Smaller banks are outraged over the one-time fee, which could wipe out 50 percent to 100 percent of a bank’s 2009 earnings, Camden Fine, president of the Independent Community Bankers of America, said yesterday in a telephone interview.
“I’ve never seen emotions like this,” said Fine, adding that he’s received more than 1,000 e-mails and telephone messages from angry bankers.
“The FDIC realizes that these assessments are a significant expense, particularly during a financial crisis and recession when bank earnings are under pressure,” Bair wrote. “We did not want to impose large assessments when the industry and economy are struggling. We searched for alternatives but found none better.”
Ah, isn’t it wonderful. Reaping the whirlwind of government “deregulation” and government “insurance.” Does anyone other than me remember the “deregulation” of the Savings and Loans ([i]S-and-Ls[/i]) and the resulting collapse when all those [i]junk bonds[/i], in which the [i]S-and-Ls[/i] had invested their depositors funds, proved fundamentally worthless? If so, do you understand what the nature of the problem was with the FSLIC (the government-run “insurance” on deposits in [i]S-and-Ls[/i] that is the latter’s counterpart to the bank’s FDIC)?
If not, perhaps a small lesson in economics is called for. Insurance, when underwritten by insurance companies (whether stock or mutual in ownership), demands payment of a premium by the insured that is [b]proportional[/b] to the risk to the insured. This risk is determined in the insurance industry by people, called actuaries, who are educated in [i]actuarial science[/i], which latter is the discipline that “applies mathematical and statistical methods to assess risk in the insurance and finance industries.”* So what went wrong in the 1980s with the FSLIC, and in the current decade with the FDIC?
Well, when the government designs the insurance, the payments are set, not actuarially, [i]i.e.[/i], based on a statstical assessment of risk, but at a flat rate. It doesn’t matter how much risk the institution is taking in order to attract investors willing to have their money loaned to borrowers, the deposit insurance premium remains the same per dollar deposited. This has the politically desirable feature of ensuring that no bank’s/[i]S-and-L[/i]’s interest rates payable to depositors is impacted by putting their money in a riskier institution. It also frees the bank from the necessity to balance risk versus return on the deposits put out on loan at interest.
The downside of all of this is directly related to two inconvenient facts. First, this failure of the government-run insurer to base deposit insurance premiums on the risk associated with the bank’s investments effectively encourages each bank to look for riskier and riskier investments for depositor’s cash, in order to attract more depositors than competing banks. Second, when the (inevitable) collapse comes from accumulating too much risk, the funds on hand with the government-run insurers available to reimburse the losses of depositors is inadequate to the task, because the premiums were [i]underpriced[/i], relative to the risk, by the government-run insurer.
Predictable and inevitable. The question wasn’t whether it would happen again, but when. The root cause of the problem is that, in general, the majority of those whom we elect to represent us are thoroughly ignorant of much beyond how to get re-elected. So they talk about deregulation as though that is what they are doing. But now, in two cases within 30 years, they have demonstrated that they don’t understand how actually to deregulate. In each case, they deregulated one side of the market (allowing financial institutions to compete freely) and left the other side untouched (by not demanding that financial institutions pay premiums proportional to the statistically predictable costs of their risk taking).
Santayana was, I think, essentially correct. What man learns from history is that man does not learn from history. And, wonder of wonders, Congress and the President have once again written a check that you and I, as taxpayers, will be required to cash.
Blessings and regards,
Keith Toepfer
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*—Definition from Wikipedia
We knew the “big government president” would find a way to do away with banks that weren’t dependent on bailouts. Looks like he found it.
I must have missed that flurry of deregulation, #1. The last I saw, the CFR was ballooning like Michael Moore at a Chinese buffet. Can you be specific?
[i] Insurance, when underwritten by insurance companies, demands payment of a premium by the insured that is proportional to the risk to the insured. … Well, when the government designs the insurance, the payments are set, not actuarially, i.e., based on a statstical assessment of risk, but at a flat rate [/i] —Martial Artist [#1]
The law requires the FDIC to charge risk-based premiums for deposit insurance. Here is the relevant statute, enacted in 1991:
[blockquote](A) The [FDIC] shall, by regulation, establish a risk-based assessment system for insured depository institutions. . . .
(C) The term ‘‘risk-based assessment system’’ means a system for calculating a depository institution’s assessment based on—
(i) the probability that the Deposit Insurance Fund will incur a loss with respect to the institution, taking into consideration the risks attributable to (I) different categories and concentrations of assets; (II) different categories and concentrations of liabilities, both insured and uninsured, contingent and noncontingent; and (III) any other factors the [FDIC] determines are relevant to assessing such probability;
(ii) the likely amount of any such loss; and
(iii) the revenue needs of the Deposit Insurance Fund.
—12 U.S. Code § 1817(b)(1) [/blockquote]
If you believe this is not actuarially based (i.e., proportioned to risk), please explain why.
[i] We knew the “big government president†would find a way to do away with banks that weren’t dependent on bailouts [/i]
And that piece of partisan petulance leads me to point out an inconvenient fact. In 1996 the Republican Congress prohibited the FDIC from charging healthy banks any premium at all. Those banks obviously posed a risk greater than zero (any bank does), but the FDIC could collect no premiums from them. Zero. Zip. Nada. This giveaway program continued until 2006. Had the FDIC been allowed to collect a modest premium from healthy banks, the insurance fund would be in much stronger shape now.
PS: Camden Fine, the whiner quoted above, strongly supported the zero-premium giveaway. He also wanted to prevent the FDIC from having reserves of more than $1.25 per $100 of insured deposits.
