WASHINGTON — Government officials downplayed the possibility Monday that a plan to help clear toxic assets from bank balance sheets could lead to higher deposit insurance premiums.
Under the Obama administration's plan, the Federal Deposit Insurance Corp. would guarantee debt for private investors seeking to purchase illiquid mortgage assets. If the program resulted in losses, the agency would have to charge all institutions a systemic risk premium based on their total liabilities.
But FDIC Chairman Sheila Bair called such a scenario unlikely and argued instead that fees charged to participate in the program could end up bolstering the Deposit Insurance Fund.
"I actually think the credit risks for us are pretty good on this, and our anticipation is that it will make money for the DIF, as well," Bair said in a conference call with reporters. "In my opinion, I think it will be very profitable."
The issue is critical, because the level of federal reserves has declined rapidly as bank failures have mounted. At yearend the agency held only $18.9 billion of reserves, and it is now contemplating a massive premium on banks. But the agency has been working to reduce any new premium by seeking legislation to increase its borrowing authority and using revenue from a separate debt guarantee program to add to federal reserves.
Under the new program, the agency agreed to guarantee around $500 billion of debt for public-private funds that are purchasing illiquid mortgage assets. The agency would charge a guarantee fee — the exact terms were not yet public — to those funds. Most of the money would be used to create a federal reserve against future losses. But Bair said a portion would be set aside for the DIF, potentially helping to build it up.
Though Bair was confident the program would not lose money, industry representatives were not so sure.
Under the program, banks would decide which assets — usually a pool of loans — they would like to sell, in conjunction with their federal regulator. The FDIC would conduct an analysis to determine the amount of funding it is willing to guarantee. FDIC officials said the maximum leverage would be $6 of guaranteed debt for every $1 of equity.
The FDIC would then conduct an auction for the pool of loans, with public-private investment funds bidding on the assets. The winner would split equity financing with the Treasury Department.
Some industry officials said they were concerned the FDIC was taking on a lot of risk under the program.
"We do have concerns for the stability of the FDIC fund should investors overpay for these pools," said Camden Fine, the president of the Independent Community Bankers of America. "If the investor cannot liquidate the pool for at least the price minus equity that investor pays for it, then the FDIC is on the hook for the risk."
But Bair said the FDIC has safeguards. For one, investors would undoubtedly bid a price below the bank's estimate for the pool's value. Secondly, private-equity investments would be wiped out before the agency took any loss. She said the FDIC would have a cushion should the underlying value of the mortgages prove to be worse than expected.
Bair also said that the leverage the FDIC would agree to take on would vary from pool to pool, and that investors would not be allowed to use the maximum amount of leverage to purchase riskier groups of assets.
But some former FDIC officials said the plan may not work.
"The chances are good that the taxpayers and the FDIC are going to lose money on this deal, or it's not going to work, because banks aren't going to sell," said William Isaac, a former chairman of the FDIC. "My instincts are telling me that this program probably won't do a lot of damage … but I would be surprised if it works."
Isaac also said a special industrywide assessment on banks could create a "political firestorm" for the government.
"I'm very concerned about that, that the FDIC is exposing its insurance fund to this kind of risk," he said. "Because the bankers are having to pay for that. That's not what they bargained for when they signed up for deposit insurance."
Any losses would not be taken out of the DIF. Instead, the government would assess a systemic risk assessment, which banks pay according to the size of their liabilities, rather than their domestic deposits, as in the case of regular premiums.
"They'll change the way it's assessed so it doesn't hit the small banks disproportionately," Isaac said, though the concession likely would not be enough.
Legislation the FDIC is seeking would give the agency more flexibility to charge any assessment, including forcing bank holding companies — which are currently exempt — to pay.
But until that legislation becomes law, some said, community banks are at risk.
"Community bankers are furious," said Chris Low the chief economist at First Horizon National Corp.'s FTN Financial. "For the most part, they didn't make these bad bets, and they're paying to bail out others."