When the Federal Deposit Insurance Corporation's (FDIC) board meets today (Tuesday), it will be faced with some tough questions about how it will replenish its still-shrinking fund in the wake of mounting bank failures.
The FDIC has seen its fund that protects more than $4.5 trillion in bank deposits shrink to just $10.4 billion from $45.2 billion at the end of the second quarter in 2008. Its "problem list," or banks that run a higher risk of failure, grew to 416 in the second quarter of this year, up from 305 in the first quarter. That's the highest number since the second quarter of 1994, when there were 434 banks on the list.
Now, the FDIC has to decide whether it will borrow from its credit line with the U.S. Treasury, boost its levy on banks through a special assessment, ask the banks to pay their quarterly assessments early, or even borrow from the very banks that were bailed out a year ago. Or it could resort to more than one of these options.
"It's a nice irony," Karen Shaw Petrou, managing partner of consulting firm Federal Financial Analytics Inc. said of borrowing from banks in an interview with The New York Times. "Like so much of this crisis, this is an issue that involves the least worst options."
The news comes as the FDIC last week transferred deposits of the 95th failed bank this year - Atlanta's Georgian Bank - to Columbia, S.C.-based First Citizens Bancshares Inc. (Nasdaq: FCNCA, OTC: FCNCB)
Fronting the Fund Likely
When it does meet today, the FDIC is expected to take the unprecedented step of requiring banks to prepay the $12 billion per year in assessments they would have to pay in the next three years, The Associated Press reported, citing officials who spoke on the condition of anonymity because the decision has yet to be made public. These regular assessments could rise or decline based on the number of insured deposits.
This scenario would be the best because it gives the FDIC billions of dollars upfront, while banks would be able to delay the earnings hit because prepayments can be accounted for in increments over time instead of all at once.
FDIC Chairwoman Sheila Bair said earlier this month that she is "considering all options, including borrowing from Treasury," to replenish the insurance fund, but is generally perceived as considering a prepayment to be the most unpalatable approach.
Treasury Bailing Out FDIC Could Stoke Public Anger
While the FDIC's Bair takes a "never say never" attitude about borrowing, she "would take bamboo shoots under her nails before going to [Treasury Secretary] Tim Geithner and the Treasury for help," Independent Community Bankers President Camden Fine told The Times. "She'd do just about anything before going there."
But after bailing out large banks, automakers and insurers with $750 billion under the U.S. government's Troubled Asset Relief Program (TARP), pouring a few billion more dollars into the corporation that's been plugging the holes of failed banks would likely result in a political firestorm.
The American public, which struggled amid a credit crunch as the financial crisis began last fall, has already expressed rage at the Treasury's unwritten "too big to fail" policy for certain banks such as Bank of America Corp. (NYSE: BAC) and Citigroup Inc. (NYSE: C), which have seen windfall profits in the second quarter.
"Calling on taxpayers to bail out the FDIC's insurance fund is like asking your parents to support your crack habit," said Money Morning Contributing Editor Shah Gilani. "There's only one direction that moral compass will take you: down."
However, some other analysts believe Bair should just bite the bullet and tap the fund at the expense of uncertainty.
"I don't understand why [the FDIC's Bair] just does not use her Treasury line to recapitalize the fund in the same way that she encourages banks in similar situations to recapitalize themselves," Ken Thomas, a Miami-based banking consultant who has testified before Congress on deposit insurance funding told CNNMoney.com.
"By doing this," Thomas added, "she would put an end to all of this growing and troubling uncertainty about the shrinking fund, which does nothing but detract from confidence in the FDIC which is the most important concern."
Turning to Banks For a "Bailout"
The option financial institutions favor the most is the one Bair favors the least: Borrowing from the very banks the FDIC insures.
Such an action - allowed under an obscure provision of a 1991 law passed during the savings-and-loan crisis - would give lending banks bonds from the government at an interest rate set by the Treasury secretary and ultimately be paid by the rest of the industry. The bonds would become a part of the banks' assets.
"It's a slippery slope for the FDIC, which is tasked with having to raise money from a lot of banks on the edge of failure to insure depositors of failed banks," said Money Morning's Gilani. "In the end, it's the consumer looking for bank credit who will suffer as banks that have to pay higher premiums against holding riskier loans will either have to pass those charges along in the form of higher interest rates or will choose not to lend to any borrowers with less than sterling credentials."
Banks and their lobbyists favor this option because it would likely safeguard them from a special assessment. The FDIC collected an additional $6.2 billion special assessment on top of the $2.6 billion it received from its regular quarterly assessment in the second quarter.
"The FDIC is a good credit and we'll lend you money if you need some," said a smiling JPMorgan Chase & Co. (NYSE: JPM) Chairman and Chief Executive Officer Jamie Dimon last Friday at the annual meeting of the Clinton Global Initiative, where he was on the same panel as the FDIC's Bair.
Special Assessment Could Weigh on Bailed-Out Banks
Some banks, many of which have balance sheets littered with toxic assets, may not be able endure the sudden decline in earnings that would come from a special assessment by the FDIC. Comptroller of the Currency John Dugan, who has one of the five seats on the FDIC's board, is well aware of this.
"I have been concerned about the pro-cyclical impact of doing a special assessment up front," Dugan told reporters in Washington.
The FDIC's Bair is well aware of the challenges facing banks and told Bloomberg News the board is "actively considering alternatives to a special assessment."
Still, the FDIC since May has signaled that the banking industry would be required to pay a second special assessment before December.
"We've told banks repeatedly to expect" another assessment, Bair told Bloomberg last month.
Not only could a special assessment hurt banks, but it could also be counterproductive to the FDIC as it rescues the banks that can't afford any extra expenses. The hundreds of troubled banks on the FDIC's "problem list" won't be able to contribute any more to the insurance fund, according to Money Morning's Gilani.
"Demanding that remaining problem banks pay higher premiums could easily force them over the brink," Gilani said, adding that although this scenario would be problematic, "at least it attaches a much-needed dose of reality into the risk formula banks all but have abandoned in years past."
News and Related Story Links:
- The New York Times:
FDIC May Borrow Funds From Banks
- Associated Press:
FDIC Expected To Require Banks To Prepay Fees
- The Washington Times:
FDIC Chief May Tap Treasury For Funds
- Money Morning:
Citigroup and Bank of America Post Second-Quarter Profit but Will Likely Struggle in the Second Half
- Dow Jones Newswires:
FDIC's Bair: Tapping Banks For Insurance Fund Not Best Option
Clinton Global Initiative
FDIC to Meet Sept. 29 On Rebuilding Insurance Fund
U.S. Regulator Wants Bank Assessments Spread Over Time
- Bloomberg News:
FDIC's Bair Seeks Alternative for Second Fee, Lauds Prepayments
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