Last summer, well before the recent economic collapse and passage of the Emergency Economic Stabilization Act, the Federal Deposit Insurance Corp. was projecting significant failures that would necessitate an increase in the Deposit Insurance Fund balance.
Now, in light of the magnitude of the financial crisis and predictions of a severe recession, troubled banks may soon fall like dominos into insolvency. Taxpayer funds may be needed to help the fund meet the FDIC's receivership needs.
The Bush administration's $700 billion plan to inject capital into the banking system failed to stabilize it, thaw frozen credit markets, or stem the rising tide of loan defaults and mortgage foreclosures. Some recipients of the Treasury Department's first $125 billion of taxpayer funds did not needed the money to plug holes in their balance sheets, nor did they desire the cash, causing many policy analysts to wonder why these relatively healthy banks were targeted, rather than the scores of truly troubled ones drowning in toxic pools of deflated mortgage assets.
If, as the theory goes, good money drives out the bad, the moral here may be to pump the next tranche into the balance sheets of banks facing threats to their solvency. Otherwise, if the coming recession is as deep and broad as experts are forecasting, the FDIC will have to gear up for a year of closings of historic proportion.
Its fund may not have the resources necessary to cover uninsured deposit accounts and the agency's other operational activities. As of the end of June, the most recent date for which data is available, the fund's balance had fallen to just $45.2 billion, its lowest level since 1995, and the reserve ratio had fallen to a low of 1.01%.
The number of banks in desperate need of capital increases daily. And regulators know from the last spate of failures that delaying the resolution of dying banks only increases, often by magnitudes, the cost to the Deposit Insurance Fund.
Time is of the essence. On Oct. 28, Anthony Ryan, the Treasury undersecretary for domestic finance, said the federal government will be forced to borrow an unprecedented amount of money this fiscal year to cover, among other things, the FDIC's need for resources to deal with a rising number of bank failures.
How many failures are expected and in what dollar amount were not disclosed. But the fact that the FDIC may be considering taxpayer funds to capitalize the fund as a supplement to premium assessments should send shock waves through the industry, since it sheds some light on regulators' projections for the number of failures.
The plan to inject massive amounts of good money into failing banks that can meet the Treasury's nonnegotiable terms of investment may stave off some failures by propping up balance sheets, but for how long? With the FDIC guaranteeing every type of deposit in sight, the hit to its fund from wide-scale bank closings may be further magnified.
The government must use its authority under the new Troubled Asset Relief Program to encourage strong banks to acquire weak ones and force consolidation by jettisoning poisonous assets to the FDIC for management and liquidation under the Stabilization Act. This approach may offset the need to reach deeply into a troubled Deposit Insurance Fund, but it fails to resolve the related goals of stemming the storm of foreclosures and stabilizing residential real estate values.
Throwing more taxpayer money at healthy banks will not push the money into the wallets of property owners facing foreclosure or prevent more loan losses at failing banks. The fund will need more money really fast.
If the banking industry doesn't start recovering soon, there are signs that the FDIC will have a very busy new year with perhaps a historic number of failures. If so, taxpayers and other stakeholders should know that the FDIC has a successful track record in liquidating bank assets, and its management is battle-tested from the last banking crisis. Many of its senior managers demonstrated maturity of judgment and prudent decision-making during the recession-driven wave of bank failures in the late 1980s and '90s when real estate values plummeted. And current FDIC Chairman Sheila Bair has already shown creativity, prudence, and steady leadership in the first few months of this crisis.
As a FDIC veteran of the last crisis, I am confident that her performance and that of her senior staff will lead the agency and the industry through the current one.