FDIC Out of Cash?

Story Highlights:

• Since last fall's financial panic, bank failures are up—totaling 84 (so far) in 2009, increasing fears the FDIC may be running out of funds to "insure" assets of failed banks.
• Compared to the 2,935 bank failures during the savings and loan crisis in the late ‘80s and early ‘90s, today's crisis is lesser in failure number but larger in dollar amount.
• To ease the burden, the FDIC recently relaxed guidelines for private equity funds interested in acquiring failed banks, which should at least lure some firms into deals.
• The FDIC has other options to raise funds, including raising premiums on participating banks, and drawing on its $22 billion in cash and US Treasuries or a $500 billion credit line with the Treasury.
• Bank failures are not through, but there's little need to fear FDIC failure.

There've been plenty of bailouts in the last year: Bear, Fannie, Freddie, AIG, to name a few, and now…the Federal Deposit Insurance Corporation (FDIC)—created to "insure" many of the assets at failing banks—might run out of cash and force the Treasury to foot the bill.

Since last fall's financial panic, bank failures are up, totaling 84 (so far) in 2009. Scary number, and sure to rise—even as the recession eases. But comparatively speaking, bank failures remain fairly limited compared to the 2,935 failures during the savings and loan crisis in the 1980s to 1990s. Or the even more stunning 9,146 pre-FDIC bank failures during the Great Depression. It was the severity of that string of panics that led to the FDIC's creation in the first place. On a dollar basis though, today's numbers are largest on record.

Initially formed by the Banking Act of 1933 (better known as Glass-Steagall), the FDIC insures deposits in commercial banks and thrifts. FDIC participation is required for nationally chartered banks and most state chartered banks, and those participating must pay a premium to the Deposit Insurance Fund (DIF)—the FDIC uses the DIF to pay depositors in the event their bank fails. But the FDIC goes beyond just insuring depositor funds—it's also a banking regulator, monitors troubled banks (416 in Q2), and when necessary, finds healthy buyers to broker takeovers. Generally, assisted takeovers limit the impact on depositors and the cost borne by the FDIC. One high profile FDIC-brokered deal was last year's sale of Washington Mutual to JPMorgan Chase. But there've been scores of lesser heralded "shotgun weddings" since. Even so, the FDIC's funding has still been strained by elevated bank failures, and buyers are becoming harder to find.

More than a few cash-rich private equity funds have indicated they're more than willing to step in to purchase failed banks when traditional buyers (other banks) can't be found. But the FDIC has been wary of letting private equity run banks. This is a bad time to be wary of needed capital ready and waiting in the wings. The FDIC's initial private equity requirements were particularly stringent—severely limiting leverage and leaving investors open to risk. Widely panned by investors, the FDIC relented and recently released final guidelines relaxing the requirements somewhat, undoubtedly hoping to lure at least a few firms to do deals.  

In any case, it's likely the DIF's coffers will look bare for a while. But the FDIC has leeway when it comes to protecting depositors. Beyond the DIF, the FDIC keeps $22 billion in cash and US Treasuries to draw upon if needed. (Or, to put it plainly, it's very unlikely the federal government won't foot the bill if it comes to that.) The FDIC can also further raise bank premiums (which it's already done) or borrow up to $500 billion from the Treasury. So although bank failures will continue, even rise, there's no need to fear FDIC depositor protection will fail too.

Just about every finance-related regulatory body has been scrutinized and criticized over the last year. In all, the FDIC played an important stabilizing role through the crisis and served its function well. Will it need to evolve and adjust as the financial landscape changes? Of course, but regulators of all shapes and sizes are, by their nature, reactionary creatures.