The Hard Truth, Courtesy of the FDIC 19 comments
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Via ZeroHedge, comes a smoking gun release today from the FDIC (pdf). I mentioned last week that the FDIC, which is essentially broke (and by the FDIC, I mean, of course, the DIF - the Deposit Insurance Fund which insures customer deposits up to $250,000), was discussing a plan to re-fund itself by borrowing from its member banks. Tuesday's FDIC press release confirms (pdf) just that. "But wait, Kid Dynamite," you might say, "the release says that the FDIC will have banks prepay 3 years' worth of fees." Yes - that's the same as borrowing from the banks.
Sadly, the FDIC wants to go this route, instead of using a special assessment on the banks, because, in their own words:
"Furthermore, any additional special assessment or immediate, large increase in assessment rates would impose a burden on an industry that is struggling to maintain positive earnings overall."
In plain English, that's like saying "everyone wants to pretend that the banks are solvent, but if we make them actually pay us extra money, it will make it harder to cover up the fact that the banks are insolvent." Thus, we wave a magic wand, and even though the FDIC is asking the banks for 3 years' worth of money today, the banks will be able to recognize the cost over 3 years. Since when do we treat insurance as a depreciating asset? It's not like when you buy an airplane and recognize the cost over 20 years! There is a simple, unarguable fact: if Citibank (C) pays the FDIC $1B today (I'm making this number up) in fees for the next 3 years, Citibank has $1B less in cash today. Not $333MM less in cash - $1B less in cash.
The FDIC's release from yesterday (pdf) is a must read - it contains some serious and scary truths about our national financial situation, despite what the press and the administration have been telling us over the past six months.
Take, for example, this gem:
"Staff’s current projection of $100 billion in failure costs from 2009 through 2013 is higher than staff’s projection in May of $70 billion over the same period. Projected failures have increased due to further deterioration in the condition of insured institutions, as reflected in the increasing number of problem institutions. Asset quality problems among insured institutions are not expected to abate in the near-term."
In plain speak: While you read headlines every day about the end of the recession, improvement among all metrics, green shoots, and how great it is to have 9.7% unemployment and over 500k in new jobless claims weekly, the fact of the matter is that in the last 4 months, the estimate for losses from bank failures over the next 4 years has increased by 43%! And guess what - asset quality problems are not expected to abate!
The FDIC also reminds us of their previous time frame for restoring the Deposit Insurance Fund:
"In October 2008, the Board adopted a Restoration Plan to return the Deposit Insurance Fund (DIF or the Fund) to its statutorily mandated minimum reserve ratio of 1.15 percent within five years. In February 2009, given the extraordinary circumstances facing the banking industry, the Board amended its Restoration Plan to allow the Fund seven years to return to 1.15 percent. In May 2009, Congress amended the statute governing establishment and implementation of the Restoration Plan to allow the FDIC up to eight years to return the DIF reserve ratio back to 1.15 percent, absent extraordinary circumstances."
So, last year, the FDIC hoped to replenish the DIF within 5 years. As reality hit, they adjusted this estimate to a 7 year time frame in February. Then, in May, despite an epidemic spread of green shoots in the media, the FDIC again extended the estimate of time needed until the DIF was replenished to 8 years.
There is another terrifying tidbit in the FDIC's release that's easy to gloss over:
"At the beginning of this crisis, in June 2008, total assets held by the DIF were approximately $55 billion, and consisted almost entirely of cash and marketable securities (i.e., liquid assets). As the crisis has unfolded, the liquid assets of the DIF have been used to protect depositors of failed institutions and have been exchanged for less liquid claims against the assets in failed institutions. As of June 30, 2009, while total assets of the DIF had increased to almost $65 billion, cash and marketable securities had fallen to about $22 billion. The pace of resolutions continues to put downward pressure on cash balances. While the less liquid assets in the DIF have value that will eventually be converted to cash when sold, the FDIC’s immediate need is for more liquid assets to fund near-term failures."
