FDIC Is Broke, Taxpayers at Risk, Bair Muses

Bloomberg (Link) - Jonathan Weil (September 24, 2009)

The FDIC�s insurance fund is going broke, and Sheila Bair is wondering aloud about how to replenish it. This means one thing for taxpayers: Watch your wallets.

Bair, the Federal Deposit Insurance Corp.�s chairman since 2006, says the agency has many options. One way to boost its coffers, now running low after a surge in bank failures, would be to charge banks higher premiums. It could make them pay future assessments in advance. Alternatively, the FDIC could borrow money from the banks it regulates. Or it could borrow from the Treasury, where it has a $500 billion line of credit.

�There�s a philosophical question about the Treasury credit line, whether that is there for losses that we know we will have, or whether it�s there for unexpected emergencies,� Bair said Sept. 18 at a Georgetown University conference in Washington. �This is really a debate for Washington and for banks,� she added.

Far be it from me to intrude on this closed-circuit conversation. The question Bair posed should be a no-brainer. Borrowing taxpayer money to bail out the FDIC should be an option of last resort reserved for unforeseen emergencies. That the agency would consider this now underscores how dire its financial condition has become.

Whatever path it chooses, we shouldn�t lose sight of this: The FDIC has been mismanaged, and its credibility as a regulator is in tatters. Its insurance fund wouldn�t be in this position today if the agency had been run well.

Flipping Out

Bair�s comments last week reminded me of a year-old article by Bloomberg News reporter David Evans, who wrote that the FDIC soon could run out of money and might need a taxpayer bailout by the Treasury Department. Most revealing was the FDIC�s reaction. It flipped out.

The day the story ran, the agency released an open letter to Bloomberg from a spokesman, Andrew Gray. He said the piece �does a serious disservice to your organization and your readers by painting a skewed picture of the FDIC insurance fund.�

Gray said �the insurance fund is in a strong financial position to weather a significant upsurge in bank failures� and that he did not foresee �that taxpayers may have to foot the bill for a �bailout.�� He said the fund �is 100 percent industry backed,� and �our ability to raise premiums essentially means that the capital of the entire banking industry -- that�s $1.3 trillion -- is available for support.�

Tapping Capital

If needed, he said, the FDIC could borrow from the Treasury, noting that the funds by law would have to �be paid back from industry assessments.� He stressed the FDIC had done this only once. It happened in the early 1990s, and the money was repaid with interest in less than two years.

Gray told me this week that he stands by his earlier remarks. His notion that the FDIC could tap the capital of the entire banking industry still baffles me. While hypothetically this might be true, I doubt all $1.3 trillion would be available in any practical sense.

The FDIC said its insurance fund�s assets exceeded liabilities by $10.4 billion, a mere 0.22 percent of insured deposits, as of June 30. The liabilities included $32 billion of reserves the FDIC had set aside to cover bank failures that it believed were likely to occur during the next 12 months.

As recently as March 31, 2008, the FDIC had earmarked just $583 million of reserves for future failures. This was after the rest of the financial world already knew we were in a crisis. By the end of 2008, it had boosted these reserves to $24 billion.

Projected Losses

The balance-sheet reserves don�t capture all the insurance fund�s anticipated losses. In May, the FDIC said it was projecting $70 billion of losses during the next five years due to bank failures. The agency said it expects most of those collapses to occur in 2009 and 2010.

The FDIC�s problem is that it didn�t collect enough revenue over the years to cover today�s losses. The blame lies partly with Congress. Until the law was changed in 2006, the FDIC was barred from charging premiums to banks that it classified as well-capitalized and well-managed. Consequently, the vast majority of banks weren�t paying anything for deposit insurance.

Of course, we now know it means nothing when the FDIC or any other regulator labels a bank �well-capitalized.� Most banks that failed during this crisis were considered well- capitalized just before their failure. After the law changed, the FDIC still didn�t charge enough premiums.

So far this year, 94 banks have been shut, the fastest pace in almost two decades. Hundreds of others are in trouble. The FDIC said 416 banks were on its �problem� list, a 15-year high, as of June 30. That was up from 305 three months earlier.

Regardless of the law�s requirements, if the FDIC starts tapping its credit line at the Treasury, there can be no assurance it would be able to pay back all the money through future assessments on banks. That�s why it should be reluctant to borrow from taxpayers now, even though the banking industry whines that it can�t afford any short-term cost increases.

At the rate it�s going, though, the FDIC may not have a choice much longer. Perhaps Bair and the FDIC someday might see fit to deliver a full account of how the agency managed to mess itself up this badly. The country deserves an explanation.