Q&A on the FDIC's Prepayment Plan

We just noticed a piece the FDIC released, giving what it considered answers to frequently asked questions about the proposed prepayment of three years' worth of insurance premiums by banks. This prepayment would bring in an estimated - and probably desperately needed - $45 billion, so that the FDIC can keep its dog and pony show going a little while longer.

Please read the FDIC's prepayment FAQ first, as in the rest of this post we will provide actual answers to the listed questions. We will be writing the replies in the manner of an awkward FDIC employee injected with truth serum. Pretend, if you will, we stand with you in a darkened room. It is stuffy and hot. A sweating accountant is 'cuffed to a chair, blinded by an extremely bright light; his eyes are squinted nervously. A squeaking fan is over in a corner, next to some doughnuts; throw in a couple beefy guys with names like Moose or Rocco for good measure. You get the idea.

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Question #0: Has things gotten this bad because the FDIC is incompetent, or because its leadership is corrupt?

The answer is, obviously, yes.

Question #1: Why is it preferable to prepay assessments rather than borrow from the Treasury?

Well, as revealed by a former FDIC chairman, the FDIC really doesn't have any money at all in the Deposit Insurance Fund; in fact, it can be argued that the DIF doesn't exist at all. The monies which the FDIC takes in for the DIF actually go onto account at the U.S. Treasury, whereupon the money automatically becomes part of the Federal Government's General Fund, and the FDIC gets a lovely I.O.U. But, if you want to pretend the DIF exists, no skin off my nose.

Anyway, prepayments are probably preferable because it is a back-door way of getting real, cash money out of the private sector and into the greedy hands of the U.S. Congress. God knows the need as much money as they can get, and this is a pretty quick way of getting it. Plus it has the perfect cover story: the FDIC needed to 'repair' the DIF, and it needed the prepayments to do so. The money goes into the Treasury where the FDIC can pretend it is on its balance sheet, and the Congress can pretend it hasn't already spent the money a gajillion times over. Sure, the prepayments are only about $45 billion, but it's real money, which is hard to come by these days.

Question #2: Isn’t this a short term solution predicated on a swift banking recovery?

Oh, you noticed?

Ow! Okay, okay!

Yes, this does assume a swift recovery, because banks are going to need all the cash they can get in order to stay afloat when their balance sheets take another nose-dive. That'll be especially true when the Alt-A mortgages start rolling over, because you know those house owners will default right and left. At that point banks will find themselves the proud owners of really overvalued property, as opposed to the merely overvalued stuff already on their books from the sub-prime fiasco. Even if they don't foreclose, the non-performing loans will be bad enough. They'll need cash to try and stop-up the leaks.

Another tidal wave that banks face is the commercial property catastrophe. You had better believe that strip-malls and mega-shopping-centres are on the ropes, and there is no way that consumption will ever recover enough, and quick enough, to rescue those outfits. So, they'll naturally go under, default, and presto the banks have more useless property or non-performing loans on their balance sheet. More leaks, which will need more cash.

Question #3: Would smaller banks be affected disproportionately by this action?

Tough call... probably not all at once, but in the medium term, it will definitely be bad for smaller banks. In theory, it will be worse for the big banks, like Wells Fargo or Bank of America, but those guys have a government guarantee to never run out of money. So, even if this prepayment hurts banks, the smaller banks will feel the pain more, because they don't have a hotline to [Treasury Secretary Tim] Geithner.

Sure, the FDIC could give some exemptions, let a few stressed banks of the hook, but between you and me that probably won't happen much. We need that money, perhaps Congress needs that money to fund something or other that shouldn't be happening, but is anyway. Even if the prepayments help kill a few weak banks, they were probably going to go sometime soon anyway, so it's no big deal

Question #4: Didn’t Congress raise the FDIC’s borrowing limit for just this scenario?

