FacebookTwitterRedditEmail

The Shortfall at the FDIC

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

Weekend Edition
July 10, 2020
Friday - Sunday
Lynnette Grey Bull
Trump’s Postcard to America From the Shrine of Hypocrisy
Anthony DiMaggio
Free Speech Fantasies: the Harper’s Letter and the Myth of American Liberalism
David Yearsley
Morricone: Maestro of Music and Image
Jeffrey St. Clair
“I Could Live With That”: How the CIA Made Afghanistan Safe for the Opium Trade
Rob Urie
Democracy and the Illusion of Choice
Paul Street
Imperial Blind Spots and a Question for Obama
Vijay Prashad
The U.S. and UK are a Wrecking Ball Crew Against the Pillars of Internationalism
Melvin Goodman
The Washington Post and Its Cold War Drums
Richard C. Gross
Trump: Reopen Schools (or Else)
Chris Krupp
Public Lands Under Widespread Attack During Pandemic 
Alda Facio
What Coronavirus Teaches Us About Inequality, Discrimination and the Importance of Caring
Eve Ottenberg
Bounty Tales
Andrew Levine
Silver Linings Ahead?
John Kendall Hawkins
FrankenBob: The Self-Made Dylan
Pam Martens - Russ Martens
Deutsche Bank Fined $150 Million for Enabling Jeffrey Epstein; Where’s the Fine Against JPMorgan Chase?
David Rosen
Inequality and the End of the American Dream
Louis Proyect
Harper’s and the Great Cancel Culture Panic
Thom Hartmann
How Billionaires Get Away With Their Big Con
REZA FIYOUZAT
Your 19th COVID Breakdown
Danny Sjursen
Undercover Patriots: Trump, Tulsa, and the Rise of Military Dissent
Charles McKelvey
The Limitations of the New Antiracist Movement
Binoy Kampmark
Netanyahu’s Annexation Drive
Joseph G. Ramsey
An Empire in Points
Kollibri terre Sonnenblume
COVID-19 Denialism is Rooted in the Settler Colonial Mindset
Ramzy Baroud
On Israel’s Bizarre Definitions: The West Bank is Already Annexed
Judith Deutsch
Handling Emergency: A Tale of Two Males
Michael Welton
Getting Back to Socialist Principles: Honneth’s Recipe
Dean Baker
Combating the Political Power of the Rich: Wealth Taxes and Seattle Election Vouchers
Jonah Raskin
Edward Sanders: Poetic Pacifist Up Next
Manuel García, Jr.
Carbon Dioxide Uptake by Vegetation After Emissions Shutoff “Now”
Heidi Peltier
The Camo Economy: How Military Contracting Hides Human Costs and Increases Inequality
Ron Jacobs
Strike!, Fifty Years and Counting
Ellen Taylor
The Dark Side of Science: Shooting Barred Owls as Scapegoats for the Ravages of Big Timber
Sarah Anderson
Shrink Wall Street to Guarantee Good Jobs
Graham Peebles
Prison: Therapeutic Centers Or Academies of Crime?
Zhivko Illeieff
Can We Escape Our Addiction to Social Media?
Clark T. Scott
The Democrat’s Normal Keeps Their (Supposed) Enemies Closer and Closer
Steve Early - Suzanne Gordon
In 2020 Elections: Will Real-Life “Fighting Dems” Prove Irresistible?
David Swanson
Mommy, Where Do Peace Activists Come From?
Christopher Brauchli
Trump the Orator
Gary Leupp
Columbus and the Beginning of the American Way of Life: A Message to Indoctrinate Our Children
John Stanton
Donald J. Trump, Stone Cold Racist
Nicky Reid
The Stonewall Blues (Still Dreaming of a Queer Nation)
Stephen Cooper
A Kingston Reasoning with Legendary Guitarist Earl “Chinna” Smith (The Interview: Part 2)
Hugh Iglarsh
COVID-19’s Coming to Town
FacebookTwitterRedditEmail