Wednesday, April 16, 2008

Does the FDIC really guarantee your bank deposits?

Make sure you don’t miss today’s Debt Rattle, April 16 2008: Witnessing madness

Ilargi: I don't think we can question the FDIC guarantee of US bank deposits enough. We've done it a thousand times here already, but we'll keep going on the topic, if only because it's an idea that dies hard.

As a smart lady said a few months ago: the FDIC insures banks, not their clients. And then there's the superlien that the FHLB has on the FDIC, which means they get their loans back before you do your deposits.

If and when there are multiple bank failures in the US, I can't see how deposits would be reimbursed. From what? The FDIC has no funds to do it. And I'm by no means the only one who thinks that way. Look at the numbers, and draw your conclusions. A reserve of 1.22% doesn't look all that great to me, for one thing. Nor does a $30 billion maximum. Here's Chris Martenson's take:

How Safe is My FDIC-Insured Bank Account?
Your bank account may not be as safe as you think (or hope). Taking a deeper look at the legal details and the financial depth of the FDIC reveals several troubling details that call into question how the FDIC would fare during a true banking crisis.

The US is coming out of a period of unusually low banking stress and failures. Since it is typical human behavior to let one's guard down during tranquil periods, we might legitimately ask if this has happened with respect to the FDIC.

Before we address that though, we probably should understand bit more about the FDIC. There's a fair bit of both good and bad information about the FDIC floating around out on the internet, so I thought we could stick to the facts. In this article I even go straight into the language of the 1933 FDIC act itself so that you can decide for yourself whether it's worth spending any of your precious concern on this matter.

What is the FDIC?

Let's begin with a snippet from Wikipedia on the FDIC
The Federal Deposit Insurance Corporation (FDIC) is a United States government corporation created by the Glass-Steagall Act of 1933. The vast number of bank failures in the Great Depression spurred the United States Congress into creating an institution which would guarantee deposits held by commercial banks, inspired by the Commonwealth of Massachusetts and its Depositors Insurance Fund (DIF). The FDIC provides deposit insurance which currently guarantees checking and savings deposits in member banks up to $100,000 per depositor.

Accounts at different banks are insured separately. One person could keep $100,000 in accounts at two separate banks and be insured for a total of $200,000. Also, accounts in different ownerships (such as beneficial ownership, trusts, and joint accounts) can be considered separately for the $100,000 insurance limit. The Federal Deposit Insurance Reform Act raised the amount of insurance for an Individual Retirement Account to $250,000. 

The two most common methods employed by FDIC in cases of insolvency or illiquidity are the:

Payoff Method , in which insured deposits are paid by the FDIC, which attempts to recover its payments by liquidating the receivership estate of the failed bank.

Purchase and Assumption Method , in which all deposits (liabilities) are assumed by an open bank, which also purchases some or all of the failed bank's loans (assets).

In short, if your bank gets in trouble, the FDIC will ride in and either pay off your account (up to $100k), or sell your bank off to another bank which will then assume the usual duties of your bank. Under normal circumstances, a bank failure should not impact you in the least. But these are not normal times. We might reasonably ask how the FDIC would respond during a major banking crisis. After all, this is our money we're talking about. Faith and hope are great at weddings and sporting events, but they should not form the basis of our strategy for handling our finances.

How many bank failures could the FDIC handle at once?

When we take a look at the financials of the FDIC (Figure 1) we see that the level of insurance (in circles below) is not terribly high either, when viewed as an aggregate amount (in blue) or on a percentage basis (in red). 

click to enlarge

The 1.22% Reserve Ratio means that for every dollar in your bank account, the FDIC has 1.22 cents “in reserve” ready to cover your potential losses. This has proved to be an ample amount during the period of stability we've recently had, but it doesn't seem particularly significant, considering the recent headlines about banking losses (Spring of 2008). 

Consider, for a moment, the collapse of Bear Stearns. In order to assume that bank, JP Morgan asked for, and received, a special waiver from the Federal Reserve to keep $400 billion of suspect of Bear Stearn's assets off the books of JPM (page 4 of the linked document). While JPM may have been padding the books a little bit here, due to the uncertainty of how bad the wreckage might turn out to be, $400 billion dwarfs the $52 billion reserves of the FDIC. 

If one medium-large bank collapse could wipe out the FDIC by a factor of nearly 8, what do you suppose would happen if there were multiple, simultaneous bank failures? At this point, my guess would be that Congress would be sorely tempted to borrow additional funds to remedy the situation, but I worry that hardship and losses might result while the laws were amended and sufficient funding avenues identified. So how many bank failures could the FDIC endure? The data suggests slightly fewer than one big one. 

I thought the FDIC has full faith and credit backing by the US treasury?

Actually, no, it does not. The language in Section 14 of the FDIC Act is clear and unambiguous (emphasis mine): 

(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 that's pretty interesting. First, that any additional money from the federal government is not a guarantee, but rather a loan, which will only be made subject to the approval of the Secretary of the Treasury. Further, that the loan is to be made at “current market yields." What do you suppose would happen to US Treasury yields during a true emergency? I can imagine a few scenarios where they might skyrocket, and this would serve to compound the difficulty of keeping the FDIC fund solvent.