Sure they did, but the FDIC doesn't want to touch that line with a ten-foot pole. Why? Well, the big buzz is that the line is being saved for some 'emergency.' That emergency should be obvious: a sudden and unexpected implosion of, say, Wells Fargo, or Bank of America, or JP Morgan . Hell, maybe this $500 billion has Goldman [Sachs'] name on it, just in case they have some trouble refueling their yachts, or something.

At the same time, if the FDIC were to tap its Treasury credit line, it would have to start paying interest at the Treasury rate. That would mean the FDIC would have to start earmarking money coming in from regular [deposit insurance] premiums, which would be bad because the FDIC is cash-starved. We need every penny coming in to keep up operations, at least at some level, and to have to set aside money for Treasury interest would be dangerous... who knows what that interest rate could do? If it went up sharply, for whatever reason, the interest payments would take a bigger and bigger chunk out of incoming FDIC fund. Hell, interest could end up being more than incoming premiums!

Question #5: Wouldn’t this take much needed capital out of the system and constrict lending?

Hahahaha, lending? Who's lending? Nobody important is lending, you dumkopf! All the big banks are taking their free government money and using it to buy T-bills and other government debt, because that's viewed as an utterly safe investment. I suppose it is, in a way, because they're guaranteed to get paid the face value of their bonds and such. The question is, of course, how much will that buy at the end of the game?

As for capital, well, like I said that really doesn't matter to the big banks, at least not right now. Those banks can simply get a dump-truck of new money dumped into their vaults overnight, problem solved. It's the real banks out there, the smaller ones which tried to be responsible and maintain standards, those are the banks to get socked in the mouth by capital shortages. They probably won't get a bailout from the Treasury or the Fed[eral Reserve]. Instead, if they go insolvent, the FDIC will just close them down and sell them off to bigger, more irresponsible banks which have a Treasury or Fed credit line.

Question #6: How would the banks account for the prepayment?

Ah, here's where it becomes genius. Let's say that Wells Fargo has to cough up $1 billion in cold, hard cash and mail it off to Aunt Sheila [Bair, FDIC Chairwoman]. In the real world, that should show up as a large, one-time draw on liquid assets, like when you write a cheque for cheese doodles and beer at the Seven Eleven.

But hey, this isn't the real world. Instead, accounting law allows Wells Fargo to count that $1 billion as an asset. Cool, yeah? Wells Fargo would thus end up with a three-year 'asset,' which would 'depreciate' by the value of the bank's monthly premium payment. This is how we can claim that banks can handle this prepayment, because they can spread out the pain over three-plus years, when in reality most banks probably couldn't handle such a large outlay of cash.

Question #7: How would the FDIC account for the prepayment?

Well, suddenly we'll be about $45 billion richer, so of course we'll get extra cream-filled doughnuts that day. Beyond that, and at the same time, we'll pretend we only got that quarter's premiums, without the subsequent quarters' prepayment being acknowledged. As the quarters roll by, we'll then pretend that we just received that quarter's premiums, and so on, until three years go by and everything is back to normal.

Hahahaha, normal...

Anyway, it's like having our cake and eating it, too: we've got the money from the next three years, but we'll still count it as regular income over that period, instead of in one lump sum. Don't let that fool you, though, because the FDIC will count the entire $45 billion as being available for spending during the whole period, if the money actually lasts that long.

Question #8: Isn’t this the same as borrowing from the industry without charging interest?

Well, if my pulling a gun on you and demanding all your money is considered borrowing without interest, then yes, this is like borrowing without interest. But really, no, this isn't borrowing. The FDIC doesn't believe in 'borrowing.' Borrowing means the other party has the right to refuse, and Shelia [Bair] doesn't like hearing negatives. The FDIC says jump, and all the insured banks say how high.

Question #9: How many banks would be exempt from paying the assessment up front?

Who knows, probably only a handful. Those banks will be very weak indeed, and they probably should have been closed anyway. If anyone could get their hands on the list of exempted banks, they would've just found the list of the next banks to be failed in the future.

