It is time to reflect on a crisis that did not happen in 2009 or 2010: depositors did not display a crisis of confidence in the Federal Deposit Insurance Corp. and its Deposit Insurance Fund following the financial meltdown. A crisis of confidence could have easily happened, given the circumstances, and some might suggest that it almost did.
Instead, insured deposits were a center of stability for the U.S. throughout the recession and the financial panic. In 2009, deposits in U.S. banks grew by nearly $200 billion. They grew by nearly another $200 billion in 2010 and they are still growing, though not quite as robustly since savers are feeling more comfortable about investing their savings.
Things could have been otherwise. By the end of 2009, the $53 billion surplus that the DIF held going into the recession was on track to become a $21 billion deficit. A major part of the deficit came from the FDIC's estimates of future losses, a requirement of its accounting practices. The failure of several mid-size mortgage lenders (among 140 banks that failed in 2009) had already hit the FDIC with tens of billions of dollars of deposit insurance costs, and more were on the way with over 700 banks on the problem bank list. That is to say, in 2009, the FDIC was not yet on the verge of running out of money on hand, but its outgo was going out fast.
The FDIC needed to do something, quickly and carefully. Under the law and previous practices, it had several options, neither of which looked very good, especially in the prevailing financial psychology. The FDIC could raise deposit insurance premium rates, but it had already quadrupled them in 2008 and 2009. An increase in annual premium rates in the teeth of a recession would be another blow to banks already reeling from losses from loans going bad. It was also not clear if it would be possible to raise premium rates high enough to bring cash in fast enough to meet the FDIC's near-term cash needs.
The FDIC could have gone to the Treasury for funding. However, in light of the unpopularity of the TARP programs and the various other emergency funding facilities of the federal government, the image of the FDIC going cup-in-hand to the Treasury threatened to feed images of government panic. One of the stabilizing differences between 2009-2010 and the 1930s was that this time there were no panicked depositors lining up outside of closed bank doors. Retail bank transactions continued pretty much in normal patterns.
Instead, the FDIC board chose a bold and innovative experiment. It required banks to pay deposit insurance premiums, at existing rates, three years in advance. In exchange, the FDIC gave banks a non-interest bearing asset that would remain on banks' books until redeemed through regularly scheduled premium payments. The FDIC received an immediate cash infusion of $45.7 billion from the banking industry. The banking industry that had always funded the FDIC would continue to shoulder the financial responsibility for deposit insurance.
That advance lump-sum payment was a major hit to banks at a precarious time. But as a one-time hit rather than a general rise in premium assessments, it did not become a prolonged increase to banks' cost of business and was therefore better absorbed by banks in their operations.
In the end, not all of that cash was needed. No fault to the FDIC, which, like any insurer, operates conservatively with an eye on its obligations to those it insures. In recent weeks, with DIF resources growing well ahead of schedule, the FDIC has announced that at the end of the month it will refund to banks $5.7 billion of those prepaid assessments that the FDIC did not use.
And so this June the FDIC will conclude what turned out to be a very successful experiment. Regarding deposit insurance fund shortages, the law really only lays out two options: Go to Treasury or raise rates. The FDIC chose to do something that is not specified as an option in the law and developed a brand new option that had not been contemplated in the statute.
The financial line to the U.S. Treasury still exists on paper, but the FDIC's experience with funding its emergency needs by calling upon banks to prepay future premiums suggests that the line to the Treasury may never be used. That is a good thing. And so is the fact that the banking industry continues to shoulder all of the funding for deposit insurance.
Wayne A. Abernathy is executive vice president for financial institutions policy and regulatory affairs at the American Bankers Association. Previously he served as assistant secretary of the Treasury for financial institutions and as staff director of the Senate Banking Committee.