Money Matters - Simplified

How Not to Solve a Banking Crisis

The FDIC is broke -- running out of cash even as the number of failing
banks it insures is rising. With $10.4 billion backing $4.8 trillion in
assets at the end of June, the agency is, as a doctor might put it, not
compatible with life.

No need to worry, though. The agency has several possibilities to refill its coffers relatively quickly.

Show me the money

The most fail-safe
option is to borrow from the Treasury, where the FDIC has a $500
billion line of credit. This is politically thorny, though, since it
reeks of yet another taxpayer bailout.

Another option is a one-time assessment charged to the thousands of
banks the FDIC insures, as happened earlier this year. But this makes
bankers squeal, since it eats into earnings -- especially troubling for
deposit-heavy banks such as Wells Fargo (NYSE: WFC) and Bank of America (NYSE: BAC).

A third, mind-bending option involves borrowing money from strong banks like JPMorgan Chase (NYSE: JPM) and US Bancorp (NYSE: USB).
This might seem rational, but as my colleague Anand Chokkavelu noted
last week, "[I]n effect, the Treasury is funneling money to the banks,
who are then funneling money to the FDIC, so that the FDIC doesn't have
to borrow money from the Treasury."

Door No. 4

The FDIC proposed a
little-known fourth option on Tuesday. Rather than a one-time special
assessment, banks will prepay their standard FDIC premiums at the end
of this year through 2012. Rather than making a standard quarterly
payment, they'll make a three-year payment up front.

The FDIC says that doing so will raise $45 billion. Great! That'll
put its deposit insurance fund back up to the levels it occupied before
banks started dying in droves.

But this is no panacea. In many ways, it's just delaying the inevitable.

Banks love the idea, because it sidesteps the one-time assessment
that would have hammered earnings. By prepaying standard fees, they can
amortize charges out to 2012, and hold the balance as a prepaid asset.
Earnings won't take anymore of a hit than they would from paying
standard fees.

However, by not charging a special assessment, the agency raises no additional money. The FDIC gets the money sooner, but it doesn't get more than it otherwise would from standard charges.

So what happens if this $45 billion runs out, especially if it
happens before 2012? The FDIC just announced that losses from bank
failures could hit $100 billion through 2013. That will almost
certainly put the agency back in a bind at the same time banks aren't making quarterly payments anymore, since future payments will already have been prepaid.

Where will the money come from then? You guessed it: one-time assessments.

Sure, maybe the banking system will be strong and spry by then, able
to refill the FDIC's coffers with ease. But maybe not. By 2012,
interest rates will be markedly higher than they are today. Goldman Sachs (NYSE: GS) and Wells Fargo are making record earnings these days because the interest rate climate is about as favorable as it gets.

Could higher interest rates -- perhaps substantially higher, to
drain excess liquidity -- put a damper on bank earnings over the next
few years? That's a certainty. And it could make special assessments
even tougher to impose in the years ahead than they would be today.

Just close your eyes and make believe

aren't standard bank failures. Standard FDIC fees, even frontloaded,
won't suffice. The banking sector must bear the excess cost. Rather
than short-term measures that appease those who rarely care what happens more than a few quarters in the future, the FDIC needs to actually solve problems, not just push them off to later years.


© 2009 UCLICK, L.L.C.