WASHINGTON -- Despite a House subcommittee's approval of a plan to continue federal deposit insurance for public pensions, state and local government officials say the insurance system needs to be further refined before municipalities are treated fairly.

As part of an omnibus financial restructuring bill moving through Congress, the provision for public pension plans, known more commonly as 457 plans, was approved 22 to 14 in mid-March by the House Banking Committee's financial institutions subcommittee, even though there is a general sentiment among panel members that the scope of deposit insurance should be scaled back.

State and local officials lauded the subcommittee's actions to insure public pensions but urged further reforms of the federal deposit insurance system to cover deposits municipal governments hold in banks.

Under current law, money deposited in banks by state and local governments is covered by federal deposit insurance only up to $100,000 per account. In other words, in the case of most bank failures, the municipality would have insurance only for $100,000 per account.

To guard against looses on deposits in excess of $100,000, most states require collateralization of deposits or have other arrangements to make localities whole if a bank failure occurs. But these protections, unlike federal deposit insurance, cost municipalities money.

"I'm concerned because collateralized deposits are not the same as coverage by the FDIC," said Frank Shafroth, chief lobbyist for the National League of Cities.

"It's true that if the deposits are collateralized, you don't lose your money," Mr. Shafroth continued. "But it costs about 50 basis points. It's not the same thing."

Too-Big-to-Fail Banks

The only other way for municipalities to ensure the safety of their funds is to place them in an institution that is considered "too-big-to-fail" -- a bank of such systemic importance that its collapse would drag down the nation's entire financial structure.

But Cathie Eitelberg, director of the Government Finance Officers Association's pensions and benefits program, noted that some states prohibit local governments from placing their funds in out-of-state institutions.

Idaho, Nebraska, Washington, and West Virginia all bar the use of out-of-state banks, and none of those states is home to the type of mega-bank contemplated under the government's amorphous too-big-too-fail doctrine.

Despite the perceived safety of municipal deposits in so-called too-big-to-fail banks, the choice is not clear-cut for treasurers.

Mr. Shafroth noted that most treasurers ideally would like to keep public money in local banks. Such deposits would enable banks to use the money to make loans locally, helping to ensure community reinvestment.

"The current system provides a bias in that a sharp local official will want to put money in a too-big-to-fail bank," Mr. Shafroth said. "But that, in most cases, is going to mean the money is deposited outside the community, and [it is] not going to get the benefits of community reinvestment."

Nevertheless, Mr. Shafroth facetiously suggested to Treasury Department officials that they supply a list of too-big-to-fail banks that the league of cities could distribute to members.

"Public deposits are not like those of some big player for the L.A. Lakers," Mr. Shafroth said. "It's taxpayer money. And a city is a fiduciary for that money and has to make sure it's safe."

The general consensus among state and local lobbyists is that Congress ultimately will retain current law and continue to provide insurance coverage of only $100,000 per municipal account.

But there has been talk among lobbyists that Rep. Barney Frank, D-Mass., may be interested in pursuing an amendment that would provide 100% coverage for municipal deposits. But Rep. Frank, who successfully pushed the provision that would continue coverage for 457 plans, has not committed to the idea.

Lobbyists said they will continue discussing the matter with Rep. Frank, and at least one believes such a measure could pass.

"If [Rep.] Frank makes a decision to do it, I'd be modestly hopeful that it would pass," the lobbyist said.

In the meantime, representatives of state and local governments are pleased with the subcommittee's vote to continue pass-through insurance coverage for participants in 457 plans.

"We're very happy with the amendment," Ms. Eitelberg said. But she said the government finance officers group remains concerned about another amendment cleared by the subcommittee that would eliminate coverage for bank investment contracts.

"There is some concern that we could win the battle and lose the war," Ms. Eitelberg said.

Investment Type Is Important

The group's concern stems from the fact that some 457 plan managers may choose to invest in bank investment contracts. If they did, those investments theoretically could be denied insurance coverage. "The type of investment the plan is using could make the difference," Ms. Eitelberg said.

During a colloquy among sub-committee members, it appeared that bank investment contracts held by 457 plans would retain coverage. But lobbyists are hoping the report drafted by the subcommittee in connection with the legislation clearly will reflect that members intended to exempt 457 plan investments from the insurance ban.

Ms. Eitelberg noted that there is little difference between 457 plans and individual reitrement accounts or 401(k) plans, the private-sector equivalents of 457s. State and local government employees place money in 457 plans and instruct the plan managers on how they would like their money invested.

The primary difference is this: The money in 457 plans by law is considered the property of a municipal worker's employer until dispersed. Congress authorized 457 plans in that fashion to avoid current taxation.

While the amendment providing coverage for 457 plans appears destined to remain in the comprehensive financial restructuring bill, it remains unclear whether the bill itself will clear Congress.

The legislation includes a number of controversial reforms -- such as repealing the 1933 Glass-Steagall Act's prohibitions on the integration of investment and commercial banking -- that could derail the entire package.

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