Agency Plan Tries to Avoid Past Mistake

By Joe Adler


The Federal Deposit Insurance Corp.’s plan to require banks to prepay three years’ worth of premiums appears designed to ensure the agency does not repeat the fallout from the last time the government took dramatic steps to rebuild federal reserves.  Twenty years after the savings and loan crisis, the FDIC finds itself in a situation similar to that of the early ’90s, with a negative fund balance and a need for more liquidity to handle expected failures.  Back then the FDIC charged banks as much as 25 basis points — only to find out it had reserved too aggressively. A rapid economic improvement starting in 1992 meant fewer failures than projected, causing a boomerang effect for federal reserves. The banking industry, which had argued the high premiums were coming at the worst time, was left wondering why it had paid so much. The current FDIC plan is designed to avoid the same situation, letting the agency receive enough to handle expected failures, but ensure that if the situation does improve, banks will not have overpaid. The FDIC, on its way to handling well over 100 failures this year, said its Deposit Insurance Fund at the end of the third quarter was in the red, mostly because of money set aside for future failures, which are expected to cost $100 billion through 2013. Yet conditions improved seemingly overnight as the economy turned around. Failures, which had totaled 127 in 1991, fell by five the next year, and dropped to 42 banks in 1993. By that year the balance of the two funds had shot up to $14 billion. According to some estimates, about 81% of the loss reserve was returned to the fund balance. “It’s always possible, but of course … recovery rates are considerably less than they were at that time and the macroeconomic outlook as at the very least uncertain,” said Karen Shaw Petrou, managing partner of Federal Financial Analytics Inc. “It’s important for the FDIC, as one would hope banks would do, to err on the prudent side with their reserving policy.” She added that the FDIC was also helped during the savings and loan crisis by a greater potential for asset recoveries. In the current crisis, most of the assets available to the FDIC are troubled mortgage-backed securities. “Assets are far more complicated than they were then and therefore inherently riskier,” she said. “A lot of the assets, if not virtually all in the late ’80s or early ’90s, were loans or physical assets with ready rights to collateral. That is clearly not the case in the market” today.