Who's Watching the FDIC?

by: Linus Wilson

Another Friday and another bank that was deemed “healthy” by regulators and the U.S. Treasury sees its bailout shares wiped out. Taxpayers this time lost $4.1 million as the Federal Deposit Insurance Corporation (FDIC) seized the southern California Pacific Coast National Bank. Sunwest Bank of California will assume Pacific Coast’s deposits and assets.

FDIC head Sheila Bair, apparently anxious about the fact that her agency had wiped out a combined $303 million in taxpayer capital injections in two weeks, sat down with Paul Solomon of PBS’s Newshour. The FDIC is as much in the bailout business as the U.S. Treasury, but she used the interview to slam the U.S. Treasury’s efforts. She criticized the Troubled Asset Relief Program (TARP) capital injections into the big banks and, in the same breath, she said that the FDIC’s under-priced credit default swaps called the Temporary Liquidity Guarantee Program (TLGP) was the best way to run a bailout.

Just because the FDIC has not lost much money on their under-priced credit default swap insurance does not mean that it never can or never will. American International Group (NYSE:AIG) profited handsomely from selling credit default swap insurance until a few months before the Federal Reserve and later the U.S. Treasury injected billions of dollars into that failed institution. The FDIC is moving into the lines of business that brought AIG near bankruptcy.

I’m no fan of the Treasury’s capital injections from TARP. The Congressional Oversight Panel’s February Report and I have criticized them as overly generous to the recipient banks. Moreover, my solo and joint research has argued that the Treasury injected the wrong type of capital if they wanted banks to make more good loans. That research has said that there is little economic justification for injecting cheap capital into institutions that pose no systemic risk. This point seems particularly relevant after the failures of CIT Group (NYSE:CIT) and UCBH Holdings (UCBH), which cost taxpayers a combined $2.6 billion.

Yet, the FDIC’s loan guarantees are probably worse than the TARP capital injections. TARP was passed by Congress and signed by the President. What Congressional or Presidential authority did the FDIC have to get into the credit default swap business? The Congressional Oversight Panel (COP) stated in its November 2009 report estimates on page 69 (71) that the FDIC’s loan guarantee program amounted to a $13.4 billion to $28.9 billion subsidy to the banks. The impact of this subsidy is that banks such as Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS), which may have received subsidies of $2.3 billion and $3.7 billion under that program, will be encouraged to be over-reliant on the short-term, repo financing that brought down Lehman Brothers and Bear Sterns. If short-term creditors get nervous, the FDIC or the Federal Reserve will step in through discount window loans and bail them out.

For all its problems, the U.S. Treasury has been much more transparent in its efforts to shore up the financial system. It publishes term sheets and contracts in a timely manner. Not so with the FDIC. The FDIC is flaunting the Freedom of Information Act (FOIA) by not disclosing basic details of the loan guarantees and lines of credit that have granted a group of hedge fund and private equity investors that bought the failed assets of Corus Bank. My research shows that these loan guarantees inflate asset prices, yet the cheap loans may not hurt taxpayers and the deposit insurance fund if the toxic asset sales are from failed banks.

Perhaps more questions need to be asked of the FDIC. So far it has been clever in avoiding the bailout tag, but it has been and still is an active participant in bank bailouts.

Disclosure: I only have long positions in broad-based index funds. This is not investment advice.