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By Radhika Miller~Inteldaily
We hear the parting words from television commercials and radio advertisements: “Member FDIC Insured.” The Federal Deposit Insurance Corporation has been insuring our money, our livelihood, up to $100,000. This was supposed to make working-class people feel safe and comfortable. But when a series of huge banks collapsed, falling like dominos one after the other, individual financial safety was put in serious jeopardy.
With the passage of the Wall Street bailout legislation, the rules for the FDIC have changed. The sum per bank deposit guaranteed by the FDIC has been temporarily raised to $250,000. The FDIC is also allowed to borrow from the Treasury to cover losses that might occur as a result of the new, higher insurance limit.
The FDIC, however, currently has enough in its reserve fund to cover only 1 percent of insured deposits. As of September 2008, the Deposit Insurance Fund had a balance of $45 billion, which is about $10 billion less than the amount projected in March 2008 for the end of the year. If there is an all-out run on the banks and everyone decides to try to collect their money, millions of workers might not be able to recover any of their money, let alone the up to $250,000 now guaranteed by the FDIC.
A federal corporation
The FDIC is a federal corporation that provides deposit insurance for member banks. It emerged as an institution with passage of the Glass-Steagall Act of 1933. The concept was motivated by the bank panics of 1930-1933, during which thousands of banks failed. The newly established FDIC paid a bank’s depositors roughly 85 percent of their deposits in the event of failure, up to a maximum of $2,500 per depositor.
The FDIC’s mandate covers both insolvent and illiquid banks. Insolvent banks are those whose liabilities (including deposits) exceed their assets (such as holdings of government securities and home and commercial mortgages); illiquid banks are those whose assets cannot be readily converted into cash. Illiquid banks may often be insolvent if no market exists for some of their assets.
When banks become troubled, the FDIC usually intervenes through one of two methods: The purchase and assumption method, or P&A, in which an open bank assumes all the liabilities (deposits) of the failed bank and purchases some or all of the failed bank’s assets (loans); or the payoff method, in which the FDIC pays the insured depositors and liquidates the bank’s assets to recoup at least part of its outlays. The payoff method, which requires the FDIC to provide large sums of money to cover deposit losses, is only used when no bank is willing to participate in a P&A rescue.
The ultimate promise of the FDIC is that depositors will not lose—if a bank fails, the FDIC, sponsored by the government but funded by premiums paid in by its member banks, will guarantee that a solvent bank will assume their deposits or the FDIC itself will compensate them for any deposit losses, now capped at $250,000.
The truth is that the FDIC does not have the reserves to finance this promise.
Too big to let fail
The FDIC has been able to operate with reserves amounting to only 1 percent of the insured deposits because it has never had to compensate for deposit losses exceeding that amount at one time. Essentially, the FDIC works within the same concept of “risk management” and speculation that plagues the financial markets, betting that large numbers of people will not attempt to withdraw their money from the banks all at once.
As long as it has to cover only occasional, individual bank failures, the FDIC is capable of fulfilling its mission statement. However, if a large number of banks fail over a relatively short period of time, the FDIC, too, will likely fail. Stanford Financial analyst Jaret Seiberg predicts more than 100 banks nationwide will fail next year.
The FDIC has predicted that at the end of 2008, insured deposits will total $4.4 trillion. The FDIC has only $45 billion in its Deposit Insurance Fund. Workers could face a gargantuan loss if large number of additional banks was to go under and the Treasury did not come to the rescue.
