"Moral hazard" has reared its ugly head again in federal deposit insurance as the banking industry continues to lobby for greatly reduced premiums and reserves in the insurance fund.

American Banker commentaries on April 6 and April 20 by William Isaac of the Secura Group reflect not only this moral hazard but also "memory hazard" - a failed or incomplete recollection of banking history as recent as his tenure as FDIC chairman from 1981 to 1985.

Mr. Isaac has almost always taken a pro-banker position, even at the FDIC, which may explain why he found my recent testimony, based on a pro-taxpayer position, to be "outrageous." (I was the "independent bank consultant" quoted in his column of April 20).

Mr. Isaac now proclaims, "There is no deposit insurance fund," in contradiction to all he said during his FDIC years dedicated to strengthening the fund.

If there is no Bank Insurance Fund or Savings Association Insurance Fund, then why do he and his banking industry friends object to their merger? Doesn't zero plus zero equal zero?

Mr. Isaac takes particular exception to my point that the FDIC fund last had a 1.25% reserve ratio at yearend 1981, before beginning the free-fall to a negative number in 1991 and 1992. Today the bank fund is nearly back to the 1.25% ratio that he began his FDIC term with.

Perhaps Mr. Isaac forgets about all the banks that were closed or adversely affected by the FDIC's requiring over-reserving for grossly overestimated future losses when he was chairman. Continental Illinois Bank wasn't one of those closed banks, though he unconvincingly argued when he was chairman that it did not have a solvency problem (which was later shown to be the case) but only a liquidity problem. Though he refused to call it a failure at the time, the FDIC now counts it as the largest bank failure in the nation's history.

Yes, Mr. Isaac, there are two insurance funds, but the truth is they are ultimately backed by the taxpayers. The fiction is that the banks and thrifts stand behind them. Was it not the taxpayers who bankrolled the $150 billion for the S&L bailout, the $30 billion line of credit for the FDIC, the $15.1 billion working capital the FDIC borrowed from the Treasury's Federal Financing Bank, and the $8 billion appropriated through the RTC Completion Act of 1993 to backstop the thrift fund?

The insurance fund concept provides a reasonable and practicable way of assessing an appropriate premium on a stand-alone basis.

Premiums have traditionally been based on maintaining a 1.25% reserve ratio, the average between 1933 and 1983. But those were mainly "good" years for the industry. My testimony documented several reasons why 1.25% is insufficient, beginning with the obvious one that it was not enough in 1981 to keep the fund from becoming insolvent.

I argue for a minimum 1.5% ratio, which likely would have prevented the ultimate insolvency embarrassment that the bank fund was forced to endure in 1991 and 1992, and for a merged bank and thrift fund to handle the Fico obligations that Mr. Isaac and the bankers would prefer to use RTC funds for.

The proposed $5 billion reduction in the bank-fund premium - an industry windfall - would have to be delayed for two and a half to three years to get the fund to 1.5%.

Mr. Isaac has generally relied too much on "market discipline" to reduce bank failures, and he now cites early intervention and depositor preference policies in this context. His "pay as you go" justification for a reduced or eliminated insurance fund is likewise unrealistic in cases where bank earnings are insufficient to cover losses.

Consider the fact that 1987 bank earnings of $2.8 billion just exceeded failure losses of $2 billion but were below 1988 losses of $6.7 billion. There are too many uncertainties in pay-as-you-go to instill confidence in the system.

A reserve ratio of 1.5% would provide the needed cushion and allow us to learn from and not repeat past mistakes.

Mr. Thomas runs a Miami consulting firm, K.H. Thomas Associates, and is a lecturer in finance at the Wharton School of the University of Pennsylvania.

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