WaMu Failure Could Trigger Extension of Deposit Guarantees

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.

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  1. Steve

    The exposure of the FDIC fund to a WaMu failure is not as great as it seems, at least under the most likely scenario, which is a conservatorship a la IndyMac. If they follow the IndyMac playbook, they could pay out an advance dividend of 50% to the excess depositors, say $10B, and that would approximate total cash out of pocket, for the present. The fund balance is insufficient if FDIC attempted to transfer all or part of the deposits (say $100B – $130B) to another
    institution, unless that institution also purchases assets, which purchase would be an offset to the FDIC wire. If, big if, FDIC can find a purchaser willing to take > $100B of WaMu's assets, then the fund would be walloped but not emptied.

    Whether FDIC has enough bodies and talent to handle a failure the size of WaMu is of course a different matter.

  2. a

    My mother (80 years old) has too much at one bank. I’ve been suggesting (you don’t tell her anything!) that she move some of it to other banks, but she doesn’t *like* the other banks where she lives. Treasuries, Mom? Too much trouble. Agh.

  3. Anonymous

    Your mom is not the only person in denial of the economic calimity in progress. I have attempted to warn friends and family for years with little but hostility to show for my efforts (shoot the messenger).

    I stopped trying to get the message out several years ago. If depositers/investors want their heads to remain in the sand, then so be it…I have had my fair share of scorn.


  4. Anonymous

    “Many firms carry more than $100,000 in balances over the course of a month, particularly if they have a healthy payroll.” The solution is to stop paying in currency and start paying “in kind”. Businesses could negoitiate with local retailers for vouchers which could be used for payment to workers. Of course, the local retailers would have to be paid. Maybe the solution would be for businesses to open an account at the Fed.

  5. Anonymous

    One point that got glanced over.

    Per FT article:

    -FDIC has $45 billion.
    -FDIC has $70 billion in Treasury credit lines.
    -Washington Mutual had $143 billion in insured deposits.
    -Washington Mutual had $164 billion in uninsured deposits.

    Steve in his post says just give out half of the money for uninsured depositors. Well, that’s $82 billion…and that is after the insured deposits have to be taken care of.

  6. Anonymous

    Anon @ 7:37,

    Your voucher idea won’t
    happen; it’s far too open to abuse.

    Consider the lyrics of “16 tons”.

  7. Anonymous

    “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.”

    Yeah, all 6 of them.

  8. Anonymous

    The voucher idea will not work. Who would want their employer to decide where they ccan and cannot shop? This system existed in the 19th century where factory bosses controlled the factories where people work and the shops where they can buy their food.Gone is your economic freedom.

  9. Anonymous

    Is the $300bil of assets a real number (i.e. what the assets would realistically fetch in today’s market during a liquidation), or mark to make-believe numbers like level 3 valuation or what they’d be worth if housing prices were still at 2006 levels?

    If it’s the former, then the FDIC may not have to pay out much (at least for WM, no bets on other banks), and most depositors will be made whole. After all, the $100,000 is only what the govt will guarantee, not what a bankruptcy judge will force WM to pay out. To any bankruptcy experts out there: are depositors the first in line in a BK, or are there higher priority entities?

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