Back to 1991: the FDIC

FDIC chairwoman Sheila Bair introduced two unusual ideas last week: one, that banks should prepay their assessed fees through 2012 by the end of this year; two, that the FDIC might indeed end up borrowing substantial amounts from Treasury in order to manage liquidity.  The reason for this, of course, is that the 98 bank failures year-to-date (through October 2, 2009) have put a heavy strain on the Deposit Insurance Fund (DIF).   Having started out the year with $17.3 billion in assets the fund’s balance was down to $10.4 billion at the end of June and has just dipped into negative territory – a first since 1991 at the height of the savings & loans crisis.

The fact that the DIF is in the red is not highly worrisome in and of itself, in my opinion.  What is worrisome, though, is that the FDIC is expecting bank failures to continue at a similar pace next year, and that the DIF is expected to stay in the red through 2012 and at uncomfortable levels until 2017.  In addition, while the DIF is backed by the full faith and credit of the US government, Bair believes that borrowing from Treasury to solve the liquidity problem would be problematic  because “the American people would prefer to see an end to policies that looked to the federal balance sheet as the remedy to every problem.”

My more immediate concern is that if the FDIC does need to turn to Treasury for money, depositors will see the move as a sign of the potential lack of reliability of FDIC coverage; this in turn might easily prompt runs on the bank across the country, which would result in a vicious cycle that would put an added strain not just on the FDIC but also on the federal balance sheet.  How worried should we be about this?

For some quick back-of-the-envelope math: the FDIC had 416 (and rising) banks on its list of problem candidates at the end of June and is currently expecting losses to the DIF of ~$100 billion due to bank failures through 2013, 25% of which have already been realized.  The total number of commercial banks and savings institutions in the US is around 8200, or roughly 20x the number of institutions on the watch list.  The total amount of assets covered by the FDIC at the end of Q2 2009 was roughly $4.7 trillion or more than twice the size of the Fed’s balance sheet which stood at $2.2 trillion as of October 1.

Judging by the lack of news coverage of the DIF dipping into the red it seems to me that Washington is more than a little alarmed by the prospect of depositors panicking because of the FDIC’s lack of liquidity.  What do you think?

Advertisement