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Friday, October 10, 2008

FDIC Insurance not a Sure Thing!


Radhika Miller

Workers stand to lose as banks continue to topple

We hear the parting words from television commercials and radio advertisements: "Member FDIC Insured." The Federal Deposit Insurance Corporation has been insuring our money, our livelihood, up to $100,000. This was supposed to make working-class people feel safe and comfortable. But when a series of huge banks collapsed, falling like dominos one after the other, individual financial safety was put in serious jeopardy.

FDIC logo
With the passage of the Wall Street bailout legislation, the rules for the FDIC have changed. The sum per bank deposit guaranteed by the FDIC has been temporarily raised to $250,000. The FDIC is also allowed to borrow from the Treasury to cover losses that might occur as a result of the new, higher insurance limit.

The FDIC, however, currently has enough in its reserve fund to cover only 1 percent of insured deposits. As of September 2008, the Deposit Insurance Fund had a balance of $45 billion, which is about $10 billion less than the amount projected in March 2008 for the end of the year. If there is an all-out run on the banks and everyone decides to try to collect their money, millions of workers might not be able to recover any of their money, let alone the up to $250,000 now guaranteed by the FDIC.

A federal corporation

The FDIC is a federal corporation that provides deposit insurance for member banks. It emerged as an institution with passage of the Glass-Steagall Act of 1933. The concept was motivated by the bank panics of 1930-1933, during which thousands of banks failed. The newly established FDIC paid a bank’s depositors roughly 85 percent of their deposits in the event of failure, up to a maximum of $2,500 per depositor.

The FDIC’s mandate covers both insolvent and illiquid banks. Insolvent banks are those whose liabilities (including deposits) exceed their assets (such as holdings of government securities and home and commercial mortgages); illiquid banks are those whose assets cannot be readily converted into cash. Illiquid banks may often be insolvent if no market exists for some of their assets.

When banks become troubled, the FDIC usually intervenes through one of two methods: The purchase and assumption method, or P&A, in which an open bank assumes all the liabilities (deposits) of the failed bank and purchases some or all of the failed bank’s assets (loans); or the payoff method, in which the FDIC pays the insured depositors and liquidates the bank’s assets to recoup at least part of its outlays. The payoff method, which requires the FDIC to provide large sums of money to cover deposit losses, is only used when no bank is willing to participate in a P&A rescue.

The ultimate promise of the FDIC is that depositors will not lose—if a bank fails, the FDIC, sponsored by the government but funded by premiums paid in by its member banks, will guarantee that a solvent bank will assume their deposits or the FDIC itself will compensate them for any deposit losses, now capped at $250,000.

The truth is that the FDIC does not have the reserves to finance this promise.

Too big to let fail

The FDIC has been able to operate with reserves amounting to only 1 percent of the insured deposits because it has never had to compensate for deposit losses exceeding that amount at one time. Essentially, the FDIC works within the same concept of "risk management" and speculation that plagues the financial markets, betting that large numbers of people will not attempt to withdraw their money from the banks all at once.

As long as it has to cover only occasional, individual bank failures, the FDIC is capable of fulfilling its mission statement. However, if a large number of banks fail over a relatively short period of time, the FDIC, too, will likely fail. Stanford Financial analyst Jaret Seiberg predicts more than 100 banks nationwide will fail next year.

The FDIC has predicted that at the end of 2008, insured deposits will total $4.4 trillion. The FDIC has only $45 billion in its Deposit Insurance Fund. Workers could face a gargantuan loss if large number of additional banks was to go under and the Treasury did not come to the rescue.

But the FDIC knows that the government cannot allow the FDIC-insured banking system to fail. If the large banks failed, without other banks willing to assume insured liabilities, the FDIC would have to pay all depositors the insured amount, which it is incapable of doing. Trillions of dollars could disappear into thin air.

The effects would ripple through the money and credit markets throughout the world. Deposits carefully recorded in computers and balance sheets would vanish. Workers’ life savings would evaporate, corporations depending on cash flow would fold, and the capitalist economy, beholden to the ability and motive of turning a profit, would collapse.

Just like the government has bailed out a number of major financial players, the FDIC, too, would likely be rescued. From the perspective of the capitalist class, this would be a simple matter of necessity to avoid even more instability in an already stormy economy. Following the multi-billion-dollar Wall Street bailout, financing such a rescue would likely require intervention by the Federal Reserve, which would essentially print more money so that the FDIC’s financial obligations could be covered.

The result would be a depreciation of the dollar and an inflationary pressure on prices. Essentially, workers might recover every single one of their insured deposit dollars, yet each dollar would purchase less than it did before as a direct consequence of the inflationary effects of the Fed intervention. The Fed can print money, but it cannot create value.

This Catch-22 reveals the limitations of the FDIC system in the face of a major crisis of the capitalist system. There is no mechanism that can be put in place to eliminate the devastating consequences of the bust phase of the capitalist cycle of production. Even a government-backed FDIC bailout will not preserve the value of workers’ deposits. Under the profit system, nothing can provide workers the necessary guarantees against the devastating effects of a capitalist crisis.
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