So the FDIC is proposing to have banks pay three years worth of deposit insurance premiums in advance, as opposed to the single year contemplated just a few days earlier. (see “Humpty Dumpty and the FDIC”). This move should raise around $45 billion, replenishing a fund which had fallen to less then $11 billion at the end of the second quarter and apparently slipped into a negative balance this week.
A prepayment of fees is seen by the banking industry as preferable to a special assessment like $5.6 billion they got hit with earlier this year, since rather than being treated as an immediate expense it’s counted as an asset which gets drawn down as the premiums would normally come due. So by this bit of accounting legerdemain a sudden hit to bank earnings is avoided and (regulators willing) the lending capital of the bank may be preserved.
As I noted earlier, insurance premiums should be set counter-cyclically, which is to say raised during periods of strong bank earnings and eased during periods of contraction. And indeed, the FDIC proposes its’ next outright increase in assessments (3 basis points) to be postponed to 2011.
The problem here is that the proposed prepayment constitutes a massive shift on the asset side of banks balance sheets from actual cash to funds pre-paid to the FDIC, and that’s an asset that can’t generally be tapped to meet liquidity needs except in very limited form and under dire conditions e.g. a potential bank failure. The FDIC’s decision to go the prepayment route as opposed to borrowing from the Fed or Treasury may be more politically palatable, but for weak banks that have received government support these premiums will effectively be prepaid with taxpayer money anyway. As for stronger institutions, one has to question the wisdom of weakening the cash position of viable firms just as a wave of commercial real estate mortgage defaults may be about to hit the banking system.
Since we as taxpayers are in essence loaning much of the money to prepay these premiums through federal bailout funds, a more forthright and stabilizing alternative would be to be straight with the American people: have Treasury or the Fed loan the money necessary to recapitalize the FDIC and, for now, let strong banks keep as much cash on the books as possible, facilitating both stimulative lending and confidence in the event of further losses. And then, when the recovery finally does come, have the discipline and recall of history to raise deposit insurance premiums on all sound banks, tapping bank profits to pay back the taxpayer with interest.
After all, haven’t we had enough smoke and mirrors for one crisis?