Seeking Alpha

Vernon Hill


About this author:

When FDIC head Shelia Bair says her agency might have to bolster the FDIC's insurance fund with Treasury borrowings to pay for the new spate of bank failures, a lot of us, this 40-year banking veteran included, assumed there's an actual FDIC fund in need of bolstering.

We were wrong. As a former FDIC chairman, Bill Isaac, points out here, the FDIC Insurance Fund is an accounting fiction. It takes in premiums from banks, then turns those premiums over to the Treasury, which adds the money to the government's general coffers for "spending . . . on missiles, school lunches, water projects, and the like."

The insurance premiums aren't really premiums at all, therefore. They're a tax by another name.

Actually, it's worse than that. The FDIC, persisting in the myth that its fund really is an insurance pool, now proposes to raise the "premiums" it charges banks to make up for the "fund's" coming shortfall. The financially weakest banks will be hit with the biggest tax hikes.

Which makes absolutely no sense. You don't need me to tell you the banking industry is on the ropes. The last thing it needs (or the economy needs, for that matter) is an expense hike that will inhibit banks' ability to rebuild capital, extend new loans, or both. If the FDIC wants to raise its bank tax once the industry has recovered, I suppose that's fine. But to raise taxes on the industry now is perhaps the dumbest thing the agency can possibly do. At the margin, the FDIC will be helping bring about more of the failures it says it wants to prevent.

But this is the government we're talking about, so logic goes out the window. First, the FDIC insists its mythical bank insurance fund exists, when it really doesn't. Then the agency does what it can to run the imaginary fund's finances straight into the ground. Your tax dollars (sorry, "premiums") at work. . . .

Print this article with comments

This article has 32 comments:

  •  
    This is more laissez-faire silliness.

    The difference between the government as an insurer/credit enhancer and any such actor in the private sector is that the government can print money and issue debt at the risk-free rate whenever it wants - and Republicans generally want it to do that a whole lot.

    So, just as the government does to pay for Republican "tax cuts" (aka - "increasing borrowing on our spending"), they will issue debt to back FDIC, since, of course, our entire system is based on debt.

    Banking relies on deposit insurance. Diamond and Dybvig proved that long ago. If the spending-mad Republicans spent-and-borrowed away the FDIC's reserves the way they spent-and-borrowed away the Medicare and Social Security trust funds, the nation will do what it has done since the New Deal - issue debt and invest to add value.
    2008 Sep 12 04:29 AM | Link | Reply
  •  
    This is really sick stuff. Didn't know about this.
    2008 Sep 12 05:19 AM | Link | Reply
  •  
    The banking system needs to be taken down, period.

    2008 Sep 12 10:44 AM | Link | Reply
  •  
    nothing needs taking down. it will come down on its own.the american sheeples will see to it as they keep relecting the same fools.
    2008 Sep 12 11:14 AM | Link | Reply
  •  
    I suspect, out there in the 'heartland', hah, they've done it to themselves. They, the financial institutions, deserve the just rewards.
    2008 Sep 13 10:51 AM | Link | Reply
  •  
    I suspect the general feeling out there in the 'heartland' is 'just rewards', and that the financial institutions did themselves in when federal regulations pre-Reagan evaporated and they could have their way in the market place and wall street.
    2008 Sep 13 10:53 AM | Link | Reply
  •  
    "I mean seriously, did you think they "invested" it in something...stocks? mutual funds? mortgages? commercial loans?"

    Perhaps you don't understand the idea of "insurance". There are tons of insurance companies all over the world, some with exposures significantly greater than the FDIC, and they find useful ways to park their money.

    The whole idea of compartmentalizing is to reduce risk. The idea of a separate corporation for the FDIC is to keep the risk managed in one place, so (theoretically) managers at the FDIC should have pulled the fire alarm a couple of years ago, saying that their cost of risk was starting to exceed their capital.

    When you're simply paying a tax and getting a direct siphon into the US Treasury, all the advantages of the "insurance" structure are gone.
    2008 Sep 13 12:46 PM | Link | Reply
  •  
    So the FDIC is an insurance company that invests entirely in T-Bills? I don't see the problem. Actually, this is smarter than diversification. As I see it, most other investments (stocks and mutual funds, primarily) suffer in at least the short term with bank failures, making them a bad FDIC investment (you lose money in your investments right when you need to use it to cover your insurance obligations).

    Notably, the FDIC is itself insured by the federal government.