Question #10: If a bank’s total deposits or actual assessment rate decreases during the next three years, would the FDIC refund a portion of their prepaid assessment?

What, does this look like the March of Dimes?

Ack! That hurts, man! C'mon!

Honestly, no, okay? It's part of the deal of getting the insured banks to swallow a prepayment plan. Even if their assessment rate increases, they won't have to pay extra for the next three years. It's actually a pretty sweet deal for banks which are planning on expanding deposits: they pay out, then enjoy insurance on their new deposits for a lower cumulative cost. It's bad for shrinking banks, though, because they'll theoretically be paying extra even if their real assessment has gone down.

Of course, if by some miracle there are any leftover funds in three-years' time, the FDIC will return that to the bank or banks in question. Nice idea, right? Too bad there probably won't be any money left!

Question #11: When is the DIF expected to go negative?

Go negative, as in the future tense? Haha, try July of last year [2008]! Indy Mac was a kick in the pants, far more than we can admit publicly. Simply put, we bit off more than we could chew, and boy did that hurt us bad. Our original estimated cost was over $2 billion short of the actual cost [which was $10.7 billion]. We've been scraping bottom since then, trying to manage closures to keep costs to the DIF down.

Of course a couple times we were forced into action, like with Colonial Bank or Corus Bank. We were hoping that those banks could pull themselves together, but in the end the Comptroller [of the Currency] and Alabama's Banking Department pushed those pieces of crap on us. It was pretty lucky that we could scrape up the money needed [$4.5 billion for the two] in order to get them out the door. Wasn't pretty.

Question #12: When was the last time the insurance fund had a negative balance, and why?

During the [Savings and Loan] fiasco, before I was working at the FDIC. From what I've heard from people, though, the FSLIC [Federal Savings and Loan Insurance Corporation] was trying to pull the exact same thing we are now: hold off on closures as long as possible, keep their costs down, and pray hard that financials could pull themselves together on their own.

That didn't turn out so well, and the FSLIC ended up blowing out so bad that the FDIC had to step in and take over. It was a real mess, as I understand it, and damned expensive. Kinda funny that the FDIC is doing the same mistake the FSLIC made, isn't it?

Question #13: If the DIF goes negative, does this mean that the FDIC will no longer be able to protect insured depositors?

In theory, yes. If the DIF comes up dry, then there's no more money to cover deposits if the sale of banks' assets doesn't cover the full amount of their insured deposits. However, the FDIC has some money squirrelled away which it could tap in a pinch, as well as that infamous $500 billion credit line which it could tap.

However, if the FDIC gets the prepayment to go through, it could be shooting itself in the foot. See, if we do blow through that $45 billion, that's it for three years on premiums. We could levy special assessments, but that would get unpopular really fast. We'd have to tap the Treasury for money, but it we don't have income, how can we pay the interest? It's a no-win scenario. Deposit insurance goes up in smoke, because the NCUA [National Credit Union Administration] doesn't have the resources to take up the slack. Depositors will be at the mercy of their bank's bad investing.

Realistically, though, I suspect that if the FDIC becomes undeniably, inescapably insolvent it will probably be absorbed by the Federal Reserve. It's the only institution big enough to handle the mandate of the FDIC, and it has the ability to simply print up money to pay out insured deposits, even if a bank's assets are completely worthless. That will probably create some serious moral hazard, because with the printing press guaranteeing all deposits banks will have no real reason to seriously invest in real assets.

Question #14: Has the FDIC ever required prepaid assessments or borrowed from the Treasury before?

Yes. There was a prepayment once for... I think it was just an extra quarter, nothing more. So this three-year prepayment is completely unprecedented. We've never done anything like it, and frankly it's because we're desperate for money, and lots of it. We're taking a big chance with the prepayment too, because it removes income flexibility for a very long time. Who knows what can happen in three years? I really don't know what Sheila [Bair] is thinking...

