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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