon hole you have to put more in the other. Ultimately all the pigeon holes have to be covered and they are curently covered by the Federal debt which is covered by foreign investors who buy U.S. bonds. So the FDIC is no longer backstopped by the American people, it is backstopped by foreign investors. It is amazing that the people at the FDIC repeat the same line over and over again: “no one has ever lost a penny.” That may be largely true, but moving forward are they speaking the entire story or are they speaking in a “gov-speak” vacuum, repeating the FDIC lingo which they are told to repeat to the American public. It is not the FDIC’s problem to manage the deficit, true; but, they are doing a disservice to the American depositor when they speak in a vacuum. Shelia Bair should be screaming her head off at Geithner, the President and the U.S. Congress to get their act in order before the American depositors get very nervous about the safety and soundness of the American depositary system. These monies represent the work of millions of hardworking American savers who lend their money to the American banking system so that the banks can make good loans to good citizens and good corporations. Isn’t that the foundation the American banking system is suppossed to be built upon?

Posted by Ric | Report as abusive

are you sure that the fdic account has an overdraft protection feature? i think someone might have got their account password and turned it off for a laugh.

Posted by q | Report as abusive

Felix,

This is not OK – rather, the FDIC’s premium is yet another tax on American savings. The premium comes out of taxpayers’ accounts, the losses in failed banks are paid by taxpayers’ taxes, while the entire time the reason for the failures are the deliberately poor decisions made by management of the failed banks because they have no personal liability.

I want to see bankers in jail. Make bad loans just to skim the origination fee? You’re serving time at Sing Sing.

Stop sugarcoating the issue, Felix: The reason the FDIC exists is to keep the American people quiet while the bankers continue the greatest transfer of wealth in the history of mankind.

Posted by Unsympathetic | Report as abusive

@Unsympathetic

Feel free to withdraw your money from any FDIC-insured bank. That would solve your problem of paying the FDIC premium (which likely is felt through lower rates paid on your deposits, anyway).

Posted by ab | Report as abusive

“Remember that depositors are at the very top of the capital structure: not just stockholders but bondholders too need to be wiped out before the FDIC takes any losses.”

This is not generally speaking true. Secured creditors get paid before depositors at FDIC backed institutions.

See for example this opinion from Smith and other lawyers at Bingham:
“The FDIC will generally recognize a perfected security interest. The FDIC will not seek to avoid any perfected security interest that meets the following conditions: 1) the security agreement was entered into in the ordinary course of business; 2) the secured obligation represents a bona fide and arm’s length transaction; 3) the secured creditor is not an insider or affiliate of the depositary institution; 4) the security interest was granted for adequate consideration; and 5) the security interest is evidenced in a writing that was approved by the board of directors of the depository institution or its loan committee, and remains an official record of the depository institution.”
http://www.insol.org/emailer/FEB2009_dow nloads/Highlight%20Article%20-%20Februar y%202009.DOC

“Remember that depositors are at the very top of the capital structure: not just stockholders but bondholders too need to be wiped out before the FDIC takes any losses.”

Please tell that one to GM shareholders.
This is Amerika…..laws are meant to be changed…daily!!

Posted by kirk | Report as abusive

What is this sudden case of fiscal conservatism about tax money? Want to know a bigger waste of tax money? Fighting wars! Building F22 bombers! Incarcerating non-violent offenders. Look high spending was not invented in the last 8 months… so its not the dollar amount that gets spent that bugs you … its what it gets spent on. Conservatives never objected to any spending on conservative ideas. This FDIC is a non-issue. As the author said they will raise bank premiums to get the money back. And besides, banks just print the money they loan anyway … so whats the big deal? Moreover, turn off Glen Beck! A nationwide contraction after 8 years of economic boom built on easy credit doesn’t mean there is a grand conspiracy of high level blacks, gays, and jews bent on taking over free enterprise and destroying the moral fabric of America. That’s like drinking yourself blind on a bottle of cheap Tequila then suspecting that your hangover is the result of malicious poisoning. They didn’t have to … you where all to willing to poison yourself. The empty bottle should be all the proof you need.

Posted by Juls | Report as abusive

You are making too much of the separateness of the FDIC from the Treasury. If mid-sized banks must be bailed out en masse that would add to the public funding needs and increase the chances for inflation, higher taxes and a weaker USD. The FDIC deficit should be viewed as essentially adding to the national debt.

