Comment: Banks Shouldn't Hold Thrift-Fund Fix Hostage

Law school civil procedure courses teach the classic example of inconsistent pleading, involving a suit against a man accused of damaging a borrowed kettle. "I didn't borrow the kettle," the defendant pleaded, "it was cracked when I got it." And, "It wasn't damaged when I returned it."

The arguments of some bankers in opposition to the Clinton administration's proposal to recapitalize the Savings Association Insurance Fund are reminiscent of that apocryphal case. Bankers plead: "There's no problem that needs to be fixed," "We shouldn't have to pay for a problem we didn't cause," and, "We deserve something in return for helping to cure the problem."

However inconsistent these arguments may seem, each deserves a response.

First, there clearly is a problem that needs to be fixed. The thrift fund is seriously undercapitalized. As a consequence, SAIF-insured thrift institutions pay substantially higher deposit insurance premiums than banks insured under the Bank Insurance Fund. The healthiest thrifts pay 23 basis points, while their bank counterparts effectively pay nothing at all.

This enormous disparity in costs, which has nothing whatsoever to do with the comparative health or efficiency of banks and thrifts, gives thrifts a tremendous economic incentive to reduce their reliance on SAIF- insured deposits.

They can do so by using other forms of funding that are not subject to premium assessments, such as repurchase agreements and Federal Home Loan bank advances. Or thrifts can "migrate" deposits to affiliates. It is a relatively simple matter, for example, for a holding company owning both a thrift and a bank to entice depositors from one to the other. A number of large thrift holding companies have applications pending to charter banks for just this purpose.

Two serious consequences would flow from such a reduction in SAIF- insured deposits.

First, it would create the threat of a default on the Fico bonds, as that portion of the assessment base available to pay interest on the bonds diminishes. (You will remember that $8.2 billion in 30-year fixed-rate, noncallable Financing Corp. bonds were issued between 1987 and 1989 and that the principal was "defeased" through the purchase of zero-coupon Treasuries purchased with about $700 million contributed by the Federal Home Loan banks.)

The Fico-available portion of the assessment base, which has been shrinking at an average rate of 11% per year since 1989, stood at $468 billion on Sept. 30. At current assessment rates, a minimum Fico-available base of $328 billion is needed to assure payment of the annual Fico interest obligation. Thus, there is presently a "cushion" of $140 billion. At the current shrinkage rate, this cushion would disappear in about three years, but in reality it is highly likely to disappear much more quickly.

The total deposits of the thrifts that are currently seeking to establish bank affiliates in order to migrate deposits, combined with those that are already affiliated with banks, come to $150 billion. If all of those deposits were successfully migrated, the Fico cushion would be obliterated.

While it is not likely that the entire $150 billion would or could move in the short term, the dimensions of the threat are clear, particularly when one considers that additional assessment-base erosion is likely to be brought about by other means and through other institutions.

Simply put, thrifts have a strong incentive and a realistic ability to reduce their thrift fund assessment base, and if the Fico-available portion of that base were to erode by as much as 20% per year in 1996 and 1997, we would be facing a serious threat of default in 1997.

Second, because stronger thrifts would probably be more successful than weaker ones in shrinking their deposits, the fund's risks would concentrate further. This presents a significant concern in light of the SAIF's serious undercapitalization. While the condition of the thrift industry is improving, if SAIF reserves are not brought up to the target level of 1.25% of insured deposits, as the special assessment would do, the failure of one or two large thrifts could leave the fund insolvent.

This is clearly a problem that needs to be fixed, and fixed now.

Under the administration's proposal, bank fund and thrift fudn members would share pro rata in the burden of paying the Fico obligations. There is, admittedly, some surface appeal to the bankers' pleas that they should not have to pay because they did not "cause the problem." The trouble is that those who did cause the problem - the thrifts that failed and bankrupted the old thrift deposit insurance fund - are long dead and buried.