This is the doozy - the FDIC has been exchanging cash for trash - as banks fail, the FDIC takes assets (as they've admitted above: illiquid, presumably low quality paper - perhaps MBS that will turn out worthless?) and gives the failed banks cash to protect depositors. The last sentence of the quote above presumes that in the end, if they wait long enough, these illiquid assets will have value. The problem is, the FDIC needs cash now, and these assets simply cannot be sold for what we're pretending they are worth right now. If you've been following the crisis, you should realize that this is no different from what the banks the FDIC has not yet seized have been hoping - that their trash assets will eventually recover. Everyone is sitting around extending and pretending, delaying and praying, refusing to mark to market, and keeping their fingers crossed that in the end, these assets will be worth what we pretend they are worth. What happens if they're wrong?
Obviously, I'm adamantly against continued attempts to hide the health of the banking industry. The FDIC doesn't want to impose special fees on the banks because it's a tough time for the banks, so they concoct a plan to cook the books -they admit this! They acknowledge that the "prepayment" plan doesn't really change the balance of the fund!
"Although the FDIC’s immediate liquidity needs would be resolved by the inflow of approximately $45 billion in cash from the prepaid assessments, it would not initially affect the DIF balance. The DIF would initially account for the amount collected as both an asset (cash) and an offsetting liability (deferred revenue)."
When you pull forward revenue, you're not improving the long term health of the insurance fund- you're taking money now, and giving up money later.
We need to have another round of special assessments on the banks to shore up the DIF, write trash assets down to realistic levels, seize the bad banks, take the pain, and then we'll be able to move on unencumbered by a never ending pile of bad debt. As we stand now, failed banks have passed their problems on to the other banks, since the FDIC has inherited fantasy assets which are clogging up the balance sheet of its fund.
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> jack
www.calculatedriskblog...
so, for those scoring at home: Citi borrows money using a guarantee from the FDIC. then the FDIC needs money, so Citi prepays its FDIC fees for the next 3 years - with money it just borrowed under an FDIC guarantee! if your head isn't smoking yet, it should be
Since its essentially a pre-paid expense why shouldn't they amortize it. How is it any different than paying a utility bill in advance?
GAAP Accounting 101: The bank expenses the current year portion of the three year assessment, and recognizes the future year portion as a prepaid asset. If they booked expenses attributable to future years in the current year, current earnings would be understated. That's not allowed, although it would be nice to reduce taxable income.
So, in short, it is a balance sheet item, but not a deprecating asset.
If the estimates prepared by IRA, which suggest another 1000 bank failures, are even close to reality there will be panic in the halls of the FDIC and they will draw down their credit line at Treasury at a furious pace. After that we will hold some congressional hearings which might prove quite embarrassing for the Fed and Treasury at which point they will be terminated.
Did you see the BIG DROP this morning?
Each and every time there is a major drop there is a MASSIVE effort by the U.S. Government and possibly other in the G-20 to shill the markets up, usually through the likes of GS.
Rest assured that there will NEVER be another day of 300 or 700 point drops in the market. Ben and friends will print paper to buy-up paper as though their lives depended on it.
No way, no how will the con artist at the FED and G-20 every let the truth out: The United States Government and G-20 are FLAT BROKE!
FDIC... Just covering paper with more paper. If you don't like the wallpaper, just wait a minute and Ben will redo it for you.
The SAD TRUTH is that Ben, Obama and others are starting to believe their own lies!
Current year earnings wouldn't be understated - they'd be accurate - the money must be paid in order for the banks to keep their insurance, which in turn allows the banks to keep their deposits and stay in business. Another way of saying this is that PAST earnings were overstated - the insurance fees charged (by the FDIC) were lower than they should have been.
On Sep 30 11:32 AM The Simple Accountant wrote:
> Kid asks "Thus, we wave a magic wand, and even though the FDIC is
> asking the banks for 3 years' worth of money today, the banks will
> be able to recognize the cost over 3 years. Since when do we treat
> insurance as a depreciating asset?"
>
> GAAP Accounting 101: The bank expenses the current year portion of
> the three year assessment, and recognizes the future year portion
> as a prepaid asset. If they booked expenses attributable to future
> years in the current year, current earnings would be understated.
> That's not allowed, although it would be nice to reduce taxable income.
>
>
> So, in short, it is a balance sheet item, but not a deprecating asset.
I realize that C will have $1 b less today (not $333mm less) - but this is a balance sheet item, not a cash flow statement.
