The movie “It’s a Wonderful Life” highlights the fragile dependence of the community of Bedford Falls on its banking institutions.
The potential failure of its saving and loan because of a financial crisis will destroy the idyllic community. The alternative is hellish Pottersville.
One of the cardinal reforms of the New Deal was the establishment of the Federal Deposit Insurance Corp., whose primary function was to protect depositors, such as the fictional citizens of Bedford Falls.
Unfortunately, the FDIC must take drastic steps to prevent its own liquidity crisis.
The regulator projects that without additional fees or increases in regular premiums, its insurance fund will become significantly negative next year and could remain in deficit until 2013 — an intolerable situation.
The agency guarantees $4.8 trillion in deposits at FDIC-insured depository institutions such as U.S. banks and savings and loan associations. This insurance provides a cornerstone of global confidence in our banking system.
To bolster its insurance fund, the FDIC has proposed borrowing from member banks up to $45 billion to shore up its insurance fund. It is asking member banks to prepay their annual assessments for 2010-2012. It would be the first time the agency has required prepaid insurance fees.
Critics argue that instead of borrowing from their members, the regulator should take money from the Treasury. The FDIC has the ability to borrow $100 billion from the Treasury, and up to $500 billion upon the approval of the Treasury secretary and the Federal Reserve.
The FDIC proposal to borrow from its members has some major pitfalls.
First, even after receiving $45 billion, the FDIC’s liquidity would remain less than the congressionally mandated minimum. Congress requires the FDIC to maintain balances amounting to 1.15 percent of its guarantees.
Moreover, regulators expect that over the next four years FDIC losses could reach $100 billion given the nation’s continued residential and commercial loan problems.
The FDIC needs to secure sufficient liquidity to meet a worst-case scenario.
Second, the prepayment to the FDIC means that the banks will have less money to lend. Diverting funds to the FDIC contradicts other government policies aimed at encouraging lending.
Third, paying out $45 billion and expensing it would certainly wipe out the industry’s earnings for years. The New York Times reported in an article, “Banks to Prepay Assessments to Rescue FDIC,” that in the first half of 2009 the banking industry reported only $1.8 billion in income. To avoid showing a loss, regulators are permitting the banks to record the prepayments of premiums as an asset known as a “prepaid expense.” The payments will convert to an expense when these premiums would have ordinarily have been due.
Fourth, borrowing from the banks undermines the FDIC’s regulatory role. Under its New Deal mandate, the agency requires its member institutions to comply with its established guidelines. The FDIC can change management, insist on policy changes or even close a bank. Borrowing from institutions under its auspices compromises the FDIC’s historical independence.
Why did the agency not borrow from the Treasury?
The FDIC hopes to remain a top-tier regulator. Borrowing from the Treasury would undermine that goal. During the next year, the role of our regulating agencies will undergo significant changes in the wake of expected major financial reform.
The current financial crisis, the greatest since the Depression, highlighted a fundamental FDIC weakness.
Specifically, it does not have the financial wherewithal to fulfill its cardinal purpose — protect the deposits of the consumer.
Protecting the depositor helps keep it “A Wonderful Life.”
Originally published in the Sarasota Herald-Tribune
