The alert have taken note that the failure of Washington Mutual, which looks increasingly likely, would consume the FDICs reserves and, as in the savings and loan crisis, force the agency to go hat in hand to Congress for more money.
But this is comparatively early in our burgeoning banking crisis for the bulwark of commercial banks to be tested. Worse, the concern is that uninsured depositors will flee weak banks, and in process, push more over the edge.
Many readers might think there is no reason for anyone to be so exposed. It’s easy to divide one’s deposits across many banks to remain below the $100,000 limit, right?
Not if you are a business. Many firms carry more than $100,000 in balances over the course of a month, particularly if they have a healthy payroll. And the requirements of payroll processing in particularly make it prohibitively expensive to operate multiple accounts. Although the Financial Times article does not address that issue, it does discuss that it may be necessary to increase the scope of FDIC insurance in this nervous environment.
From the Financial Times:
Attention has focused on the danger presented by the failure of Lehman Brothers. But the failure of a commercial bank such as Washington Mutual can have systemic consequences if it threatens a run on other weak banks….
The failure of a bank its size would test the strength of the US deposit insurance system and its ability to maintain the confidence of the nation’s savers.
The US Federal Insurance Deposit Corporation covers the first $100,000 in deposits held by each individual in a given bank. As of June 30, 64 per cent of the total $7,000bn deposits were insured in the US – a much larger proportion than in the UK at the time when Northern Rock. the commercial bank, failed.
Nonetheless, this still leaves $2,500bn in uninsured deposits. If a high-profile failure causes these uninsured deposits to shift abruptly in a flight to safety, it could be highly destabilising for the banking system.
The US could be forced to adopt a de facto blanket guarantee on all bank deposits, as the UK did on a temporary basis during the Northern Rock crisis.
There are other precedents. At the start of the Asian financial crisis in the 1990s, the International Monetary Fund opposed extending deposit guarantees. But the IMF soon changed tack and told crisis-hit countries to issue full guarantees.
A formal blanket guarantee in the US would require legislation. But under a 1991 law, the FDIC could seek a systemic risk exemption to cover all the deposits of a failing institution, subject to the approval of its board, a supermajority of the Federal Reserve governors, and the Treasury secretary in consultation with the president.
The FDIC has no desire to invoke this authority…
The FDIC is respected for its operational effectiveness. But its $45bn deposit insurance fund is underfunded according to its own guidelines,….analysts fear it may have to draw on its $70bn Treasury credit lines. Alan Avery, a partner at Arnold and Porter, said a single failure – if big enough – “would cause the FDIC to immediately draw on the Treasury credit”.
Washington Mutual had $143bn in insured deposits on June 30 – about three times the size of the deposit insurance fund, but less than half of its $307bn assets.