    I agree that now is not a great time to raise premiums on banks, but the banks have done risky things themselves. Noone can argue that a bank isn't more likely to fail in 2008-2009 than in 2005-2006. As the risk in insuring banks rises, the premiums need also rise.
    2008 Sep 13 05:56 PM | Link | Reply
  •  
    No. The FDIC fee pays for the useful service of paying off part of deposits when a bank fails. The government needs to charge higher fees when it pays out more to depositors. For the bank it is a cost of doing business and if it cannot pay the higher fee it should go out of business. Ignore "fund" and "tax".
    2008 Sep 13 06:07 PM | Link | Reply
  •  
    John in NC - there's a third option. A bank can exist without FDIC backing. However, it's going to have a harder time drumming up business (because you can lose your money if they go under). Such a bank would face a multitude of additional hurdles and limitations, but it's not impossible, merely unattractive.
    2008 Sep 13 06:12 PM | Link | Reply
  •  
    "The financially weakest banks will be hit with the biggest tax hikes."
    Mr. Hill, I'm not questioning you at all, but is there a reference you can offer to support this? I'm just curious.
    From the sounds of it, they turn bank premiums over to the Treasury in return for T-bonds/bills/notes, which are slightly less-liquid than the premiums in cash-under-the-mattres... form, but the bonds at least maintain some purchasing power. Plus--correct me if I'm wrong--the FDIC would choose to free up cash by liquidating their nearer-maturity Treasury portfolio at a premium, since the front-end of the curve's rates are down, right?
    Echoing Zachary, what's the problem with raised premiums? Regulators could demand that banks hedge their loans against nonperformance with CDSs, but there's a premium on swaps because default probability is high. When the probability of bank collapse is high, premiums for insurance should be too... however, I think that it should be a case-by-case, subjective assessment. Capitalization, solency, and reserves are a case-by-case, bank-by-bank assessment, so why aren't insurance premiums wrought from the same analysis?
    2008 Sep 13 11:35 PM | Link | Reply
  •  
    Hardball...would you believe it....Mr. Hill is a banker who got out when the getting was good. He will be back....to help pick up the mess I am sure. He just wants to make sure that his new bank will not have to pay the real going rate....."Meet the new banker...same as the old banker."
    2008 Sep 14 01:43 AM | Link | Reply
  •  
    The financially weakest banks are weak for a reason. Who does this author want to pay for the upcoming defaults of Wamu, Wachovia, Citi, etc. ? The banks themselves are supposed to pay for the insurance.
    Moral hazard indeed.
    2008 Sep 14 04:43 AM | Link | Reply
  •  
    "The insurance premiums aren't really premiums at all, therefore. They're a tax by another name."

    A tax enacted at the same time as a deposit guarantee, with the intent that the tax should, in the long run, be approximately enough to pay for the deposit guarantee. In any given year, of course, the money coming in may be more or less than the money going out, just as with an ordinary insurance company. And, just as with an ordinary insurance company, the money must be invested somewhere, preferably someplace that (as Zachary points out) won't fail at just the time you need to make a lot of payouts.

    The important differences with an ordinary insurance company are
    (a) an ordinary insurance company would also have to earn a profit to pay dividends to its shareholders, which FDIC doesn't have,
    (b) an ordinary insurance company's policies are set by its own interest, rather than by (Washington bureaucrats' estimates of) the national interest, and
    (c) since FDIC doesn't have a precise bank balance, it is theoretically possible for it to make LOTS of payouts in an emergency, limited only by the total Federal treasury and Congress's willingness to spend it.

    You can decide for yourself whether each of these three differences is a good idea :-)

    If deposit insurance were done by the private sector, do you think they would be raising premiums right now? Darn right they would, and probably more than the Feds will (since they wouldn't be obligated by "national interest", only by covering their own bottom lines).
    2008 Sep 14 08:24 AM | Link | Reply
  •  
    This country needs to adopt the following