Further, while this isn't a great deal for the banks (because they will have a zero-yielding asset on their books), at the end of the day it is still better than paying MORE in deposit insurance premiums via special assessments.
Finally, it's not a bad deal for the FDIC because they're essentially getting an interest-free loan/advance.
Finally, this is not an attempt to "hide" the insolvency of the bank industry, but rather give the deposit insurance fund the necessary capital to work through today's bank failures.
I am as negative as anyone on the US Bank & Thrift sector, but this idea is definately not the worst to come out of Washington DC in the last few months.
Le déluge.
Regarding the accounting aspects, if they were not banks the treatment would have made no difference regarding their (in)solvency. Since they are, the government will have to decide on whether to use CSAP (Common Sense Accounting Principles) or GAAP.
In the end, Bair will have to put her tail between her legs and go hat in hand to Timmy (which she is trying ever so hard to avoid). Why not tap the line of credit at Treasury and get it over with now!
I know that, from an accounting stand point, an asset is an asset. But to make loans that are backed by a paper entry instead of cash just doesn't seem as sound, especially when the bank goes under. It seems that it will just multiply the problems for the FDIC when all the laundry comes in to be washed.
Thanks for the comment District Banker - but your first sentence is my point: the expense is incurred NOW! not over the next three years - it's incurred NOW because the FDIC - aka the "Banks' Insurance Fund which allows them to operate" is insolvent! The hit should be taken now - and if the FDIC does not need more money in the next few years, then future earnings for the banks (without FDIC fees for the next few years) will look better.
On Sep 30 02:25 PM District Banker wrote:
> You need to brush up on your Accounting 201, Kid. This is a fairly
> simple (and common) ledger line, and prepaid expenses like this one
> are recognized as they are incurred - not paid - as standard practice.
>
>
> I realize that C will have $1 b less today (not $333mm less) - but
> this is a balance sheet item, not a cash flow statement.
>
> Further, while this isn't a great deal for the banks (because they
> will have a zero-yielding asset on their books), at the end of the
> day it is still better than paying MORE in deposit insurance premiums
> via special assessments.
>
> Finally, it's not a bad deal for the FDIC because they're essentially
> getting an interest-free loan/advance.
>
> Finally, this is not an attempt to "hide" the insolvency of the bank
> industry, but rather give the deposit insurance fund the necessary
> capital to work through today's bank failures.
>
> I am as negative as anyone on the US Bank & Thrift sector, but
> this idea is definately not the worst to come out of Washington DC
> in the last few months.
During the S&L crisis, FSLIC's slogan was "We do it with mirrors". FDIC's ought to be "What, me worry?"
Bernie Ebbers was thrown in jail for capitializing expenses, now it is being used as a system patch.
My motto is now the same as Homer Simpson's "AAAAAAAAGHH"
I agree, it is not a good sign for either the FDIC (obviously the DIF is hurting at best, and likely insolvent), or banks (who are incurring higher insurance costs because of the increased number of bank failures).
We are in 100% agreement on this. However, nothing in the above paragraph suggests that banks should simply take this massive hit to equity all at once, immediately. GAAP accounting allows for the recognition of this expense as it is incurred - NOT PAID.
Similar to a deferred tax asset, there is value in this prepaid expense line. There are circumstances where the prepaid expense line may be accelerated - for example if the FDIC comes with their hands out yet again. However likely that may be (and I agree that this almost certainly will happen), it has not happened YET, and thus - GAAP accounting should be applied.
On Sep 30 08:31 PM Kid Dynamite wrote:
> yes i understand the theory of accounting for expenses - but you
> guys are crazy if you just nod your head and apply it here.
>
> Thanks for the comment District Banker - but your first sentence
> is my point: the expense is incurred NOW! not over the next three
> years - it's incurred NOW because the FDIC - aka the "Banks' Insurance
> Fund which allows them to operate" is insolvent! The hit should be
> taken now - and if the FDIC does not need more money in the next
> few years, then future earnings for the banks (without FDIC fees
> for the next few years) will look better.
do you disagree that the expense is incurred AND paid NOW? if you don't think the expense is incurred now, then fine - i don't want to argue that with you.