Rolfe Winkler

I was heading out for Thanksgiving vacation when FDIC released the quarterly banking profile, so I wasn’t able to update an important chart: Total Insured Deposits, Unofficially…..

(ht Stephen Culp)

When the world was falling apart, FDIC increased deposit insurance limits….to $250,000 for individual non-retirement accounts and unlimited for business transaction accounts. But those increases were treated as “temporary” and so left out of FDIC’s total.

Since the $250,000 limit was extended to 2013 — decidedly not “temporary” — FDIC started collecting that data from its member banks. The data was published for the first time in Q3.

So in Q3, the official figure — which includes $250k limits — jumped from $4.8 trillion to $5.3 trillion. Throw in the $761 billion insured by the transaction account guarantee program and you’ve got a total of $6.1 trillion of insured deposits. Compare to Q3 ’08. Back then, before all the emergency measures, the total was $4.5 trillion. So the increases added $1.6 trillion, or 34%, to the total.*

I’ve juxtaposed that with the reserve balance on the Deposit Insurance Fund. It’s now negative, though that doesn’t mean FDIC is out of cash. And they’ve got another $45 billion coming this quarter, but for accounting reasons the reserve will still be listed as negative.**

But even with that cash coming in, the FDIC’s resources are under a lot of pressure. With 552 banks and $346 billion in assets on the “problem” list, FDIC will struggle to pay its bills.

Sheila will have to increase assessments on banks at some point, or start drawing on FDIC’s credit line at Treasury…

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*The transaction account guarantee program is scheduled to expire in June of next year.

**The $45 billion to be collected isn’t a “special” assessment, it’s front-loading three years of “regular” assessments. The distinction is crucial. Since these assessments are regular, banks can treat them as a prepaid expense on their balance sheet, i.e. as an asset to be drawn down quarterly. That means they only have to draw down capital quarterly. The flip side is that FDIC can’t count the $45 billion as revenue. It has to treat it as “deferred revenue.” Deferred revenue is a liability on the balance sheet. Normally an assessment counts as revenue, which is added to the DIF’s equity balance.

Don’t you just love accounting?

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.

There’s good news and bad news in the FDIC’s quarterly profile of the banking sector. The good news is that FDIC has more resources than you think to handle the problem banks on its radar. The bad news is that the too-big-to-fail banks aren’t on it.

The balance in the FDIC’s deposit insurance fund ended the quarter at $10.4 billion — its lowest since the savings and loan debacle — but it isn’t the only security blanket protecting insured depositors. The agency also has a “contingent loss reserve.”

If you add the loss reserve to the deposit insurance fund balance, the FDIC’s total resources were $42 billion at the end of the second quarter. Despite 24 bank failures during the quarter, that total actually increased by half a billion dollars.

How could that be? The biggest reason is that the FDIC is finally getting serious about charging premiums for the insurance it provides. Member banks were charged $9.1 billion to replenish the fund last quarter. That’s up from $2.6 billion in the first quarter and $640 million a year ago.

(Click chart to enlarge in new window)

A similar amount may be raised this quarter if the agency charges banks another “special assessment.” While that decision won’t be made till next month, it looks likely. That’s great news for taxpayers who would otherwise have to plug the hole if the FDIC runs out of money.

Banks complain that special assessments put too much pressure on them at a tough time. But it’s their own fault the deposit insurance fund is running so low.

According to a Boston Globe article by Michael Kranish earlier this year, about 95 percent of banks paid nothing for their deposit insurance from 1996-2006. But that wasn’t FDIC’s fault; they were prevented by law from charging premiums. Congress didn’t think it was necessary. Oops.

So the deposit insurance fund will be under pressure for some time. FDIC’s problem bank list grew to 416 at the end of last quarter. These banks have $300 billion of assets.

In total, FDIC estimates the banking sector is wrestling with $332 billion worth of loans and leases on which borrowers have stopped making payments. That excludes hundreds of billions worth of underwater loans that may be current now but will ultimately default. Many banks, including the largest ones, are likely to struggle for some time.

(Click chart to enlarge in new window)

And that’s the bigger story here. Citigroup and Bank of America have received hundreds of billions of dollars of government support, but, precisely because of that support, they’re not on the FDIC’s list. Adding them to it would multiply total problem assets 10 times, to $3 trillion.

Overall, the deposit insurance fund is tiny compared with the total amount of deposits that are insured. The official total is $4.8 trillion, but that excludes “temporary” increases in deposit insurance instituted last fall.

One program, which increased insurance limits to $250,000 for individuals, now backs $725 billion of deposits. Earlier this year it was extended to 2013. The other program, which provides unlimited insurance coverage for transaction accounts, backs $736 billion of deposits. On Wednesday, that program was extended through June of next year.

Add those amounts to the official figure and you have the real total: $6.3 trillion, huge relative to the resources of the insurance fund.

(Click chart to enlarge in new window)

Asset prices aren’t going back to their highs of 2006-2007, so loans held against them will be generating losses for years. The FDIC may raise enough cash from banks to fund depositor losses in small and medium-sized banks, but it is clear that the biggest banks are far too large for them to handle.

As a result, the government’s emergency rescue measures aren’t going away for a while. And taxpayers should expect to be writing fat bailout checks to the financial system for years to come.