Bailing Out the Bailer

GonzoBankers, I’m sure you’ve been following the Indiana State football team’s slide to infamy. Sadly, the team is nursing a 30-game losing streak that began in October 2006. Of the 82 players on the roster right now, 4 have experienced a win while playing at Larry Bird’s alma mater

Well, the FDIC is in more dire need of a bailout than the Sycamores’ football team. That’s right, Sheila Bair, the FDIC’s chairman, has been flexing her political muscle all over the news, asking for mo’ money, mo’ money, mo’ money!

Now wait just a minute! Hold the presses! The picture at right is the 1990 women’s American Natural Bodybuilding Conference champion, whose name just happens to be Sheila Bair. The picture below is the FDIC’s frowny-faced Sheila Bair.

OK, we have seen nearly 100 banks shut their doors this year alone, so maybe we can forgive or at least understand a bit of a cash pinch at the FDIC. According to Bair’s recent speeches, the FDIC currently has roughly $10.4 billion in the insurance fund (down from $45 billion as of 2Q08), in addition to the $32 billion already reserved for expected losses in 2010. The current fund represents .22% of insured deposits according to the Associated Press. Federal mandates require the fund to be at 1.15% – minimum.

Yikes! Now THAT’S a shortfall! Regardless of what we think about who’s to blame for the shortfall – FDIC, banks, the Fed, Wall Street, Treasury, consumers, even consultants! – our gut probably tells us there is not enough in the FDIC’s coffers to make anyone comfy long term.

So what’s a gal to do? Well, there are a number of “informed sources” throwing around plans being mulled by the FDIC’s chairman and her fundraising minions. (FDIC even pulled some senior people off the United Way campaign to pitch in with this, allegedly.) Popular wisdom holds 4 paths the FDIC could take:

1. Require banks to prepay future assessments
This option, proposed earlier this week after a meeting of panicked and coffee-addled FDIC honchos, will require banks to prepay their assessment fees for 2010 – 2012 – potentially raising around $45B. The good news is that banks will not have to expense the prepayments until the quarter they are due, somewhat lessening the blow. (FDIC also promised and crossed their hearts not to implement Option #2 below if they end up going down Option #1’s path.)

Compared to the Special Assessment option (#2 below) which would register an immediate kick in the nards to today’s earnings, banks prefer the Prepayment option. Still, I suspect at least a few mid-sized and community banks, struggling for earnings as-is, will find Prepayment to be a highly unacceptable choice. What happens in 2011 or 2012 as the fund again begins to shrink to sweaty armpit levels? I bet we’ll be back in the same boat facing the same uncertain waters.

Even though the FDIC announced that Option 1 is their preferred course of action, this ain’t over by a long shot. This is a firebrand issue that is sure to draw massive scrutiny and active feedback during the public comment period. Other options that the FDIC has reviewed include:

2. Levy another special assessment on the banking community
This just is not going to happen. FDIC charged the industry a special assessment earlier this year, to much gnashing of teeth and clenching of jaws. They raised about $5.6 billion in the process. Clearly, with current earnings the industry can not foot the size of bill that FDIC is now talking. Even with rules that can put a disproportionately large portion of the burden on the biggest banks, the FDIC would face a political donnybrook if they were to try to assess themselves out of this problem.

3. Borrow the money from large, relatively sound banks
Why not just borrow the needed funds from banks who can handle the load, the FDIC asks? Option #3 has gotten a lot of press since it is so seemingly counterintuitive. The FDIC would borrow money from the very banks it supervises? Feels incestuous at worst, Escheresque at best.

This is another option favored by “the banking industry” – mainly the large banks that would stand to make the guaranteed loans to the FDIC. Other than the points above, one has to question whether these loans to the FDIC would in effect be taking available capital away from the potential borrowing business community that needs it. Also, this option is targeted at banks that have, in the FDIC’s opinion, the soundness to accommodate the additional loan volumes. FDIC has shown that it’s not exactly worthy of chest thumping in the risk assessment arena in recent years. What happens when a bank with a huge loan outstanding to the FDIC tiptoes on the steep precipice of failure? Talk about the potential to further tarnish Public Trust in banks. Could this option taint supervisory judgment or artificially slow (or hasten?) the process of closing banks? You never know, and the fetid look and smell of this option is what should lead to its demise.

And as a regulator buddy of mine pointed out, there honestly is not much difference between this option and the prepayment option when it comes to a big, ugly shiner of a conflict of interest. It’s the banks fronting money to their supervising agency in either case. At least with this option the banks get repaid.

4. Tap the FDIC’s credit line at Treasury
This is what the FDIC should have proposed this week and what it should do. The FDIC has a $100 billion direct line at the Treasury, which can be expanded to $500 billion under certain extreme circumstances. It would be a way to raise the money the FDIC needs now, avoid ripping further into a wildly struggling industry’s earnings and capital, and raises the possibility for the debt to repaid – clearly by FDIC member banks – over a reasonable period of time without punishing earnings for the next 3 years. Yes, the American public would be immediately burdened by this option. But tell me, which option eliminates consumer hardship, either directly or indirectly?

FDIC says that it does not want to go to the Treasury for reasons of public appearance (keep the FDIC funding in the family) and the fact that these funds are earmarked for emergencies. Let me give you a hint, Sheila – FDIC already looks really, really, really bad. In fact, FDIC really doesn’t have much further down it can go in the eyes of the American public – whether that perception is justified or not. And if we are not in an emergency now, I shudder to imagine what circumstances will merit Emergency Status.

Popular speculation is that the FDIC did not truly consider this option because it puts the agency in the position of groveling at the Treasury’s feet for cash. Bair and Treasury head T-Geith are not exactly hunting buddies (unless you mean it in the way that Dick Cheney has hunting buddies). Far from it. In fact, they are pretty well known to fight like dogs and cats.

It’s pathetic that political posturing can come between the FDIC and the most solid option for the funds it needs so urgently.

Don’t mistake this week’s FDIC announcement as granite-engraved Policy. It’s not even marginally too late to sound off on this topic, GonzoBankers. In fact, the public comment time is the right time to be real freakin’ loud and obnoxious about your views.

Even the most cynical among us should know that it’s not at all unusual for regulatory bodies to fine tune or even make wholesale changes to their proposals based on public feedback. This is a mammoth issue with gargantuan potential to chop and dice your bottom line.

Even in the highly unlikely event that you think I’m completely out to lunch on the matter, you simply Have To respond to the public comment period, which ends October 28. Have To.

Take ‘er easy – Hodgins

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