Winston Churchill was once asked what qualifications would be desirable for a young person wishing to become a politician. Churchill responded:
"It is the ability to foretell what is going to happen tomorrow, next week, next month, and next year. And to have the ability afterwards to explain why it didn't happen."
There are a number of folks around Washington and academia who had best be about the task of honing their political skills, for they have a lot of explaining to do.
False Fears, Bad Policies
Despite their dire predictions and wrongheaded policies, the banking system has not collapsed and the Federal Deposit Insurance Corp. has not gone broke.
Indeed, the FDIC fund has a positive cash balance today that exceeds $10 billion.
Think back to just a couple of years ago., People who should have had more sense were proclaiming on national television that the sky was falling - that nearly all of the nation's largest banks were insolvent and the FDIC would likely need upward of a $100 billion taxpayer bailout.
To justify massive increases in FDIC premiums, the Chicken Littles had to scrap a 50-year-old accounting system so they could show the agency to be in much worse shape than it was.
A Sound Old System
When I was chairman of the FDIC, and for the half century before I became chairman, it reserved for losses on bank failures only as the banks failed.
That seemed like a perfectly sensible system, because it was, and remains, extremely difficult to forecast bank failures more than a few months in advance, and it is even more difficult to estimate the losses the FDIC will suffer once the banks do fail.
Unlike private insurers, the FDIC has the authority to tax its customers and borrow from the U.S. Treasury. Thus, there is no need for the FDIC to anticipate hypothetical losses, particularly when doing so will drain private capital from the banking system precisely when it is most needed to support lending activities.
Challenge from GAO
The General Accounting Office first tried to get its nose under the tent in early 1985. Continental Illinois had failed a few months earlier, and the GAO wanted the FDIC to create a reserve for losses on it immediately.
I refused, because I felt we would need a reasonable amount of time to come up with a reliable loss estimate.
I offered to put a footnote in the FDIC's financial statement to the effect that the Continental Illinois transaction was very large and the losses on it could be material. That was not good enough for the GAO, which threatened not to certify the FDIC's financial statement.
However, I was not about to put out a bad number just to satisfy the GAO.
My successor as chairman sought immediately after assuming office to make peace with the GAO. He established a reserve for losses on the Continental Illinois transaction of $1.8 billion. That reserve, we now know, was $1 billion too high.
The GAO's next move, which was backed by critics of the FDIC on Capitol Hill and in academia, was to insist that the agency establish a reserve for losses on failures that had not yet occurred but were reasonably certain to occur in the next year or so.
Regrettably, the FDIC again capitulated. Last year it increased its reserve for losses to $16.7 billion, which took the fund from a positive balance of some $9 billion to a negative balance of $7 billion or so.
The Sky Has Not Fallen
It seems certain that the FDIC's reserve was calculated on the assumption that three or four large eastern banks would fail. Thanks in part to the interest rate decline, not one of those banks now appears in any serious danger of failing.
Moreover, the FDIC's reserves for losses on failures that have occurred, such as that of Howard Savings Bank, appear to be much higher than the actual losses.
In the meantime, the banking industry, due in no small part to the Chicken Littles on Capitol Hill and in academia, has paid a high political and financial price.
While it might not bother many people that banks have been made to suffer so needlessly, they should reflect on the price the entire nation has paid - a painfully prolonged slump out of which the banks have not been able to help lead us.
Mr. Isaac, a former chairman of the Federal Deposit Insurance Corp., is managing director and chief executive of the Secura Group, a Washington-based financial services consulting firm.