Banks should pay for FDIC fund
The banking system is still suffocating under the weight of bad loans, and it’s well known that the FDIC doesn’t have enough cash to deal with the problem.
What to do? According to a plan floated in the New York Times, FDIC may borrow from the banks themselves in order to replenish its Deposit Insurance Fund.
The optics may be good, but don’t be fooled. The plan would be another balance sheet gimmick to paper over losses.
The FDIC itself is throwing cold water on the idea. Andrew Gray, FDIC’s director of public affairs, says that “although this plan is an option, it’s not being given serious consideration.”
That leaves Sheila Bair with two unpopular options to replenish the Deposit Insurance Fund, which had just over $40 billion in reserve at the end of the second quarter.
One approach — the right one — would be to charge special assessments on banks themselves. FDIC insurance is the best marketing tool in American finance, and for too long banks paid next to nothing for it.
The other option is to borrow from taxpayers. Earlier this year the FDIC secured a $400 billion emergency line of credit at Treasury to go with the $100 billion line it already had.
To her credit, Sheila Bair has been very reluctant to tap Treasury. She’d prefer that bank shareholders and creditors absorb the cost of failure. In the meantime, she’s charging banks special assessments to replenish the insurance fund.
Before the end of September, Bair has to decide whether she’ll charge banks another special assessment in the third quarter.
Banks would prefer that she not do so, and have apparently floated a plan to offer themselves as lenders to the FDIC as an alternative.
It’s an accounting gimmick, and a pretty simple one at that. Banks would replenish the Deposit Insurance Fund, but from the asset side of their balance sheet, buying bonds issued by the FDIC, rather than paying large “special” assessments directly out of earnings.
Theoretically, banks themselves would pay back the FDIC’s bonds, but in smaller amounts that FDIC assesses over time. In the meantime, because their capital levels aren’t reduced, banks can continue to lend. More lending will spur “recovery,” and banks will eventually earn their way out of trouble. Or so their argument goes.
The idea that more lending is going to help us recover from a credit binge is itself laughable. But the bigger issue is the size of losses that are festering on bank balance sheets. The losses are so large that normal assessments are unlikely to be able to cover them.
But banks don’t want to admit to their losses. They’d prefer to extend and pretend in order to avoid the kind of wholesale restructuring that is necessary to repair the financial system’s balance sheet.
And in any case this plan most likely wouldn’t spur lending into the real economy. It may actually cause lending to contract.
Right now banks have hundreds of billions of excess reserves parked at the Fed earning an interest rate of just 0.25 percent. Presumably FDIC-backed bonds would pay better.
So besides avoiding the pain of special assessments, banks would have a new, more profitable place to park reserves.
Sheila Bair should ignore such delaying tactics floated by banks and order them to pay more special assessments into the Deposit Insurance Fund.
To emerge from the financial crisis in better shape, we need to shrink the financial sector. An important way to do that is to reduce the return on equity available to bank shareholders. Charging banks appropriate fees for deposit insurance can help achieve that.