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Monday, September 15, 2008

FDIC Can't Afford Washington Mutual Failure

Read that:

“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.”

Read it again. Think about it.

Washington Mutual (WM) will probably be dead by Friday. How will that work?

Deposit insurance system may face WaMu test: “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.

Washington Mutual - the sixth largest bank in the US - has lost more than a third of its market value recently as investors fear it lacks liquidity and capital to survive the credit crisis.

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 - which has never been used; would be unpopular with taxpayers; and would carry a cost in terms of moral hazard.

The FDIC is respected for its operational effectiveness. But its $45bn deposit insurance fund is underfunded according to its own guidelines, at 1.01 per cent of insured deposits.

The FDIC is preparing a capital replenishment plan that would involve raising premiums paid by banks.

But 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.”

10 comments:

Anonymous said...

Thx for the posts Ben.

This is where it gets scary.

If FDIC runs out of $$$ to cover bank failures, and taps the Tres, the USD is going to tank even further.

This is like any industry pop... like the telecom/dot.com boom. Lots and lots of consolidation and bankrupt companies.

But like it was said, the LEH failure dwarfs the worldcom implosion (for example) AND, even when the dot.com'ers were imploding, the financial backbone of the economy (banks, fed, tres) was (fairly) sound.

How Alan/Ben let people live $100K/year lives but with only $50K/year of earned income is beyond me?

People will now have to work harder, longer, etc...to pay it all back. Its like the entire country was high on credit. Now the US is going cold turkey....and all the pain associated with it.

SKF/DUG - yeee haa!

Unknown said...

"WM dead by Friday". You got that right, if they haven't really been dead since '07!

Anonymous said...

The Law giving the Executive the power to insure all deposits is probably unconstitutional but that has never stood in the way of this Executive.
Way to handle the purse-strings, Congress!

Anonymous said...

There is actually no FDIC fund. The 'premiums' they collect are funneled directly into the treasury to be spent on roads, school lunches, bombs, etc. So every account that the FDIC has to make whole comes directly out of the treasury anyway, so while WaMu is a huge liability to the treasury, so is every other bank that is going to fail.

FDIC premiums are just basically a tax by another name.

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