Sunday, March 1, 2009

FDIC: $19 billion now backs over $4.8 trillion

By Rolfe Winkler (Option ARMageddon):

Yesterday I wrote that we should do away with public deposit insurance. It encourages depositors to shop for high interest rates rather healthy bank balance sheets; it forces onto the public the cost of risks taken by imprudent individuals; and last it massively misdirects society’s resources by underpricing the cost of government-backed insurance. Why are taxpayers now pumping hundreds of billions into a bailout of Fannie and Freddie? Because the government guaranteed their debt essentially for nothing. Had the government’s guarantee been priced properly, investments in Fan and Fred would have been far less remunerative. We offered trillions of $ worth of free lunches and now we have to pay for them.

The same is true of public deposit insurance.

Why are Treasury and the Fed moving mountains to save failing banks? Because taxpayers offered trillions of $ of free lunches to depositors for which we now are being forced to pay.

There’s nearly $5 trillion worth of insured deposits in the American banking system. But the FDIC’s Deposit Insurance Fund (DIF) is less than 1% of that total: $18.9 billion. And it’s falling fast, down from $52.4 billion (-64%) at the end of 2007.

[Having trouble seeing the red highlighted area in the first chart? Then you see my point. I use constant dollars so readers can see the inflation-adjusted growth of insured deposits. Click to enlarge]

FDIC doesn’t have the resources to bail out the depositors of even one large failed bank, much less the entire banking system. And let’s not kid ourselves: The entire banking system remains very much at risk.

To put the $18.9 billion figure in perspective, consider FDIC’s estimate for insured deposits at the two major banks closest to collapse—Citi and BofA: $103 billion and $449 billion respectively. And those figures understate the total because they don’t include “temporary” increases in deposit insurance coverage to $250,000 per account per bank from $100,000.*

To be sure, should those banks fail, the FDIC would be able to sell seized assets in order to fund deposit guarantees. So the DIF wouldn’t have to pay back depositors dollar-for-dollar.** Nevertheless, the total cost will, like the Fannie and Freddie bailout, run into the hundreds of billions of $ or more. Because FDIC has an open line of credit on the Treasury, taxpayers would be responsible.

[By the way, bank deposits aren't the only assets guaranteed by FDIC. As part of the government's October bailout efforts, FDIC now backs certain debt issues for financial companies. As of mid-January, companies had issued $232 billion under the program...]

FDIC Chairwoman Sheila Bair is taking a quixotic step in the right direction. This week she announced that FDIC will charge a special assessment on banks in order to raise $27 billion for the Deposit Insurance Fund. Give her points for effort, sure. Unfortunately, $27 billion is a meaningless figure when compared with the pool of deposits that are being bailed out. As you can see from the second chart, the Deposit Insurance Fund has always been a tiny fraction of total insured deposits; it hasn’t been above 1.5% since the 60s. We let the banking system expand without expanding protections against its failure. Another $27 billion now hardly makes a difference.

FDIC argues that bank failures will only cost the DIF $65 billion over the next five years. In reality, bank failures have cost us far more than that already. TARP and the Fed’s various lending arrangments are backdoor methods meant to rescue banks that would otherwise have to be rescued by FDIC via the front door.

And they have little choice. The front-door method would likely be impossible without igniting major inflation and/or crashing Uncle Sam’s balance sheet. Lending directly to the banks to prop them up “sterilizes” that lending’s inflationary impact. Banks take more capital onto their balance sheets, but that money doesn’t flow through into the economy. Instead, banks hoard it in order to repair their capital base, which is absolutely necessary given their insane leverage ratios. Bailing out depositors directly might be impossible to begin with as FDIC has no money to do so. Could Treasury borrow in one shot the multiple trillions of $ it might need if the banking system collapsed outright? Not to mention that if it actually gave those trillions to individuals, they would likely spend it quickly, igniting massive inflation.

If we want to avoid financial crises in future, we need to stop encouraging excess credit creation via “free” government guarantees…

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*The increase in the deposit insurance limit to $250,000 from $100,000 is scheduled to expire at the end of this year. It will most likely be rolled over indefinitely. Incidentally, since FDIC isn’t including “temporarily” insured deposits in its total for individual banks, I wonder if it includes them in the total amount of insured deposits?? My guess is no, that the $4.9 trillion figure is calculated using the $100k threshold per depositor.

**I have heard rumors that changes to banktruptcy law in the last decade actually give certain derivative counterparties priority claim over depositors in bank bankruptcies. Can anyone confirm?

All the data for the charts is on the FDIC’s website. Here is a one-page PDF that has historical info for the DIF going back to 1990.

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