The Temporary Problem
— Rolfe Winkler is a Reuters columnist. The views expressed are his own —
NEW YORK, June 25 (Reuters) – “Nothing is so permanent as a temporary government program,” Milton Friedman said. That’s the danger of the financial bailout programs, as officials hesitate over whether to start taking them down. The larger risk is that not removing them will inflate a bigger credit bubble.
One agency, the Federal Deposit Insurance Corporation, has now taken a step in the right direction, proposing two alternatives for “successfully concluding” one rescue facility, the transaction account guarantee program, or TAG. But the FDIC has much more work to do.
Since October, the FDIC has had three “temporary” guarantee programs to stabilize the banking system. Two were higher limits for deposit accounts — $250,000 for individual non-retirement accounts and a new unlimited guarantee for certain transaction accounts. The third was its Debt Guarantee Program (DGP), which allows banks to issue FDIC-guaranteed debt.
This essentially turned participating banks into wards of the state, in the manner of Fannie and Freddie. No longer was FDIC merely in the business of protecting depositors; now it explicitly backs some bank creditors as well.
Between the two deposit facilities, FDIC now backs $6.26 trillion, a figure that is 30 percent higher than the official total of $4.83 trillion. The official figure excludes the two “temporary” increases in deposit insurance. As of March 31, the TAG program added $700 billion and the increase to $250,000 added approximately $725 billion.
For its part, the Debt Guarantee Program added another $346 billion of potential liabilities as of May 31.
Underneath this pile of risk sits FDIC’s very meager resources, approximately $50 billion at the end of the first quarter if you include reserves taken against estimated future losses. A large chunk of these reserves will disappear as bank failures mount. Estimated losses for the 40 banks that have failed so far in 2009 add up to $10.2 billion. Acting responsibly, FDIC has scheduled a special assessment on banks to replenish the fund, but additional bank failures are likely to eat through that amount quickly.
Last month, Congress extended the $250,000 limit to 2013. Having been made effectively permanent, this program will be counted among the official total for insured deposits beginning in late November. But the other two programs, the DGP and TAG, are still set to expire. And on Tuesday this week, FDIC moved a step closer to running out the clock on TAG.
Under Alternative A, TAG would be allowed to expire as scheduled, on December 31, with participating banks paying, in effect, insurance premiums of 0.1 percent of the amount insured through that date. Under Alternative B, TAG would be extended through June of 2010, but banks would see their insurance premiums rise to 0.25 percent.
By raising premiums, FDIC would be encouraging banks to opt out of the program before its scheduled termination. Easing onto the brakes as it were.
The sooner these programs go away, the better. Offering essentially free deposit insurance, FDIC grossly distorts investor incentives. Seeking refuge from financial Armageddon, investors quickly run to FDIC-insured banks, even ones close to insolvency if they offer high interest rates.
FDIC is aware of this, which is why they want to wind down these programs. Still, that’s risky. Will removing them pull the rug out from under the financial system? This is the same question facing Ben Bernanke and Tim Geithner as they plot their “exit strategies.” Removing these programs might indeed cause panic. But that’s a bad argument in favor of maintaining them.
A credit bubble is not a stable foundation on which to build an economy. Inflated FDIC deposit guarantees — along with runaway Fed printing and incremental borrowing from the government — serve only to reflate the credit bubble that just imploded.
Good rescue facilities should be like methadone clinics, offering replacement therapy that eases addicts off the junk. What isn’t helpful, and only sows the seeds of the next collapse, is making rescue facilities permanent.