So let’s create a run on the banks by saying that the FDIC won’t have the money. Of course, they’ll have the money – they can always go to the Treasury. But this state of panic seems to be a constant in Obama White House strategy.
[i] But this state of panic seems to be a constant in Obama White House strategy [/i]
That’s an off-the-wall response to what the FDIC is doing here: namely, taking prudent, responsible steps to replenish its reserves.
But some see only what they want to see.
I have no problem with the FDIC taking prudent, responsible steps to replenish its reserves. I do have a problem with imprudent language that only increases the average American’s fear of the safety of his/her money.
Branford [#8]: Here is [url=http://www.fdic.gov/news/news/speeches/chairman/spmar0209.html]the text of Sheila Bair’s speech[/url].
Please [i]read[/i] the speech, then explain how it’s calculated to “create a state of panic.”
Her comments on insolvency were from a March 2 letter – not a speech. From the Bloomberg article –
So I’m not sure why you’re referencing a speech when the quote came from a letter.
I glanced at her speech. Is’t not bad. But one fundimental elephant in the living room is the corporation itself. The corporation is a legal fiction and creats the corporation as a legal person. This is to shield the actual legal persons from what they do as natural persons. But corporations can own other corporations and thus layer the shielding. Thus you can have a non-regulated holding company owning a regulated company. And, if you are smart, you divert the assets from the holding company, and thereby indirectly from the regulated company. That way you can get past the regulators.
Now the regulators aren’t stuped. They know what is going on, but neverless the manipulation of corporate entities is a real regulatory problem.
[4] [i]Irenaeus[/i],
From the date of passage of the requirement (1991), it is obvious that they attempted to do a better job with FDIC than they did with FLSIC up until the 1980s. I was unaware that they had made that change, but, apposite my point, it was after the first set of horses were out of the barn.
Secondarily, I stand corrected on the current requirements. However, having acknowledged my factual error, the fact that there are currently insufficient funds in reserve with FDIC to cover the current mess is clear evidence that the government’s actuaries were, for whatever reason, not up to the task. While it does affect the conclusion stated in my initial comment, I still maintain that government bureaucracies, or government-established corporations, are proven to be very, very poor substitutes for private firms that require profits, however small, to stay in business. It is amazing how needing to make at least zero profit to retain one’s job clarifies one’s performance, compared to government agencies, bureaucracies and government-established corporations, whose main driver is remaining employed by not embarrassing Congressmen and Senators.
If you can provide counter examples, please feel free to do so. I have spent most of my adult working life (US Navy: 241 months, County government: 54 months, Federal Agency: 53 months and counting) in direct contact, as an employee, with government bureaucracies, and that experience is not of the sort that inspires confidence.
One possible, and plausible, and not particularly uncommon, possible cause for “not being up to the task” is, of course, pressure from federal politicians, jealous of the perquisites of their elective offices.
Martial Artist [#12]: The FDIC’s current underfunding has two basic causes. First, at the insistence of the banking industry, Congress has capped the FDIC’s reserves at $1.50 per $100 insured deposits; anything more must be rebated to the banks. Second, for reasons explained in comment #5, Congress precluded the FDIC from charging most banks premiums from 1997 through 2006.
The system is, at bankers’ behest, set up so that the FDIC charges low premiums during good times and has to raise premiums during hard times.
This is not how you’d run an insurance company. On the other hand, state insurance guaranty systems, which protect failed insurance companies’ policyholders, have an even more hypercyclical structure. They impose premiums on insurance companies only [i]after[/i] an insurer fails—an approach supported by the insurance industry.
Irenaeus,
I’m curious about this 10 year hiatus you speak of. I can’t find much information about it on line. Could you provide some references for further reading?
Why did Bill Clinton sign the premium reduction? Why did the Republicans change things again in 2006? It seems like there’s more here than meets the eye.
I’m also wondering how the NCUA fits in the picture. Are they connected to the FDIC fund at all?
[i]I’m curious about this 10 year hiatus you speak of. Could you provide some references for further reading?[/i]
The 1996 amendment was codified in 12 U.S. Code § 1817(b)(2)(A)(iii), (v). Under the amendment, if the FDIC had $1.25 in reserves for each $100 of insured deposits, it could assess premiums only on banks that “exhibit financial, operational, or compliance weaknesses ranging from moderately severe to unsatisfactory, or are not well capitalized.†The result was to exempt from premiums banks holding 97% of all FDIC-insured deposits. Nearly 1000 banks chartered after 1996 never paid a cent in premiums until 2007.
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[i]Why did Bill Clinton sign the premium reduction?[/i]
It was part of the price for the 1996 budget agreement.
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[i] Why did the Republicans change things again in 2006? It seems like there’s more here than meets the eye [/i]
Oh, yes. The zero-premium premium giveaway encouraged Merrill Lynch to move enormous sums (e.g., from brokerage customers’ cash balances) into its subsidiary bank. These sums diluted the FDIC’s ratio of reserves to insured deposits by enough so that the ratio was about to fall below the legal minimum of 1.25%. That got the bank trade associations to rethink the zero-premium giveaway. The FDIC worked out a deal under which it could begin charging premiums again. By 2006, the issue was nonpartisan: the big backers of the 1996 amendment largely left the Hill, and no one defended Merrill Lynch’s gamesmanship.
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[i]I’m also wondering how the NCUA fits in the picture. Are they connected to the FDIC fund at all?[/i]
Federal deposit insurance has the same coverage limits for credit unions as for banks. But the National Credit Union Share Insurance Fund is fiscally and administratively separate from the FDIC. It also has a different financial structure: credit unions keep 1% of their deposits in the insurance fund and must replenish the 1% if the insurance fund becomes depleted.