There is a lot of dialog about the FDIC funding proposal. Here’s Denninger:
Senior regulators say they are seriously considering a plan to have the nation’s healthy banks lend billions of dollars to rescue the insurance fund that protects bank depositors. That would enable the fund, which is rapidly running out of money because of a wave of bank failures, to continue to rescue the sickest banks.
The plan, strongly supported by bankers and their lobbyists, would be a major reversal of fortune.
Of course it would. Writing insurance on yourself is a highly-lucrative business, especially when you can charge interest to the supposed insurer who you are supporting!
Insurance is supposed to work the other way around – you are supposed to pay into a pool to cover the risk of loss that some people in the pool might suffer.
Who would have thought that a government agency would actually contemplate paying the insured party for the coverage on their own risk?
In a world where we had a rule of law this would be identified instantly as what it is: rank, outrageous fraud.
But we don’t live in such a world.
The plan, to put it in plain language, makes no sense.
Why would the FDIC borrow at all? The FDIC – the Federal Deposit Insurance Corporation – is funded by a levy charged to all banks. When the insurance fund runs low, the banks have a supplemental levy. It is the banks’ obligation to keep the FDIC fund topped up.
If the fear were that the FDIC needed money suddenly, before a levy on the banking industry could be processed, not only can the FDIC borrow directly from the Treasury, home of the lowest dollar-denominated cost of capital going, the banks from whom the FDIC would be borrowing are already themselves wards of the Treasury. Why would anyone possibly want to create a middleman?
One of Taunter’s Tips is that when you see a government action that makes no damn sense for the government, don’t assume it is being done for the government’s benefit. Sometimes the people who serve in the government have very different incentives from the government as a whole:
The Federal Deposit Insurance Corporation, which oversees the fund, is said to be reluctant to use its authority to borrow from the Treasury.
Under the law, the F.D.I.C. would not need permission from the Treasury to tap into a credit line of up to $100 billion. But such a step is said to be unpalatable to Sheila C. Bair, the agency chairwoman whose relations with the Treasury secretary, Timothy F. Geithner, have been strained.
The FDIC is not going to borrow directly from the Treasury because Sheila Blair does not want to be beholden to Tim Geithner. Way to serve the national interest, Sheila. Oh, and there’s one other party who really likes the idea of the FDIC borrowing from the banks: the banks.
Keep in mind that over the ten years leading up to the current banking crisis, the FDIC under- collected premiums from subscribers. This left the agency seriously underfunded, although this was not clear up until last year. After all, only a handful of banks failed during the bubble years.
As in all ‘insurance’ issues, obtaining insurance while a claim event is taking place prices insurance at par. That is, the cost of insuring anything – like a house that is burning down, to use Denninger’s example – will be the cash cost of rebuilding the house plus the overhead of the insurer. Before the house burns, the cost will be much lower; the number of claims for burned houses averaged across the total population of the insureds.
Insurance is a form of redistribution, it doesn’t conjure funds out of the air, only banks can do this.
Since banks can make instant money by lending it, why not put this tool to good use for once, and let the banks invent some free money to bail out depositors in failed banks? What’s so wrong with that?
Denninger’s argument is that it is wrong to pay banks for insuring themselves, while Taunter argues for Bair to man up and borrow from the taxpayers’ grandchildren. Both insist that the banks use their own funds to support depositors. Neither understands that banks are only conduits for loans from either depositors or the central bank, the only money that is theirs is the interest on the loans they make. With banking at a near- standstill, the ‘strong’ banks have legacy loans that are being serviced. At the par cost of making depositors whole, funding the FDIC out of interest would place a large burden on ‘borderline’ banks who have some interest income but might not otherwise. Remember, no profit =’s no business … and more depositors to bail out in a widening and vicious cycle!
The alternative is for the banks to make a claim against the future earnings of its customers’ grandchildren and use that claim as collateral for bank loans – from the Fed via the Treasury – to bail out depositors. It is this bailout process that has gotten the citizenry’s knickers in a twist. Laundering a Treasury bailout by the FDIC doesn’t change its character, it’s still a government bailout.
When the banks are lending (creating) money, they are lending against their own reserves and supporting their own customers/depositors – at a remove. It is not only good finance, but sensible goodwill. Right now, people hate banks because of the claims that the banks are making against the grand kids, having the banks support the customers for once rather than executives is a ray of sunshine in an otherwise bleak and hopeless world!
The interest paid to the banks would come from the Fed, laundered by the FDIC, but reserves in the entire US banking system are loan @ interest from the Fed. The claims against the future are small and since the Treasury is bypassed, Ms Bair can keep her reputation intact.
Having Bair become a secondary sock puppet to Goldman sock puppet Geithner is not in the national interest, even if doing so is ‘efficient’.
Finally, banks are failing because they are not making loans, giving them the opportunity to … make loans creates a virtuous cycle. Pressure is taken off ‘strong’ banks that would, over time become failed banks. After all, the FDIC loans would be performing loans, hard to find in today’s economy.