The Wall Street Journal has reported that the FDIC may have to go to the Treasury Department to borrow money in order to handle a rash of bank failures. It begs the question: how safe is your money, anyway?
The FDIC was created in 1933, spurred into existence by the vast number of bank failures during the Great Depression. The FDIC guarantees the deposits of member banks up to $100,000 per depositor. If you have $200,000, you can keep $100,000 at two separate banks to be fully insured. If your bank gets in trouble, the FDIC is supposed to swoop in and save the day — either by paying off your account or by selling your bank to another bank.
The FDIC keeps what is known as its Insurance Fund Balance. This is its bailout fund. At the end of 2007, that balance was at $52.4 billion, amounting to 1.22% of insured deposits. That balance fell to $45.2 billion at the end of June, in large part to the failure of IndyMac. The reserve ratio is now down to 1.01% — its lowest level since 1995.
We have been told not to worry. The pundits and government officials assure us that the FDIC will always come through. But is that really true?
“We don’t think this credit cycle has bottomed out yet,” said FDIC Chairman Sheila Bair at a recent press conference. The Chairman continued, saying, “I don’t like to make predictions, but I think it’s going to continue to be very challenging.” She also said that she expected the number of banks and assets on the troubled banks list to continue to rise.
The Wall Street Journal has reported that the FDIC may have to borrow money from the Treasury to help it through an unexpected wave of bank failures. That’s big news. In March, I wrote about the FDIC’s plan to raise staffing levels by 60% in the division that handles bank failures in an effort to prepare for an expected wave of banks gone bust. Around six banks per year fail, historically, but in the recession of 1990 – 1991, 502 banks failed in just three years.The crisis of the early 1990s marked the last time that the FDIC had to borrow money from the Treasury.
The credit crisis has left the banking system weak. This year, only nine banks have collapsed so far, but the FDIC Chairman has said that they may need to borrow money from the Treasury. That is disconcerting, to say the least. My question is this: what will happen if we experience multiple, simultaneous bank failures?
Section 14 of the FDIC Act reveals something interesting:
“(a) BORROWING FROM TREASURY.– The Corporation is authorized to borrow from the Treasury, and the Secretary of the Treasury is authorized and directed to loan to the Corporation on such terms as may be fixed by the Corporation and the Secretary, such funds as in the judgment of the Board of Directors of the Corporation are from time to time required for insurance purposes, not exceeding in the aggregate $30,000,000,000 outstanding at any one time, subject to the approval of the Secretary of the Treasury: Provided, That the rate of interest to be charged in connection with any loan made pursuant to this subsection shall not be less than an amount determined by the Secretary of the Treasury, taking into consideration current market yields on outstanding marketable obligations of the United States of comparable maturities.”
Now we know that the additional funds available to the FDIC are not a guarantee — just a loan. They also have to pay interest on the loan. I would bet that the interest rates could go sky high if things got really dicey.
If a bank did fail, when would you get paid? Section 11 of the FDIC act states:
“(f) PAYMENT OF INSURED DEPOSITS.– (1) IN GENERAL.–In case of the liquidation of, or other closing or winding up of the affairs of, any insured depository institution, payment of the insured deposits in such institution shall be made by the Corporation as soon as possible ….”
Great. If my bank fails, the FDIC will make good “as soon as possible.” I can certainly see situations in which it would be “impossible” for the FDIC to pay me, so perhaps I might not ever get paid. To top things off, the only promise of payment comes from the Bank Insurance Fund of the FDIC itself. If the FDIC ever exhausts its reserves and is unable to borrow from the Treasury, it would take an act of Congress to allocate more money. If your bank failed, you could be waiting for the FDIC make good “as soon as possible,” which could require an act of Congress.
The truth is that the FDIC system only works if times are relatively good — a bank failure here or there. They are wholly unprepared for a wave of bank busts. If China decided to declare economic war on the U.S. by dumping its Treasury holdings … if we go to war with Iran … if a tsunami hit New York City … or if all of these things occurred at once … it’s easy to see that the FDIC’s pockets are not as deep as one might hope. I think Congress would do everything they could to keep the FDIC solvent, but it’s easy to see scenarios in which Congress would be unable to fix the problem. Someone once told me that almost everything in life was smoke and mirrors. I think the FDIC “insurance” fits into that bucket.
Wade Young is a Denver mortgage broker.
Great stuff, Wade. Thanks for the “fine print” interpretation (even thought it’s a little scary).
Gina–I’ve always meant to mention that I really appreciate your taking the time to comment. You always have something interesting or complimentary to say.
Heck, at least ordinary people now know what kind of boat they’re in. Before IndyMac collapsed, no one even knew what kind of cover the FDIC provides.
I would point out that the WSJ did not imply that the claims paying ability of the FDIC was in any jeopardy at all. The ability to borrow form the Treasury is a mechanism to ensure the agency can perform its function. Member firms are required to fund the FDIC at more than sufficient levels to pay all claims; they must also pay any interest on any debt incurred. Bank failures are, indeed, disconcerting but are hardly “unexpected”, The Chairman herself is expecting them and they are hiring more staff because they expect them.
Wade great post, but I guess it comes down to the avreage Joe. he really doesnt have much to worry about, I dont think there are to many of the average joes that make $100,000 let alone have $100,000 in the one bank. they really dont have to worry about deversifing into two banks.
Based on this information, I wonder how many people will lose that secure feeling that they had in banks.
VA Refinance–
The average Joe’s money is just as important to him as the guy who has multiple six figure accounts at different banks — really even more so. If your emergency fund is $3,400 in a savings account, the security of that account is imperative. It might be a good idea to keep emergency funds in gold. After all, the devaluation of currency is what caused the Roman Empire to fall. The U.S. is in no way impervious to collapse. The point I’m making is that it doesn’t matter if you have over $100k. None of us should put our trust in the FDIC. If times got really bad, it might come through; but then again, it might not.
FDIC by their own admission only retains the funds necessary to cover expected bank failures, of course if they knew banks were unstable why wouldn’t they step in sooner. The challenge for is round of bank failures is that we do not know how deep this mess is. If anyone has any questions as to why we keep getting in this mess just read the wikipedia entry of Fractional Reserve lending, http://www.bankrate.com/brm/safesound/ss_home.asp
You cannot create wealth out of thin air, only true productive assets can create wealth.
I would point out that the WSJ did not imply that the claims paying ability of the FDIC was in any jeopardy at all. The ability to borrow form the Treasury is a mechanism to ensure the agency can perform its function. Member firms are required to fund the FDIC at more than sufficient levels to pay all claims; they must also pay any interest on any debt incurred. Bank failures are, indeed, disconcerting but are hardly “unexpected”, The Chairman herself is expecting them and they are hiring more staff because they expect them.
What if you are holding a receipt of a receiver acknowledging that FDIC owes you $27,000. When, if ever is it likely it will be paid?
The receipt only states that you have successfully presented a valid claim and acknowledge the debt (of the bank taken over by FDIC)?