FDIC the Federal Deposit Insurance

FDIC

The Federal Deposit Insurance Corporation (FDIC) plays a number of important roles in the maintenance of the nation's financial system. The mission of the FDIC is to "maintain stability and public confidence in the nation's financial system," according to the FDIC website (2009). The agency does this by performing three key tasks. The first is that it insures deposits held at banks. The FDIC also examines and supervises financial institutions for safety and soundness. If a bank falls into receivership, the FDIC is responsible for managing that process (FDIC.gov, 2009).

The FDIC also views as part of its mandate to promote sound public policies with respect to the financial system and addressing the risks in the system (FDIC.gov, 2009). These are softer parts of the FDIC vision that comes with little legislative teeth. The FDIC may offer advice to Congress, but it has no law-making power and thus may not have much impact on public policy.

The recent financial crisis put significant pressure on the FDIC, as the nation has seen 99 bank failures so far in 2009 (Wutkowski & Rascoe, 2009). There were over 20 failures in 2008 as well, including major ones such as Washington Mutual. The FDIC's mandate during these times is to attempt to find a buyer for the assets of the banks. The FDIC also guarantees the liabilities of those banks, which are the deposits the bank holds. This step is necessary because the banking system is dependent on the trust that depositors have that their money is safe. Without deposits, banks will be unable to lend, leading to economic slowdown.

What we saw during the 2008-09 recession is that banks were unable to lend, but not for lack of depositors. The banks had taken deposits and invested them in assets (mortgage-backed securities) that ultimately proved worthless. This caused the banks to lack capital for lending, and in some cases to meet their deposits. The result twofold -- credit crunch and bank failure.

The FDIC has spent much of the crisis dealing with the latter, but its role begins before the crisis began. The FDIC envisions its role as a promoter of sound public policies. This year, FDIC head Sheila Bair received a Profile in Courage award for her attempts to get the Bush administration to deal with the subprime mortgage crisis before it threatened the economy (Lizza, 2009). While this push failed, it demonstrates that after Bair's appointment in 2006 the FDIC did play an active role promoting sound policies.

During the crisis, the FDIC's performance has been stronger. The agency has been forced to deal with well over 100 bank liquidations since the beginning of 2008. This many bank failures holds significant risk for the nation's financial system. If consumers lose confidence in the system, banks could face a run, which would force them to call in loans, devastating the system. The FDIC has taken several steps to avoid this while dealing with its 100+ bankruptcies.

The first step the FDIC has taken is to maintain its deposit guarantees. The agency traditionally guarantees deposits up to $250,000 at banks. During this crisis, the FDIC has increased this guarantee to include all funds held in qualifying non-interest bearing accounts through June 30, 2010 under its Transaction Account Guarantee (TAG) program (Dropkin, 2009). This program essentially extends protection of accounts beyond the $250,000 threshold for the foreseeable duration of the crisis, enhancing public confidence in the financial system. Maintaining this guarantee has been costly and the agency's insurance fund has now run into the red. To deal with this cash crunch, the agency has asked banks to pay their fees through 2012 by the end of 2009 (Grey, 2009). That the FDIC is willing to take such a bold step is indicative of the agency's commitment to the maintenance of the financial system.

Another step the FDIC has taken, while handling the liquidation of banks, is that it is encouraging the buyers of those assets to offer unemployed homeowners temporary mortgage forbearance (Dropkin, 2009). This has two key impacts. The first is that it encourages the rapid liquidation of failed banks by defraying some of the risk, as the FDIC shares some of the risk through a loss-share agreement with the purchaser. The second key impact is that it protects unemployed homeowners in the event that their bank becomes insolvent. Without this additional protection, such homeowners could find their mortgage with a collection agency. By reducing the negative consequences to consumers of bank failure, the FDIC encourages faith in the system.

There are critics of the FDIC loss-share plan, however. The plan essentially limits the downside for purchasers of failed banks, while allowing them to retain the upside. The critics point to this as bearing too high a risk for the taxpayer (Paletta, 2009). This risk must also be taken into account when assessing the FDIC's performance in the financial crisis. While it has maintained the stability of the banking system in the face of over 100 bank failures, the FDIC has also deferred much of the risk associated with this failures in exchange of expediency in redistributing these assets.

From the early signs of the subprime crisis to the current state of rapid bank failures, the FDIC has worked consistently if not always successfully to fulfill its mandate. The promotion of sound policies failed, a reflection of the lack of true power the FDIC has in this regard. It has, however, successfully maintained stability and public confidence in the financial system. Despite the high rates of bank failures, there has not been a bank run and very stories have emerged of consumers suffering because of the failure of their bank.

The one caveat to a glowing assessment of FDIC performance is that the spate of bank failures has put tremendous strain on the organization. While it has accomplished its mandate thus far, it has done so at tremendous risk to the American taxpayer for the coming years. If banks pay fees through 2012 now, the FDIC will need new sources of funding should the recession and bank failures continue into next year. The loan-loss program has risk of roughly six times the FDIC's capacity. This means that the likelihood of a taxpayer-funded bailout of the FDIC is strong. The institution's successful handling of the economic crisis thus far could be undone if it is forced to absorb too much of the bad debt it has taken on in the name of expediency.