To the Editor:
Each of us has served as general counsel of the Federal Deposit Insurance Corp. and is a practicing attorney with extensive bank regulatory experience. We collectively have served in that position over a period spanning from the banking crisis of the mid-1980s to the onset of the current crisis and the passage of the Emergency Economic Stabilization Act last fall.
We are writing to provide legal clarity in light of press speculation that the FDIC's anticipated role in the Treasury Department's Public-Private Investment Program might not comply with Section 15(c)(5) of the Federal Deposit Insurance Act. In view of that speculation, we believe that it is useful to address the question of whether the proposed FDIC participation in PPIP complies with Section 15(c)(5) of the FDIA. We believe that it does comply.
Section 15(c)(5) prevents the FDIC from incurring "obligations" that would cause its total obligations to exceed the value of the assets held in the Deposit Insurance Fund (subject to certain adjustments) plus the amount the FDIC is authorized to borrow from the Treasury under the FDIA.
The statute defines "obligation" to include a contingent liability and explicitly provides that the FDIC shall value any contingent liability at its "expected cost" to the FDIC.
Based on our understanding of PPIP, the FDIC is analyzing its participation in PPIP in a manner that is entirely consistent with the plain meaning of the statute. In the first place, the FDIC's obligation is only in connection with the Legacy Loans Program portion of PPIP and is clearly contingent. The FDIC is not making any loans itself, but it is agreeing to guarantee the debt financing to be issued by the public-private investment funds established under the LLP. This financing will be used to fund purchases of legacy loans from the banks.
The FDIC has no immediate obligation to make payment, but it would be required to pay out on such a guarantee only in circumstances when there has been a default by the legacy loan PPIF. This liability, as is the case with guarantees generally, falls squarely within the customary definition of a contingent liability.
Second, a contingent liability is not valued at its maximum possible amount, but at its "expected cost" to the FDIC. When Congress instead intends for a contingent liability to be "scored" in its maximum possible amount, it does so expressly, as in Section 102(c)(4) of the Emergency Economic Stabilization Act.
While there can be no assurance that the program will not result in a loss, we further believe that the FDIC has articulated a solid basis on which it concluded that there is no expected loss.
The FDIC's basis includes the following: There will be a substantial equity component of each PPIF, which will not exceed a 6-to-1 debt-to-equity ratio. The assets will be purchased at market prices by investors with high return expectations.
The FDIC will engage an independent consultant to value the assets. In addition, the FDIC will have the assets as collateral for its guarantee obligations and will receive substantial guarantee fees.
This approach is not unique. Indeed, when taking an institution into receivership, the FDIC determines whether it has the authority to issue obligations by using the same methodology that it is using in connection with the PPIP. Likewise, this approach has been used for the FDIC guarantees in connection with the Temporary Liquidity Guarantee Program.
In summary, we believe that the FDIC's position is both legally correct and consistent with precedent. More generally, we believe that the FDIC's proposal is consistent with the spirit and the letter of the responsibilities vested in it by Congress.John L. Douglas
Sara A. Kelsey
William F. Kroener 3rd
John C. Murphy Jr.
