FacebookTwitterGoogle+RedditEmail

The Shortfall at the FDIC

by MARSHALL AUERBACK

Federal regulators 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” (as the New York Times recently informed its readers.)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 rationale is ostensibly to avoid the makings of another populist revolt via further taxpayer bailouts, as well as sparing Sheila Bair the humiliation of going hand in cap to Treasury Secretary Tim Geithner for more money.

Of course, had we used the FDIC as we should have done in the first place, by downsizing “too big to fail” financial institutions, while putting in place new regulations and supervisory practices to attenuate the tendency to produce a fragile financial system as the economy recovers, it would have never come to this. But there is no need to compound the error by making the FDIC a mere adjunct of current (and misguided) Treasury policy.

Sheila Bair’s reluctance to approach Secretary Geithner is well-founded. The FDIC should be allowed to do its job without any assistance by Treasury, given the latter’s cozy relationship with Wall Street. Apart from funding any expenditures which facilitate the FDIC’s existing role, Treasury should butt out. The sole purpose of any Treasury funding should be to ensure that the FDIC is free to take over any bank it deems insolvent, and then either sell that bank, dispose of the bank’s assets, reorganize the bank, or any other similar action that serves the public purpose of government participation in the banking system.

The notion of having the FDIC implement higher insurance charges on the banks, as many have suggested, is wrong on many grounds. For one thing, it is grossly unfair to force well-run banks to pay higher premiums to pay for the sins of Citi, Bank of America, or Wells Fargo. For another, the higher premiums will simply induce the banks to pass on those costs to the consumer, thereby increasing the marginal cost of credit.

The reality is that banks already have loans outstanding priced in relation to current FDIC premiums. Consequently, raising those premiums retroactively on liabilities already in place is unfair confiscation from shareholders. This is counter to public purpose, as public purpose is presumably currently best served by a zero interest rate policy to keep the cost of credit down. All a bank-wide tax (or increase in insurance premium fees) does is increase the rates charged by the banks, which  raises the cost of credit to the economy.

Having healthy banks to shore up the shorter-term liquidity needs of the fund by lending to the FDIC is probably a less onerous option than higher insurance fees, insofar as the loans to the FDIC are government-guaranteed, and therefore pose little risk as far as the banks’ lending activities go. They actually can make a profit here.

True, loans made to the FDIC do reduce bank income to the extent that the bank’s returns from these notes might be less than a standard loan. But the fact that the FDIC notes offer any kind of return is better than a higher insurance fees, which offer zero return, or higher capital requirements, which are functionally like a tax, (assuming they are not gamed via accounting tricks) because the resulting higher capital stored away by the banks is money that cannot be used for credit intermediation. What the loans to the FDIC might do is force banks to invest in lower yielding assets, which could be a modest earnings penalty, but far less than paying that same amount as a fee.

The whole approach to financial reform proceeds from too many conceptual flaws. As we said before, the primary focus of bank reform should be on regulating the asset side of the balance sheet, particularly as the FDIC has effectively guaranteed the main liabilities (i.e. the deposits). The $250,000 deposit ceiling should be removed altogether, the quid pro quo for the FDIC providing this service being that we restrict the activities of banks, so as to minimize systemic risk. With banks funded without limit by government-insured deposits and loans from the central bank, discipline should remain entirely on the asset side, which includes being limited to assets deemed ‘legal’ by the regulators and restrictions on off-balance sheet activities.

“Hold to maturity” seems a good starting point. To be sure, an inevitable byproduct of restricting securitization or proprietary trading is that they can and will reduce a bank’s profitability, but the regulation keeps them aligned with public purpose — namely, providing an ongoing, stable basis for lending, independent of market conditions — while avoiding the incentive for banks to game the higher capital requirements via questionable accounting scams.

Securitization has generally increased risk enormously, and misallocated it, without providing long-run advantages. It is true that eventually we will probably have to cover everybody, not just the banks, if we are to rely on a “hold to maturity” standard. The unregulated non-prime speciality mortgage lenders proved this. It has been rationalized based on potential increased bank risk adjusted profitability, which is outside of the public purpose behind banking – namely a government public/private partnership. Banks are set up and supported by government for the further benefit of the macro economy via providing a payments system and lending in a way that is specifically defined by regulators. The public purpose of banking is NOT to provide profits per se to shareholders. Rather, the provision of the ability to earn profits is only a tool used to support the attendant public purpose.

Of course, given the current configuration of the Obama Administration, it is foolish to expect any of these proposals to come to fruition, but in an ideal world, this is the way we should approach reform. The FDIC’s funding requirements are a secondary consideration.

