Wednesday, August 19, 2009

Why FDIC is a fraud

FDIC claims to be an "insurance" policy. Banks pay "premiums" to the Government, who puts them in a "fund", and when a bank has the bad luck to go bankrupt, the Government makes depositors whole (up to some limit) out of that same fund. Just like insurance.

Unfortunately, this whole system is a fraud, leading to nonsense articles like this one: is the FDIC bankrupt?

The FDIC is not, and cannot, go bankrupt, because it is part of the US Government and the US Government cannot go bankrupt because it is a currency issuer. All currency issuers, in a fiat, non-convertible world, have the ability to extinguish any obligation in their own scrip by changing a cell on an excel table. They may choose not to change that cell, but they always always have the option to change it, and thus, not default. There is no "fund" because it can be topped up at any time.

So, what are FDIC premiums then, if they are not premiums? Answer: they are a tax, like any other.

Why is the US Government taxing banks on one hand while it doles out money with the other? Answer: Good question. And not just for banks.

Banks are part of the private sector, although an unusual part, and taxes draw down their ability to net save just as it does to any other part of the private sector. What's even more important to banks is capital requirements, and the Government is acting counter-productively here as well. First, from Mish:
A comment concerning the FDIC - As of June 30 the rates being charged banks have increased substantially. Risk 1 category went to 12 basis points from 5, risk 2, 17 basis points, risk 3, 35 basis points, and risk 5, 50 basis points. Additionally, a 5 basis point special assessment is being charged on September 30 on total assets less tier 1 capital. It is probable that a second assessment will also be charged in December.

The cost of FDIC insurance for a two hundred million dollar, 1 risk rated bank last year would have been around $8,300 per month or $100,000 per year. It would have been much less in previous years.

For a 5 risk rated bank, which many banks have been moved into, the cost will be $1,100,000 including the 5 basis point assessment being levied in September. While warranted, this will exacerbate the problems and ultimately hasten the death or forced sale of a lot of banks.

This will certainly mark the end of the banking model using wholesale funding and aggressive deposits to fund commercial real estate projects. In other words this is going to come down hard on the FIRE economy.
The end of rapid real estate appreciation and current overhang of CRE stock marked the end of banks using "wholesale funding and aggressive deposits to fund commercial real estate projects", higher FDIC requirements are just higher taxes, and a drain on savings.

And now, from Mosler:
If these securities become ‘impaired,’ as defined by regulation, they are marked to market and capital adjusted for that loss.

But recently an additional measure was taken by the regulators.

If they are downgraded to below ‘investment grade’ they are not only marked to market for net capital calculations, but also treated as a ‘charge off’ for capital ratio purposes.

For example, if we have $1 million security that is downgraded below investment grade and has a current market value of $500,000, we reduce our stated capital by $500,000, as had previously been the case.

But now, even that $500,000 remaining value, is, for all practical purposes, counted as 0 for purposes of determining our capital ratios.

The capital ratio is the important calculation as it determines how many assets a bank can carry for a given level of capital.

This means, for example, that if a bank had securities that were below investment grade with a market value equal to all its capital it could not carry any other assets or deposits.
So, a $1M security which marks to market at $500K gets downgraded to ZERO when it is re-rated as "non-investment grade". Not downgraded to $500K, but downgraded to ZERO. This dramatically worsens banks capital ratios, and inhibits their ability to lend, or at least be in regulatory compliance (those two used to go hand-in-hand, but now no longer).

So, the Obama administration cuts rates to zero, depriving the private sector of interest income, while letting banks re-capitalize through high NIMs in this tight credit environment. With the other hand, it raises taxes on banks directly through FDIC, and de-capitalizes them through... the ratings agencies. Abysmal.


Blogger Richard C. Lambert said...

The FDIC is not, and cannot, go bankrupt, because it is part of the US Government and the US Government cannot go bankrupt because it is a currency issuer.

4:58 AM  

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