How long does the FDIC have to repay me if things go bad?

Here things get murky. We turn to Section 11 of the act and find this (emphasis mine): 

(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 , subject to the provisions of subsection (g), either by cash or by making available to each depositor a transferred deposit in a new insured depository institution in the same community or in another insured depository institution in an amount equal to the insured deposit of such depositor. 

That only says “as soon as possible” and sets absolutely no time limit or maximum. Taken to the extreme, it might be impossible for the FDIC to ever make depositors whole again, and this is one of dozens of such “outs” that exist in the document. Remember, this act was written in 1933 when money was gold, times were uncertain, and government lawyers were exceedingly careful to avoid locking the government into any possible financial black holes. 

And the FDIC Act is very clear to spell out that the only insurance funds available to depositors are those that exist within the fund itself:

(f)(1)(A) all payments made pursuant to this section on account of a closed Bank Insurance Fund member shall be made only from the Bank Insurance Fund 

So, if the fund runs dry, there isn't another possible source of funds that can be legally tapped without changing this wording. And that would take – wait for it – an act of Congress. 

Surely Congress would appropriate the necessary funds to keep the FDIC solvent? 

Here your guess is as good as mine. I would personally expect the US Congress to do everything in its power to the keep the FDIC well funded, especially during an emergency. I would not fault their desire here. But I can also think of a few scenarios or circumstances under which their ability could be taken away. For example:

1. If the banking crisis came at the same time as an interest rate spike and general funding emergency

2. If we were at war with Iran and things were not going well 

3. If China suddenly started dumping their Treasury holdings in the opening gambit of an economic war 

These would all be times under which I could easily imagine either a lethargic or inadequate response from Congress on the matter.

At my website (free registration req., see The Martenson Report) I offer a few common-sense suggestions of protective actions you might take to insulate your potential losses from a failure of the FDIC system to adequately reinstate your account losses should your bank be among the unlucky ones during this next down cycle.

By Dr. Chris Martenson


Anonymous said...

Er, I think this piece is all light and no heat.

The FDIC insures individual accounts, up to 100K per depositor. That has nothing to do with the bank, other than the bank is "member FDIC." If the FDIC is indeed holding $1.22 for every $1, then they can in fact meet their obligations. Sort of. More on that after the next paragraph.

Bringing up the BS Bailout further muddies things. BS is not a bank. The FDIC insuring individual deposits has SFA to do with bailing out an investment house.

For me, the question is: When things are _really_ turning to shit, what will be faster? People trying get their deposits, or the inflation rate?

The Fine Print: Wheelbarrow manufacturers need not apply.


Mike Nomad

Ilargi said...


You might want to read before commenting.

Works wonders for me.

"If the FDIC is indeed holding $1.22 for every $1" is way below par, if not downright illiterate, and certainly not the kind of comment the subject warrants.

This is not a "how thick in the big head is my neighbour" contest, and you won't make it one either.

I suspect the FDIC doesn't insure anything over $30 billion (which is more than they have in the vault, they'd have to BORROW IT.

And then the FHLB has first dibs, which takes pride in saying they never lost a penny on any of their loans.

Plus, you may have to wait for what money the FDIC might want to give you back until you're pushing daisies. Read.

The FDIC guarantees are there for individual bank failures, not for any systemic problem. It was never set up for that.

$30 billion insures $100 for every American, and not a penny more. Or 300.000 bank accounts at $100.000 each, if you so will.

Which in turn means that one in every 1000 Americans would allegedly get their money back.

Anonymous said...

*1.22 CENTS* Mike, not *1.22 DOLLARS*

Ilargi is right, you need to reread that article.

Btw, the BANK is "member FDIC" - NOT the depositor. So exactly *who* is insured against loss, again?

scandia said...

This article spotlights yet another vulnerability in the financial system. Wish I knew some systems theory! A wee stress sag here, a wee crack there,minor imbalances, both falls and soarings reported in several domains...increased rioting in the streets...somehow I don't think a rush to commodities is going to solve the problem(s).

Anonymous said...

Probably not worth bothering with since things move so quickly down the page...

I did read the article before commenting. Not that it works wonders for me. Rather, I feel compelled to in order to justify opening my cake hole and making noise.

I misread the article re: my confusion of $1.22 with 1.22%. My bad, thanks for the birching, etc.

However, the language behind who the FDIC insures is not ambiguous. The bank is a member because it fills out an application (interesting reading, I think). Being insured by the FDIC is a lure, if you will, for individuals to deposit their money in the bank.

When a depositor opens an account at a bank that is FDIC insured, that the FDIC insuring individual accounts is on some of the paperwork the depositor signs. That makes the written statement a contract.

The bits snipped from the FDIC Act read like they are referring to a bank they are insuring, not individual depositors.

Looking at this a day later and feeling the need to dig deeper, I'm not having any success finding the FDIC charter. It is a corporation, so it has to have a charter, right? Or is it folded into the act somewhere?

For me, the question now becomes: It there an actual dichotomy between depositors and their respective banks as the language may indicate?


Mike Nomad