As for borrowing from the Treasury, no. The only borrowing the FDIC has done in the past was from, I think it was the Federal Financing Bank in the S&L crisis. Wasn't much money either, only about $15 billion, so the $500 billion max credit line is a really big deal, especially if it gets tapped. When - not if, when - the FDIC calls on its Treasury credit line, things are very bad and will be getting much worse. Just you wait.

Question #15: How much does the FDIC expect to spend on bank failures, and how much money would the proposed prepaid assessment raise?

Well, the prepayment will take in about $45 billion, like I said. As for the cost of bank failures, the number I've seen kicking around is $100 billion from this year till 2013, but that's just bull. There's no way that the cost will be so low. Heck, this year alone has been about $26 billion, so if that rate keeps up it'll be $130 billion by 2013. But I'll be willing to bet that things are going downhill soon, and fast. Why else would we want that prepayment, and such a big prepayment at that?

Look, we've already set aside over $50 billion in the DIF's Contingent Loss Reserve, and with the $45 billion theoretically incoming, we should have our $100 billion, right? Well, what happens if the next several years ends up being like Indy Mac writ large? What if, instead of $100 billion, it's more like $130 billion? That means $30 billion has to come from somewhere, perhaps the Treasury credit line. But what happens if that comes next year? What happens if the cost is actually $200 billion by 2013? The margins are razor thin right now, and with this prepayment thing in the works it's basically guaranteeing the FDIC is going down smoking.

I hope I can get a job when that happens... Hey! What are you doing with that needle? What is that stuff? Hey, answer me!

FDIC Bank Failure Report - Late Edition

This week, the Federal Deposit Insurance Corporation closed three banks: Warren Bank of Warren, MI; Jennings State Bank of Spring Grove, MN; and Southern Colorado National Bank of Pueblo, CO. Total declared asset value of the closed banks was approximately $633,800,000, and total deposits were approximately $585,300,000. The cost to the FDIC is estimated at $293,300,000.

According to our methodology, the recoverable value of the three banks was $292,000,000, or only 46.07% of the declared asset value. This makes this week's closures distinctly below the cumulative recoverability since December, which stands at 57.44% (down from last week's 57.45%).

Cumulative cost-to-FDIC was brought to $45,998,100,000. This closure brings the total declared assets of FDIC-failed banks (since December of 2007) to $479,023,580,000, and total FDIC-insured deposits to $321,137,920,000. The recoverable value of all failed banks was only $275,139,820,000 (57.44% of the declared value).

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This week's closures were rather piddly, as you can see, with cumulative declared assets below $1 billion. Perhaps the insurance premium cheques got lost in the mail, so the board of directors had to 'pass the plate,' as it were. Frankly, we really don't see how these three little banks were the worst to be found in the U.S. bank system this week. The numbers, although bad, are not at the bottom... or the top, depending if your glass is half-empty or half-full.

We still stand by our concern that the FDIC is the proud owner of a Ponzi-style pyramid scheme, masquerading as deposit insurance. The recent news that the FDIC's forcing banks to pay ahead three years on their premiums is credence to this thought. Why, other than being desperate for liquid cash, would the FDIC force the ailing banking system to cough up around $45 billion in 'premiums?' The only scenario which makes any sense to us is that the FDIC is wholly dependent on its incoming premium payments to maintain a facade of its operations... such as this week's closures.

"In choosing this path, it should be clear to the public that the industry will not simply tap the shoulder of the increasingly weary taxpayer. This proposal is a vote of confidence for the banking industry's resilience, and it will continue to recover its strength as we work through the significant challenges ahead."

So said Sheila Bair, Chairwoman of the FDIC. We're not quite sure where she gets her ideas, as the U.S. Treasury extended the FDIC the $500 billion line of credit awhile back... perhaps she isn't aware that the Treasury plays with the weary taxpayer's money? And how is forcing banks to pay out three years' worth of premiums a vote of confidence, other than confidence that said banks are in deep trouble and the FDIC is out of money?

