FDIC tries another gimmick

September 29, 2009

In the latest government gimmick to protect bank capital, the FDIC plans to replenish its Deposit Insurance Fund by front-loading regular premiums in lieu of another “special assessment.”

The good news is that the fund gets replenished and taxpayers don’t foot the bill. The bad news is that Sheila Bair is missing a great opportunity to shrink the financial sector.

Under a proposal released by the FDIC, banks would prepay three-and-a quarter years of regular assessments on December 30, $45 billion in total.

The gimmick is how that $45 billion will be treated on balance sheets — as an asset that won’t drain capital, not all at once anyway.

Because the funds were already scheduled to be collected, banks will be able to treat this assessment as a prepaid expense on the asset side of the balance sheet. In other words, the banks will pay the cash today but will reflect it in earnings over the next three years.

Had Bair instead decided to charge another “special” assessment, the hit to earnings would have come up front.

Hitting earnings means reducing bank capital by a like amount and reducing lending a lot more. That’s because banks lend money based on a multiple of their capital — at a ratio of 25 to 1 if one uses tangible common equity in the denominator. So reducing earnings through special assessments has an outsized impact on banks’ ability to lend.

Is that really a bad thing? We’re told that without “more lending” the economy can’t recover. But the economy is still saddled by huge amounts of debt. More lending provides the temporary illusion of growth — propping up asset prices and industries dependent on credit — but in the end only adds to our burden.

In any case, we know the financial sector has grown too large relative to the rest of the economy. If we’re serious about shrinking it, that means less lending. There are no two ways about it.

“Assessments should hit earnings and reduce lending today,” says Martin Weiss, president of Weiss Research Inc, an investing consulting firm. “Gimmicks like this will backfire.”

To be sure, the proposal isn’t the worst that could have been expected. The FDIC might have chosen to borrow from Treasury or from banks themselves. It’s far better to have banks pay directly. This avoids moral hazard by making those who benefit from the Deposit Insurance Fund responsible for its solvency.

Still, given Bair’s desire to shrink the biggest banks, it’s a shame that she’s willing to sheath her sharpest weapon.

3 comments

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

Why not treat it as the prepaid expense that it appears to be?

Posted by ML Reader | Report as abusive

con’d
And reduce Liabilities annually, being an overhead expense; the prepaid expense is clearly not a source of income.

Posted by ML Reader | Report as abusive

So they pull forward $45B but will use it all in less than a year on upcoming bank foreclosures! Game the citizens into thinking it’s just about over.

How many banks do you think are going to fail over the next 4 years? What do you think the FDIC will have to pay out? Has the FDIC been anywhere close to honest on the expense of those already closed?

Honestly and integrity are completely missing in true discussions with the citizens (taxpayers), imo.

Posted by Bob | Report as abusive