The FDIC’s dilemma
by Jon Aldrich
Just about everyone is familiar with the Federal Deposit Insurance Corporation (FDIC), the federal agency that insures against the loss of deposit accounts (such as checking and savings) in the event of a bank failure. (For a brief history of the FDIC go here http://www.fdic.gov/bank/historical/brief/brhist.pdf . The FDIC insurance coverage is currently $250,000 per account holder per insured bank for deposit accounts, and $250,000 for certain retirement accounts deposited at FDIC insured banks. (FDIC coverage will revert to $100,000 on January 1, 2014, unless current law is amended) These insurance limits include principal and accrued interest. This coverage does not apply to money invested in stocks, bonds, mutual funds, life insurance policies, annuities, municipal securities, and money market funds, even if these investments were bought from an insured bank.
What many people may not know is where the FDIC gets the money it uses to pay claims when an insured bank fails. Each quarter, banks and thrifts are assessed an amount based on a formula that takes into account the total insured assets on deposit at the institution, and the “risk category” of the institution. The FDIC assesses higher rates on those institutions that it believes pose greater risks to the insurance fund. The FDIC invests the assessments it receives in U.S. Treasury securities, to provide some additional earnings. (Not much lately!) As recently as March of 2008, there was about $53 billion in the fund to cover insured deposits at failed banks. But after the failure of over 120 banks so far in 2009, that fund is now over $8.2 billion in the hole. It gets worse. The FDIC recently raised its estimate of the cost of bank failures through 2013 from $70 billion to $100 billion. Obviously, the FDIC is forecasting a continuing environment of bank failures. Right now, there are over 550 banks on the FDIC’s official problem bank list.
The only other time in history that the FDIC reported a negative fund balance was during the last banking crisis in the late 1980s and early 1990s. On December 31, 1991, the FDIC reported a negative fund balance of approximately $7.0 billion after setting aside a $16.3 billion reserve for future failures. The fund stayed in the red for five quarters, until March 31, 1993, when the fund balance was approximately $1.2 billion.
What can be done to rescue the FDIC fund? Some steps have already been taken, and others are planned:
• Special Assessment – In May of this year, the FDIC collected a special assessment from member banks of five cents of every $100 of assets on deposit, excluding Tier 1 capital, which raised $11 billion in the 2nd Quarter of 2009. But, as you can see above, that money is already gone.
• Prepayment of Assessments – The FDIC has required all member banks to prepay their premiums for the next 3 years (2010-2012). The FDIC estimates that it will collect approximately $45 billion from prepaid assessments. The payments will come from the industry’s substantial liquid reserve balances, which as of June 30, totaled more than $1.3 trillion, or 22 percent more than a year ago. Unlike the special assessment that the FDIC collected on September 30, this prepayment will not immediately affect bank earnings. Banks will book the payments at the end of each quarter.
• Borrow money from the Treasury – The Helping Families Save Their Home Act, enacted on May 20, 2009, permanently increased the Deposit Insurance Fund’s line of credit with the U.S. Treasury from $30 billion to $100 billion, and further increased it to $500 billion through the end of 2010 if certain conditions are met. The FDIC views this as a last resort, but it is looking more likely that this option will have to be utilized. If the FDIC is forced to dip into this line of credit, there will most certainly be a price to pay. Since Uncle Sam doesn’t have any extra money sitting around, more dollars will have to be printed and more debt will have to be sold in order to fund the loan to the FDIC. This will further add to the gigantic cost of the government bailouts, and further devalue the ever-weakening U.S. Dollar.
One way or another, the government will find a way to keep the FDIC insurance fund solvent and protect investors deposits. Not doing so would likely lead to a re-play of the 1930’s era bank runs and cause another great depression.
Unfortunately, any solution is going to have some negative ramifications, two of which might be the further weakening the banks and/or the continuing devaluation of the Dollar.