The surviving thrifts - which are committed to paying special assessments of $6 billion to recapitalize SAIF, and a portion of whose Federal Home Loan Bank equity was taken to defease the Fico bonds - didn't cause the problem. Nor did American taxpayers, who have already borne more than $125 billion of the $150 billion cost of thrift industry failures.

To whom do we turn, then, to remedy this threat to the deposit insurance system? I submit that "blame" is an irrelevant concept in this inquiry. Instead, we should look to those who benefited from the government's actions in resolving the thrift crisis, and to those who will benefit in the future from putting to rest questions about the strength of the deposit insurance system.

The massive failures in the thrift industry during the 1980s, which wiped out the FSLIC fund, were followed by extensive failures of commercial banks. From 1987 through 1989, more than 200 banks a year failed, and the reserve coverage of the FDIC bank fund declined from 1.19% of deposits in 1985 to 0.21% in 1990.

By 1991 and 1992, the Bank Insurance Fund had been so depleted that it appeared to be bankrupt, publicly reporting negative reserves of over $7 billion in 1991.

Yet there were no runs on FDIC-insured banks, and no crisis of confidence in FDIC insurance. Bank depositors retained confidence in the integrity of the deposit insurance system and in the reliability of the government's full-faith-and-credit pledge.

And nothing demonstrated that integrity and reliability better than the experience with the thrift insurance fund. No insured thrift depositor lost a cent, despite a staggering number of thrift insolvencies and the insolvency of the thrift fund itself.

Banks also benefited from governmental closures of scores of insolvent institutions that had been bidding up the cost of deposits.

Bank earnings are currently at record highs, and deposit insurance premiums are at an all-time low. Most banks now pay substantially less than the average effective premium rate between 1935 and 1989 of about 6.8 basis points.

The Fico-sharing provisions of the administration's proposal would cost banks not more than 2.5 basis points per $100 of deposits. We estimate that this would have amounted to about eight-tenths of 1% of banks' 1995 after- tax earnings, which translates into a one-hundredth of 1% reduction in return on assets.

Given the benefits banks have already received, the strong interest banks have in promoting the health of FDIC insurance, and the inseparability in the public's mind of the bank and thrift funds, the very modest cost involved in Fico-sharing, the current level of bank deposit insurance premiums, the large upfront amount the thrifts will pay to recapitalize SAIF, and the staggering costs already borne by taxpayers, the arguments based on lack of "blame" seem somewhat hollow.

The bankers' third argument is essentially this: "If Congress is going to saddle us with new and unjustified costs, the least you can do is to expand our powers and reduce our regulatory burdens." If there were no independent justification for Fico-sharing - or if bankers had come forward voluntarily to participate in crafting a solution to the SAIF problem - there would be greater appeal in the argument.

Of course, bank powers should be expanded, and unreasonable regulatory burdens should be reduced, and that should happen whether or not the thrift fund is recapitalized and the Fico burden shared. Banks need to broaden their sources of income, to diversify their product mix, and to reduce unnecessary costs. The administration has supported legislation to achieve these results.

But the bankers' argument mixes apples and oranges. The minimal after- tax cost that would be imposed on banks as a result of Fico sharing has nothing to do with expanded powers or regulatory burdens.

Moreover, bankers are fully aware of the legislative status of proposals that would address these subjects. Financial modernization legislation has been gridlocked by the intractable issue of insurance, and arguing that it should be enacted as a reward for Fico-sharing simply ignores political reality.

And while the regulatory burden legislation has run into controversy, the Senate Banking Committee has reported a bill that should have a high likelihood of enactment. Trying to leverage off the thrift fund proposal adds nothing to this effort.

With strong bipartisan support, Congress has already passed a SAIF recap measure that would do what is needed. While that legislation fell victim to the broader disagreement on budget priorities, it should not now be sacrificed because of opportunistic opposition.

The case for the legislation is eminently reasonable, the burden-sharing is fair, and American taxpayers have a right to ask that the problems of deposit insurance be put behind us for good.

Mr. Hawke is under secretary of the Treasury for domestic finance.

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