Why Banks Won't Need to Rescue the FDIC

It seemed like a classic "man bites dog" story. America's banks, having been repeatedly rescued by the government in the past 18 months, were about to turn the tables and rescue the government by lending billions of dollars to the beleaguered Federal Deposit Insurance Corporation. So reported The New York Times. Well, it could happen, but it's a long shot, and even then, the banks wouldn't quite be rescuing the FDIC.

True, the FDIC—which insures bank deposits up to $250,000—has experienced a dramatic decline in its cash reserves as more U.S. banks have failed. It needs money. So far in 2009, 94 banks have failed. At the end of June, the FDIC also had 416 banks with $300 billion in assets on its "problem list," the largest number since 1994.

All this has had a devastating effect on the fund that the FDIC taps to pay depositors in failed banks. In mid-2008, the FDIC's cash reserves totaled almost $56 billion. A year later, they had dropped to $42 billion and, worse, $32 billion of that was already committed to failures that the FDIC anticipated in the coming year. The remaining $10 billion is a thin cushion for additional failures. Indeed, the FDIC has projected that failures over the next five years will cost another $70 billion.

Where is the FDIC going to get the extra dough? In some ways, its plight isn't as dire as it seems. Unlike most federal agencies, the FDIC isn't supported by taxpayers. Fees on banks cover its costs. In 2009, those regular fees will total about $12 billion, and similar amounts can be expected in the future. The FDIC could supplement its regular fees with a special assessment. The agency did that in the second quarter of 2009, raising almost $6 billion. But there's a catch: the fees count as a bank expense and, by dampening bank lending, may hamstring the economic recovery.

"What they're learning is that such large expenses can do more harm than good," says James Chessen, chief economist of the American Bankers Association. "It's a hit to bank capital. It makes it more difficult for banks to lend in their communities."

The FDIC could also borrow from the U.S. Treasury. It could receive up to $100 billion almost immediately, says FDIC spokesman Andrew Gray, and could go as high as $500 billion with approval from the Treasury and the Federal Reserve. But there may be political and public-relations obstacles. Shelia Bair, head of the FDIC, has had spats with the Treasury, and the Times quotes one industry official as saying that Bair "would take bamboo shoots under her nails before going to Tim Geithner and the Treasury for help." Banks also dislike Treasury borrowing because it looks like another industry bailout.

It's in this context that borrowing from banks themselves has been discussed. The banks would lend to the FDIC and would then be repaid from the future insurance fees levied on (yes) banks. Just whether the existing fees would suffice or future fees would have to be raised is unclear. Any Treasury borrowing would similarly be repaid from banks' future insurance fees. "[I]t is a question of the timing of bank premiums, not of the willingness of banks to fully support the [FDIC]," Edward Yingling, head of the ABA, wrote Bair last week. However, FDIC spokesman Gray says that the bank borrowing is "not an option being given serious consideration."

One other possibility is that the FDIC could advance all the quarterly fee payments for 2010 to the beginning of the year. This would provide more upfront cash to deal with failures, though it would not increase the FDIC's total cash. The five-member FDIC board is expected to make some decision next week.