Ronald Pires

The Great Bank Rush of 2008: What's the Money For?

Poet1

The FDIC is committed to paying all claims for insured dollars, so you will always get paid, even if the FDIC reserve fund is exhausted. In that case, the FDIC would by law borrow money from the Treasury, even if that money had to be newly minted. Sorry if I gave you the wrong impression. Here is the problem I was getting at however.

Say a banks folds and the FDIC reserve is empty. Say the Treasury gets newly minted money to pay the depositors off. (It will likely come to this eventually.) That's inflation.

Now let's say that bank couldn't pay a single depositor back. It was flat broke. FDIC has a new dollar printed for each insured dollar. But it doesn't stop there. Under this new rule change, it has to print a second new dollar to cover the fact that each dollar was not only insured but also used as collateral. The FDIC is responsible for paying DOUBLE the amount of deposits lost, the original lost dollar AND the collateralized dollar.

Now say the failed bank was able to pay back half of the depositors. The FDIC gets a newly-printed dollar for each dollar for each insured dollar the bank couldn't pay, but then needs an additional TWO dollars for the collateralized debt.

Now obviously, the more that can be paid back out of the failed bank's own funds, the better it is for the FDIC. I don't mean to imply otherwise. Rather that when the FDIC reports lost deposits for that bank, its actual liability is at least twice that and possibly more.

One additional item. This rule change insituted under these conditions literally DEMANDS the creation of these new mega-banks we are now seeing form. If even one of them fails, the FDIC could in the conceivable future be on the hook for a trillion dollars. That's not inflation anymore; it's hyperinflation. And THAT'S the gamble Paulson has taken with the mere stroke of his pen.

The Great Bank Rush of 2008: What's the Money For?

Smarty_pants

You are correct. Shreholders and bondholders indeed did not do well. I didn't mean to imply they had.

I tend to write in a very literary style, and my words here were quite flip (and intentionally so). It made for a better storyline. Obviously no one is making out well in this. My intent was merely to highlight that among all of the losers, a few of them at least have a few crumbs left to be happy about.

And yes, it was quite convenient as scaremongering also. The banks however are just following the numbers. Insured deposits are now an irresistable acquisition. Whomever gets the most lasts longest.

The Great Bank Rush of 2008: What's the Money For?

Mikebrah

Well said. Since I first learned of the deposit rule change (change,my butt ... they just tossed it out), I've been trying to scream it out to others. (Thanks to Seeking Alpha for the help.)

And I agree with your extension of my gambling allegory. If Paulson is risking insured deposits, he indeed sees himselfas down to his last few chips. With a game that is far from over.

The Great Bank Rush of 2008: What's the Money For?

Redsox1

Credit unions are depositor owned. At this point, they are probably safer than Treasuries (and they are certainly paying more than short term Treasuries.)

The Great Bank Rush of 2008: What's the Money For?

dlaw:

You didn't specify which conclusions you disagreed with, but just on a guess, I'd say it was tying the bailout to acquisition funding. And no, I can't prove that. My case of course was made on the close timing of all of these events.

To that end (and since I wrote this article), Goldman has announced its intentions to purchase $50B of insured assets, Wells Fargo has attempted to buy Wachovia, and Citigroup has succeeded in doing so. And all of this in the entire timespan of two weeks since the deposit rule change. There's clearly a buying frenzy out there for these assets.

Also, from the Financial Times, "Lending Woes Threaten M&A Deals" ( link.ft.com/r/M2ZOXX/C... ), which speaks of funding for mergers and acquisitions drying up. Certainly if the bailout is not specifically endorsed by these parties as for acquisitions of insured deposit assets, the money from it will end up there because it's not likely coming from anywhere else soon..

Now of course, none of this activity so far is based on funding from the bailout because it simply hasn't happened yet. So far, we're just looking at distressed institutions seeking shelter among themselves from otherwise certain demise. Still, there is a definite pattern of seeking insured assets coming from this group, and the rule change undoubtablely is playing a major role in the specific decisions we are seeing.

Remember though, there are still the regionals (and locals) that have suddenly become very attractive to these majors. We'll have to watch to see how much of this happens, but if I was betting (I'm not; I don't), I'd probably be looking for long options on the regionals.