Posted by Ian | Report as abusive

@oneeyedman

Felix is still correct. Bondholders are unsecured creditors, so junior to the secured lenders you’re referring to.

Posted by ab | Report as abusive

While the fund might not go bust, there is a deadweight cost to society if the FDIC is not closing failed banks quickly enough because they do not want to draw on the Treasury line of credit. At 5 per week, the FDIC is closing around 60 per quarter, and yet the problem bank list is increasing sequentially month after month by a considerable amount.

Posted by Sam | Report as abusive

The FDIC is basically okay (at least for now) because they do have authority to borrow and levy assessments on the remaining banks. And, yes, the priority of claimants is secured creditors, depositors, everyone else, which also helps.

A real problem, however, is that the bankers who didn’t go to the party get to pay for those who did. Veteran bankers have now been through two cycles where they picked up the tab (their deposit insurance premiums pre-1996 were very substantial). More of them will not resist temptation the next time things start to get nutty.

Posted by Eric | Report as abusive

Yep let’s “Get the government out of my life” unless of course it impacts me in negative manner. So use the taxpayer money to pay off FDIC losers where their management did very well..Kind of a mini Wall St bailout at your local level, even down to big boys getting the big dollars as a reward for failing. However as in Modoff scam, the “investors” that were getting “good deals” never asked why, how or who is doing it? Now have Modoff-and Wall St fiasco combined..
Time we jail a few of the bankers and others, as this old “well we did not know it would or did not really read the” etc etc is about over. I might add that “Customers” need to get a bit more vulnerable to fix the mess, a bit more knowledgeable, and question well and listen better. Be it FDIC or WS or bailouts or CH11, time to share the risks amongst us all as this is not much more then a template for “get good deal, and if it smells a bit, not to worry, gov will bail you out one way or other and big boys rewarded selves and now reloading to shoot off other foot and collect again.
So let’s charge the banks for FDIC, let’s charge WS for each transaction to pay off the bills and let’s put the issue right back in the people’s lap if the bill ends up there.
We have become the most economic hypocrites on the planet, all is “wow look at what a ROI and if it blows out as to good to be true, well Uncle Sugar will cover”. We howl about “Capitalism makes USA” but in truth we practice rather hypocritical version of make money off paper, more a like “Robber Baron Capitalism”. We do NOT invest profits back into companies, plants, workers or R&D and etc, instead “Stockholder is the reason we are here” which is NOT pure capitalism, nor is shuffling paper about and assigning it some arbitrary value.. as USA is now learning,and FDIC is just perpetuating that myth, as is stock markets under current operations.
None might want to admit, but China is closer to REAL capitalism then USA has been lately, the protect their industry, people and currency and are not above jailing or shooting the corrupted in any job, gov or private. Theyh invest back and if an import sells well there, they simply tell the MFG, build it here or else and we will own 50% plus 1/10th or more. Half the profits and all the technology stays in China. Doubt their power, a H3 Hummer export is $130K in Shanghi, same built is $30K or less in USA.. and now they may own Hummer, same for Buicks, they love them.. and they simple told GM build them here or else.. and none asked what “else was”. So asa China takes over, it will be like Japan and USA quality, they listened to OUR expert, Dr D and we lost, same on Capitalism, they read the books, we had lawyer look for loopholes and bought congress to legitimize such.
Funds for FDIC from Treasury loans, no way.. same for WS, time we get off the “super welfare” and if it impacts the citizens, well now maybe they will just start to take an interest and learn a bit and demand a few head roll, not a few more get bonus.. FDIC charge the banker and jail a few.. as times need radical changes.. perhaps along with all else used by USA that is imported from China, we import their Capitalism?

Posted by Charles | Report as abusive

@ab
“depositors are at the very top of the capital structure”
That is what I wanted to imply was not true.

“stockholders but bondholders too need to be wiped out before the FDIC takes any losses”
The second clause is also not true if you are talking about something like debt issued by an SPV, which is exactly the mechanism by which a bank issues debt that is secured.

debt issued by a SPV is usually issued to the public as trust preferred stock which is not the same as secured debt. Trust Preferred stock would have the same status as subordinated debt in a holding company in the event of a deposit failure, ie, worthless.

Posted by renholder | Report as abusive
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