Recent waves of bank failures, and the expected continuance of those failures, has put the FDIC in an uncomfortable position. Covering the accounts held by the failing banks is depleting the FDIC’s coffers, leaving them with only two options on how to get that money back. Unfortunately, neither option is particularly attractive.
On one hand, the FDIC could borrow the money from the Treasury, but the size of the FDIC and its position as a bedrock American financial institution loads its actions with enormous relevance for the rest of the economy. If the FDIC has to borrow money from the Treasury for the first time in twenty years, it creates serious doubts concerning the strength of our economy and our recovery. If there is another large collapse, moreover, having already borrowed money from the Treasury, the FDIC will be in a more precarious position to guarantee the safety of America’s bank accounts. On the other hand, if the FDIC decides to turn to the industry to build up its funds by charging banks more insurance fees, it will end up putting more ‘at risk’ banks into further danger of collapse, which would, in turn, force the FDIC to cover those accounts.
It would seem that our nation is suffering an epidemic of problems like this and by now we’re used to hearing the usual straw-men and scapegoats brought out to take the blame. Reckless banks and regulators asleep at the job have become the stock villains of this recession, and rightfully so. We should not lose sight, however, of the reasons that the FDIC is now short of cash. During the non-recession years, the FDIC was prohibited by a 1996 law from accessing fees to well capitalized banks. During the period between 1997 and 2006, these banks made $1.28 Trillion in pretax profits and were charged $0.67 billion in insurance (about .05%).
Clearly, this crisis has revealed that these banks should have been paying more for insurance, especially given the enormous risks they took with complicated financial products like Credit Default Swaps. The nature of the law that Congress passed in 1996 makes no sense: why should strong banks be exempt from insurance fees? Don’t strong banks benefit by being able to tell their customers that their deposits are FDIC guaranteed? It is precisely these banks which should have been the warhorses for the American economy.
What seems to have happened is that, back in 1996, Congress wanted to cater to bank lobbyists who wanted to pay as little as possible to the FDIC, but who still wanted to project the image that their accounts were federally insured. Congress then passed laws which limited the strength of the FDIC which, in turn, led it to the problems that it faces now in dealing with widespread bank collapse. Did risky bank behaviors contribute to this problem? Yes. Should regulators have stepped in and prohibited those risky behaviors? Sure. But the American safety net against bank failures wasn’t weakened by either of these groups but by Congress itself. If our goal is to learn from this recession and to overhaul the American financial landscape in order to decrease its vulnerability to the economic forces that caused this recession, then part of those changes will need to be directed at Congress to keep them from passing laws which are, essentially, as responsible for the economic collapse as risky banking practices and negligent regulators.