Ms. Bair makes no sense, in our humble opinion. We're beginning to think that she is, perhaps, just a pretty face (cough, cough), rather than the head honcho of a lean, mean, deposit-insurin' machine. But maybe that's just us.

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On the basis of the ratio of bank closures to population (i.e. simply the number of failures in the State, with no account of assets or deposits), the ten most afflicted States are listed here. Only those States which have two or more closures are considered.

1. Georgia
2. Nevada
3. Illinois
4. Utah
5. Kansas
6. Minnesota (up from #7)
7. Oregon (down from #6)
8. Missouri
9. Colorado (new to list)
10. Washington (down from #9)

The recoverable value represents how much of declared assets are actually worth on the open market. The following are the ten States with the lowest recoverable value; only those States which have had two or more closures are considered in this analysis.

1. Florida (31.89%)
2. California (39.74%)
3. Colorado (42.76%)
4. Michigan (43.07%)
5. Nevada (50.13%)
6. Georgia (53.76%)
7. Utah (55.39%)
8. Arizona (56.08%)
9. Washington (56.18%)
10. North Carolina (56.7%)

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We find it interesting that Georgia, which is the worst-off State by number of closures, is actually only number six on the recoverable value list. Perhaps even more interesting is Florida's besting of California for king of the dung heap. This suggests several things to us:

First is perhaps obvious: Georgia is receiving undue punishment to its banking system, as it is no where near as insolvent as Florida's system. In fact, we will go on record here stating that Florida should have a banking holiday all its own, because it's just that special. Why Georgia is being singled out for a perhaps disproportionate number of failures is unclear to us, but we posit that it is likely politically-motivated; Georgia must have seriously pissed someone off. We can't imagine how or why.

Second is less so, and more subjective: California is getting a lot of press on its bullet-time collapse into fiscal doom, but perhaps the focus is misplaced. California's numbers were squewed by the terrific implosion of IndyMac, and removal of that bank leaves California's recoverable value at 59.49%. This would suggest that Florida is much, much deeper into financial trouble than California, but yet we haven't seen as much gnashing of teeth about how Florida is heading for a sovereign default. Hmmm... why that is, we really don't know, but we expect that Florida will probably have an 'unexpected rise' to the headlines when the State catastrophically implodes.

Is Medical Care a Necessity or a Luxury?

We do not propose to answer this question on an ethical basis, but on an experimental one. We believe that the 2007 Depression will cut into incomes so severely that social observers may get an answer to the question based on patterns of spending cutbacks.

It is irrelevant whether medical costs are paid out-of-pocket, through insurance schemes, or by a government. In the coming years there are going to be severe budgetary constraints at all levels in society from the household to the United Nations. Whether the decisions are made individually or politically, the issue of whether to spend on medical care is going to loom ever larger.

This also raises the question: if medical spending is to continue, what spending will be sacrificed? Obviously, goods and services which are noncontroversially considered luxuries such as travel, dining out, and entertainment may be first in line to the scaffold. After that, electronic and durable good purchases may be deferred or forgone. Then we are getting into the 'meat and potatoes' - necessities.

The USA has, notoriously, the most expensive and least broadly available health care system in the world. If the same or more money is spent, will the USA become a nation of people metaphorically taking each others' blood pressure? In 2008, Medical spending was 17% of GDP. If GDP falls 50%, will medical spending become 34% of GDP? Or will priorities change?

If the axe falls on medical spending the implications are quite dramatic. Workers and investors in the industry have been used to steady (often lucrative) work, and reliable returns. What will the consequence on consumers be? Will even more Americans find themselves uninsured and without access to anything but the most primitive services?

Many questions...with many answers forthcoming in the years ahead.