Insurers' Woes Rub Off on Banks
There's good news for banks in the bad news about the insurance industry these days. But somehow, many banks are failing to take advantage of it.
Insurance companies used to have spotless reputations - when they stuck to insurance.
They met their obligations, and the federal government enacted no legislation to control them in the way it has controlled banks and thrifts.
Why Insurers Are in Trouble
What changed all this? Many companies decided the grass was greener elsewhere and got into the business of handling the public's investment funds.
To offer an attractive competitive product they developed the GIC - the guaranteed investment contract - offering a top yield with no option to cut back this attractive payment for the life of the contract.
Then, to meet the yield requirements, many reached for junk bonds and speculative real estate investments.
The rest is history.
Three major insurance companies have already been taken over by their respective states, and Washington lawmakers are thinking of national legislation to restrict an industry that was superb in its own field but stumbled in its diversification efforts.
Making Banks Look Good
What has this to do with banking? Plenty.
As people wonder about the soundness of insurance companies, the federally insured deposit at a bank or thrift looks more and more attractive.
So what do the banks do? Many are taking this exact time to start selling annuities issued by insurance companies, not the Federal Deposit Insurance Corp., and are trying to woo their savers' funds from insured deposits into these vehicles.
This is not the first time that banks and thrifts have gotten into trouble trying to talk their depositors into giving up the safety of federal insurance.
Lincoln Savings - the most notorious of all thrift failures - earned its reputation by talking people into removing insured deposits and investing their money in subordinated debt that was not FDIC-protected.
Mutual savings banks and savings and loans went public in a great wave of conversions in the last decade. As they did so, they encouraged their savers to remove insured deposits and place their savings into the newly issued stock - subliminally promoting the idea that "here is a way you can get rich quick."
Annuities Are Bank Problem
The savers whose shares have become worthless or whose stock now trades at a small fraction of subscription price certainly have lost all warmth for the institutions that offered them this hard-luck opportunity.
If the insurance company that stands behind its annuities gets into trouble, a bank may say, "This is not our problem. You were told that it was not federally insured, and you bought it anyway, for the higher yield."
Yet to the public, this is patent nonsense. To the buyers, it was their bank that sold them the annuity. And it is their bank that they blame if the annuity fails to meet its promises.
So some banks are betting their reputations on insurance companies they cannot control or monitor in depth - all for the sales commission that the annuities bring in. It's quite a gamble.
A Ticking Time Bomb
And though FDIC coverage - the very coverage that some banks are throwing away with their annuity promotions - looks great today, it may even look greater tomorrow.
For we have a time bomb ticking in some money market funds that are composed of lesser-grade assets.
The public thinks "money market" means safety - that because an investment is short term, it is of highest quality.
Unfortunately, some may be disabused of this feeling if our corporate earning problems continue and some short-term paper that is included in many money funds defaults.
We have already seen at least one money fund sponsor bite the bullet and make up its fund's losses itself, lest the public see that its asset value had declined and caused investors to realize a loss.
If more money funds that are not composed only of government securities face similar problems, we may see investors develop even more reasons for running back to federally insured deposit accounts.
So we can conclude that in times of trouble like these, the seal of the FDIC is the greatest strength most American financial institutions offer the smaller investor. And we can understand why some lawmakers want to capitalize on this and limit the banks and thrifts that offer this protection to the highest quality assets in using insured deposit funds.
If our financial institutions continue to try to attract the public to pull its funds away from insured deposits and into vehicles like annuities, bank stock, and subordinated debt, the pressure to segregate insured deposits and their use from regular bank activity may increase.
If this leads to greater restraints on bank lending and investing and more governmental supervision, those who took their FDIC and FSLIC protection for granted and wooed their customers away from it at the customers' peril will have no one but themselves to blame.
Mr. Nadler is a contributing editor of the American Banker and professor of finance at the Rutgers University Graduate School of Management.
