Recent expensive bank and thrift failures have fanned concerns about the adequacy of the Federal Deposit Insurance Corp.'s Deposit Insurance Fund. Some fear the FDIC will run out of money, and that the fund will need a taxpayer bailout.
Nothing could be further from the truth, because those fears are based on myths the FDIC has failed to dispel about the fund.
Myth No. 1: The fund has money in it. False, it has no real money. It is no different than the Social Security Trust Fund or the Highway Trust Fund — it is a fictional fund largely invested in fictional Treasury securities.
The fund is a fiction because the FDIC is an "on-budget" agency of the federal government. Every dollar it collects from outside the government, primarily through insurance premiums, counts as a dollar of government revenue for the year it is collected, while every dollar it spends outside the government counts as a federal expenditure.
The fund's balance or net worth — $45.2 billion as of June 30 — is merely the cumulative effect of all the fund's financial transactions.
As with other federal trust funds, a key element of this accounting is crediting it with fictional interest income on its fictional Treasury investments. For 1997-2006, almost all the fund's income consisted of this fictional income. That changed in 2007, when the FDIC began charging all banks and thrifts for deposit insurance.
Myth No. 2: Depositor protection is weakened if the "reserve ratio" (the fund balance divided by insured deposits) drops below 1.15%. In fact, that minimum ratio, arbitrarily established by Congress, has absolutely no actuarial basis. Instead, it is rooted in the FDIC's fundamental misunderstanding, dating to the 1930s, as to how a property insurer (which the FDIC is) should be capitalized.
What the minimum reserve ratio actually accomplishes is holding the cumulative amount the agency has collected in insurance premiums since 1934 in rough balance with its operating expenses and deposit insurance losses.
In effect, over the long run, the FDIC has operated close to break-even.
Myth No. 3: The fund will run out of money. This concern has been fed by the FDIC projection of as much as $10 billion of losses for the 10 bank failures so far this year. Those losses helped to drop the fund's balance $6.1 billion below the minimum established by the 1.15% reserve-ratio requirement.
What that deficiency actually represents is a banking industry IOU to the federal government. The FDIC will collect on that IOU, because Congress has given it authority to tax domestic bank deposits for whatever amount is needed to keep the reserve ratio at or above its statutory minimum.
The key question now is how quickly the agency will hike its insurance premium rates to cover that $6.1 billion deficiency while paying for future bank failures and rebuilding the reserve ratio to 1.15%.
The FDIC has up to five years, or even longer, to accomplish that task. Presumably, it will soon announce a "DIF restoration plan," along with substantial revisions in how it calculates risk-sensitive insurance premiums.
Myth No. 4: The FDIC needs to borrow money from the Treasury. FDIC Chairman Sheila Bair was quoted at an Aug. 26 news conference as saying her agency "may need to tap into lines of credit with the Treasury for working capital."
In fact, the FDIC has ample fictional Treasuries — $51.7 billion as of March 31 — to meet its working capital needs. What it should do is sell some of these fictional securities to the Treasury Department, which in turn will sell real Treasuries to investors to raise the working capital the FDIC needs.
The Treasury's Borrowing Advisory Committee stated as much on July 29. "Recent actions by the FDIC to take over several U.S. banks, including IndyMac, has led to the need for the Treasury to borrow additional funds to meet the needs of the FDIC."
Because the FDIC is an on-budget federal agency, the money it is spending to protect depositors in failed banks adds to this year's budget deficit, hence the need for additional Treasury borrowing and premium hikes.
Myth No. 5: The FDIC will need a taxpayer bailout. Not so, for today's banking industry has the financial capacity to pay any reasonably anticipated amount of losses in failed banks.
In 1989-1996 banks and thrifts paid $38.35 billion of insurance premiums, for an average premium rate of 15 basis points, more than double today's average. The industry did not pay that sum happily, but it paid, and it can pay again, by passing higher premiums through to depositors and borrowers.
Today an average premium rate of 15 basis points would generate over $10 billion annually. Unless banking regulators continue to drop the ball by failing to enforce Congress' Prompt Corrective Action mandate for weak banks, deposit insurance losses should not require such high premiums.
The last thing anyone should want is an appropriation of taxpayer funds to the FDIC, for any such appropriation would be accompanied by new regulatory burdens and obligations that would be crippling to the banking industry and the economy.
Myths are dangerous in deposit insurance, for they lead to unwise decision-making and errors in public policy. If the FDIC will not act to demolish the myths that have developed about deposit insurance and its finances, then the banking industry needs to do that job.
