The Next Bailout

The Wall Street Journal reports on yet another government bailout at taxpayer expense. It seems that the Federal Deposit Insurance Corporation (FDIC) is burning through its reserves. In the last year the FDIC has paid out in excess of $34.8 billion. Additionally, the FDIC’s list of troubled banks has increased from 305 to 416, even as it has closed 84 since the beginning of this year. The true scope of the problem is unfathomable. Now the FDIC is letting Congress and the nation’s bankers know that they may need more cash from either increased insurance premiums, special assessments or perhaps even the Treasury itself.

Deposit insurance premiums are (supposed to be) risk based. The CAMEL ratings (for risk factors Capital adequacy, Asset quality, Management competence, Earnings and Liquidity) are between one (best) and five (worst) and averaged for a composite value. But don’t ask your local banker his CAMEL rating because he can’t tell you — it’s a secret. That is one component of the moral hazard that accompanies deposit insurance. With a bank’s level of safety and soundness concealed, depositors must base their decisions only upon expected rate of return.

In a supposed attempt to keep the insurance fund solvent, FDIC hit the nation’s banks with a special assessment in the fourth quarter of 2008, causing a further depletion of capital from the banking system as a whole and forcing even more marginal banks into the red. Banking trade associations have been advising their members to expect a similar special assessment in 4Q2009. These increased expenses reduce the net income of individual banks, thus further straining their ability to retain earnings to improve their capital adequacy. To control cost and preserve earnings, bankers are giving deposit rates hard scrutiny. Couple this with FDIC’s quiet request to Congress for the authority to borrow up to $500 billion from the U.S. Treasury (five times its regular borrowing limit,) and one can see taxpayers squeezed, on the one hand, by lower interest rates on savings and, on the other hand, higher taxes to service increased federal debt.

Bottom line is that deposit insurance is not free, and as with all insurance, there are inherent risks. After a 15-year expansion in the U.S. economy (1992-2007) with banks being encouraged (or, perhaps more accurately, extorted) to engage in increasingly risky loans, (sub-prime mortgages, community re-development and re-investment) the current economic contraction has exposed bankers to increased risk, which may ultimately be borne by the taxpayer.

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Tags: bail outs, big government, econ 101, News, Obama, Politics