    I HAVE DECIDED TO BECOME A WRITE-IN CANDIDATE.
    >
    > HERE IS MY PLATFORM:
    >
    > (1) [edited]
    >
    > (2) We will immediately go into a two year isolationist posture to straighten out the country's attitude. NO imports, no exports.
    > We will use Wal-Mart's policy, 'If we ain't got it, you don't need it.'
    >
    > (3) When imports are allowed, there will be a 100% import tax on it.
    >
    > (4) [edited]
    >
    > (5) Social security will immediately return to its original state. If
    > you didn't put nuttin in, you ain't gettin nuttin out. The president
    nor any other politician will not be able to touch it.
    >
    > (6) Welfare - Checks will be handed out on Fridays at the end of the
    > 40 hour school week and the successful completion of urinalysis and a passing
    > grade.
    >
    > (7) Professional Athletes --Steroids - The FIRST time you check
    > positive you're banned for life.
    >
    > ( Crime - We will adopt the Turkish method, the first time you
    > steal, you lose your right hand. There is no more life sentences. If convicted,
    > you will be put to death by the same method you chose for your victim; gun,
    > knife, strangulation, etc.
    >
    > (9) One export will be allowed; Wheat, The world needs to eat. A
    > bushel of wheat will be the exact price of a barrel of oil.
    >
    > (10) All foreign aid using American taxpayer money will immediately
    > cease, and the saved money will pay off the national debt and ultimately lower
    > taxes. When disasters occur around the world, we'll ask the American
    > people if they want to donate to a disaster fund, and each citizen can make
    > the decision whether it's a worthy cause.
    >
    > (11) The Pledge of Allegiance will be said every day at school and
    > every day in Congress.
    >
    > (12) The National Anthem will be played at all appropriate ceremonies,
    > sporting events, outings, etc.
    >
    > Sorry if I stepped on anyone's toes but a vote for me will get you
    > better than what you have, and better than what you're gonna get.
    [comment edited for ethnic disparagement- SA editors]

    2008 Sep 14 11:21 AM | Link | Reply
  •  
    I think I like hardballs analysis better than the authors. FDIC insurance rate premiums like all risk analysis of late has not been properly priced due to the ready availability of credit and assumed governmental backstopping. Its time to pay up lads. Iam not sure what price should be paid for insurance against a fractional reserve systemic meltdown, but as soon as you put the word "Federal" in front of it you know its going to be under priced, since prices are politically derived instead of the market.
    2008 Sep 14 12:39 PM | Link | Reply
  •  
    This is a silly and (as pointed out by others) shallow post by a former banker of a _failed_ bank whose basic strategy was to run a hedge fund lurking as a bank (Commerce Bank; thank god for Toronto-Dominion) financed by brain-dead retail core deposit providers. Vernon has zero credibility and his posting reflects his obvious lack of judgment, again, only this time related to policy and governance, not just banking.

    The FDIC insurance fund should clearly charge higher premiums when risk increases. This is fundamental to insurance, but clearly history shows that Vernon doesn't understand fundamentals. Risk-based pricing of insurance is necessary and needed. To suggest otherwise is nonsense. The real failure of the FDIC isn't that it is increasing fees now, only that it failed to assess them for years when times were good (something Vernon suggested was "good" policy back during the boom-time). FDIC needs to be reformed, true enough. But this article says nothing about what matters, or what makes sense.
    2008 Sep 14 01:52 PM | Link | Reply
  •  
    WEBISKING, so where are you going to get oil? Or chromium? Or rare earth oxides, or manganese, strontium, bauxite, potash, tin, etc.

    The US imports 75% of it's consumption or more of all of these materials.

    Then of course where are you going to get your engineers, doctors, etc.? More than 40% of all hard science, mathematics and engineering students in US graduate schools are immigrants.

    Your platform is so moronic we might as well give the US back to the Indians.
    2008 Sep 14 04:58 PM | Link | Reply
  •  
    "> (7) Professional Athletes --Steroids - The FIRST time you check
    > positive you're banned for life. "

    thank you for illustrating the problem with our country's leaders: with so many domestic and global issues and concerns, somehow athletes using steroids is viewed as a high priority.
    2008 Sep 14 10:34 PM | Link | Reply
  •  
    add on: perhaps congress should pass legislation concerning instant-replay rules.....
    2008 Sep 14 10:36 PM | Link | Reply
  •  
    any possibilities of places like td ameritrade going belly up? smith barney, etc
    2008 Sep 15 02:29 AM | Link | Reply
  •  
    WEBISKING, where do you think Walmart get their products ?
    2008 Sep 15 05:46 AM | Link | Reply
  •  
    Anybody who have learned a bit more than accounting knows that all mega transactions don't involve physical movement of cash but are paper adjustments. Once it is in the treasury they do not and cannot separate them into each department physically. Only that they should make sure amount allocated to each department is not debited or credited the wrong way. So the allegation that FDIC fund does not exist is not right. Yes, our country has some shortcomings but that doesn't mean it is a banana republic.
    2008 Sep 15 06:20 AM | Link | Reply
  •  
    This can't possibly be a surprise for anyone. For starters, it would imply that there exists transparency. There does not, and therefore I am not surprised by anything at this point.

    Uncle Sam is a crook, and reading some of the comments on this thread I now believe that others are completely clueless.

    Until there is transparency this place IS (according to another poster) a banana republic -- all fictitious smoke and mirrors based on leveraged vapor.