The Treasury still seems to conflate the banking industry’s profitability with the public interest. And to make matters worse, the Treasury-funded TARP contributions to the banks was accounted for as additional federal deficit spending, rather than classified (as it should have been) as a Federal Reserve function. As the economist Warren Mosler has argued, “This would not matter if Congress and the administrations understood the monetary system, the fact is they don’t, and so the TARP has therefore restricted their inclination to make further fiscal adjustments to restore employment and output. Ironically, the overly tight fiscal policy continues to contribute to the rising delinquency and default rate for bank loans, which continues to impede the desired growth of bank capital.”

In any case, it is deeply ironic to see that Tim Geithner is now championing the need for increased capital requirements. When he was head of the NY Fed, he presided over the most substantial reduction in effective regulatory capital requirements via his non-opposition to the change in accounting rules, which dramatically reduced the recognition of losses.

He is the last person one would like to see exercising a more prominent role in the FDIC’s deliberations, which would almost invariably accompany a request by Bair for more Treasury money, as the resultant Treasury interference would do little to enhance lending to productive businesses. The idea of the FDIC borrowing from healthy banks is not a good one, but it certainly beats the other alternatives now being discussed. And less bad is perhaps all we can hope for right now, as opposed to downright awful.

MARSHALL AUERBACK is a market analyst and commentator. He is a brainstruster for the Franklin and Eleanor Roosevelt Intitute. He can be reached at MAuer1959@aol.com

More articles by:

Marshall Auerback is a market analyst and a research associate at the Levy Institute for Economics at Bard College (www.levy.org).  His Twitter hashtag is @Mauerback

February 19, 2018
Rob Urie
Mueller, Russia and Oil Politics
Richard Moser
Mueller the Politician
Robert Hunziker
There Is No Time Left
Nino Pagliccia
Venezuela Decides to Hold Presidential Elections, the Opposition Chooses to Boycott Democracy
Daniel Warner
Parkland Florida: Revisiting Michael Fields
Sheldon Richman
‘Peace Through Strength’ is a Racket
Wilfred Burchett
Vietnam Will Win: Taking on the Pentagon
Patrick Cockburn
People Care More About the OXFAM Scandal Than the Cholera Epidemic
Ted Rall
On Gun Violence and Control, a Political Gordian Knot
Binoy Kampmark
Making Mugs of Voters: Mueller’s Russia Indictments
Dave Lindorff
Mass Killers Abetted by Nutjobs
Myles Hoenig
A Response to David Axelrod
Colin Todhunter
The Royal Society and the GMO-Agrochemical Sector
Cesar Chelala
A Student’s Message to Politicians about the Florida Massacre
Weekend Edition
February 16, 2018
Friday - Sunday
Jeffrey St. Clair
American Carnage
Paul Street
Michael Wolff, Class Rule, and the Madness of King Don
Andrew Levine
Had Hillary Won: What Now?
David Rosen
Donald Trump’s Pathetic Sex Life
Susan Roberts
Are Modern Cities Sustainable?
Joyce Nelson
Canada vs. Venezuela: Have the Koch Brothers Captured Canada’s Left?
Geoff Dutton
America Loves Islamic Terrorists (Abroad): ISIS as Proxy US Mercenaries
Mike Whitney
The Obnoxious Pence Shows Why Korea Must End US Occupation
Joseph Natoli
In the Post-Truth Classroom
John Eskow
One More Slaughter, One More Piece of Evidence: Racism is a Terminal Mental Disease
John W. Whitehead
War Spending Will Bankrupt America
Robert Fantina
Guns, Violence and the United States
Dave Lindorff
Trump’s Latest Insulting Proposal: Converting SNAP into a Canned Goods Distribution Program
Robert Hunziker
Global Warming Zaps Oxygen
John Laforge
$1.74 Trillion for H-bomb Profiteers and “Fake” Cleanups
CJ Hopkins
The War on Dissent: the Specter of Divisiveness
Peter A. Coclanis
Chipotle Bell
Anders Sandström – Joona-Hermanni Mäkinen
Ways Forward for the Left
Wilfred Burchett
Vietnam Will Win: Winning Hearts and Minds
Tommy Raskin
Syrian Quicksand
Martha Rosenberg
Big Pharma Still Tries to Push Dangerous Drug Class
Jill Richardson
The Attorney General Thinks Aspirin Helps Severe Pain – He’s Wrong
Mike Miller
Herb March: a Legend Deserved
Ann Garrison
If the Democrats Were Decent
Renee Parsons
The Times, They are a-Changing
Howard Gregory
The Democrats Must Campaign to End Trickle-Down Economics
Sean Keller
Agriculture and Autonomy in the Middle East
Ron Jacobs
Re-Visiting Gonzo
Eileen Appelbaum
Rapid Job Growth, More Education Fail to Translate into Higher Wages for Health Care Workers
Ralph Nader
Shernoff, Bidart, and Echeverria—Wide-Ranging Lawyers for the People
Chris Zinda
The Meaning of Virginia Park
FacebookTwitterGoogle+RedditEmail