    Plenty more to fail all over the world, folks.
    2008 Sep 15 10:14 AM | Link | Reply
  •  
    Wow. So along with not saving for retirement, not saving for healthcare expense, we can add not saving for bank failures. Thanks government insurance!
    2008 Sep 15 01:25 PM | Link | Reply
  •  
    Moral of the story:
    Don't loan people any more money than you're willing to lose. And that includes loans to banks.
    2008 Sep 15 03:48 PM | Link | Reply
  •  
    This is supremely irresponsible rumor mongering nonsense.

    The FDIC owns treasury bonds. The FDIC is not the treasury, so no that isn't make-believe. Any more than a bank owning lots of treasuries is supposedly insolvant because its assets are "only" "IOUs". Every asset is an IOU.

    The FDIC by law increases the contribution rate whenever its reserve drops below a statutory portion of insured assets, and falls when it exceeds a second, higher level. The changes are quite modest and take years to rebuild or run off any momentary level-change in the level of the reserve.

    The FDIC hasn't cost the taxpayer a dime since it was founded. All losses ever paid out are less than the interest accumulated on the funds collected from the banks. It repaid its initial subscribed capital (from the Treasury and the Fed) decades ago in the 1950s. It was funded by a one-off loan for less than $150 million for 15 years in hard times. Everything since has been paid for by the *insurance premiums* it collects from banks, and interest on its holdings of treasuries. No, insurance premiums aren't taxation, and they generate huge positive returns for the banks that pay them, in the form of low rates on deposits rendered safe by that insurance.

    Reckless ideologues are engaged in a systematic assault on American capitalism, and they should be ashamed of themselves.
    2008 Sep 15 04:51 PM | Link | Reply
  •  
    In theory, this author would be fine with the FDIC if they removed their premiums from the treasury and opened a checking account at their local bank branch.
    2008 Sep 15 05:16 PM | Link | Reply
  •  
    The author is correct. It is a tax, as long as banks are required by law to pay it. Banks should have the right to opt-out of the FDIC system, as long as they boldly post at the front door that the deposited are NOT insured by the FDIC.

    As far as their being no fund, that's also true. The same accounting fiction exists with the Social Security system. The government has far less in assets than it has obligations. It is insolvent. Ultimately, it can only pay someone today by taxing someone else directly or indirectly by debasing the currency.
    2008 Sep 16 12:07 AM | Link | Reply
  •  
    An FDIC account is like the tooth fairy, Santa Claus, and a Social Security Account with your name on it. If you tried operating the FDIC or Social Security on your own, you'd be thrown in jail for operating a Ponsi scheme...that is if the people you duped as "members" didn't string you up first!
    2008 Sep 21 10:33 PM | Link | Reply
  •  
    After reading many replies to this article it becomes clear to me that we as americans are in need of continuing education on the reality that we are not a Republic like the Constitution declares.States of the United States are required, like the federal government, to be republican in form, with final authority resting with the people. This was required because the states were intended to create and enforce most domestic laws, with the exception of areas delegated to the federal government and prohibited to the states. The founding fathers of the country intended most domestic laws to be handled by the states, although, over time, the federal government has gained more and more influence over domestic law. Requiring the states to be a republic in form was seen as protecting the citizens' rights and preventing a state from becoming a dictatorship or monarchy, and reflected unwillingness on the part of the original 13 states (all independent republics) to unite with other states that were not republics. Additionally, this requirement ensured that only other republics could join the union.

    In the example of the United States, the original 13 British colonies became independent states after the American Revolution, each having a republican form of government. These independent states initially formed a loose confederation called the United States and then later formed the current United States by ratifying the current U.S. Constitution, creating a union of sovereign states with the union or federal government also being a republic. Any state joining the union later was also required to be a republic. The United States could be argued to be a supra-national republic on the grounds that the original states were independent countries and was formed of several nations, most notably the original 13 colonies/states, the Republic of Texas, and the Kingdom of Hawaii, all of which would be considered "nations" under a strict definition of the word.

    2008 Dec 07 09:11 AM | Link | Reply
  •  
    I want to take this a step further. I would bet a dollar (actually worth a nickle) that the gold repository at Ft. Knox, the legendary bastion of extra-super-high security, doesn't contain so much as a single ounce of gold stored in it. Our financial institutions and their government employed co-conspirators, have raped and pilliaged every possible source of money in the country. This has been going on for decades and we are now seeing the results of this outrageous greed, and are now suffering the results. The only solution to our problems is either a visit from KLAATU, "The Day the Earth Stood Still", or the second coming of Christ (and it's NOT Barack Obama) whichever comes first.
    Mar 18 01:46 PM | Link | Reply