Quoting the Crisis

FDIC Insured for Free for 10 Years

crazynutjob:

It was news to some people that the FDIC wasn’t charging some banks their Deposit Insurance Fund premiums leading up to this crisis. A quick search turns up this lovely quote:

Now take a guess as to what the FDIC and Congress choose to do during the economic boom years of 1996-2006? The biggest reasons for our FDIC reserve shortage is because most banks paid no premiums from 1996 to 2006. Yes, it’s a little reported fact that they paid no insurance premiums for 10 years.

Not one private insurance company would stop charging premiums on your auto, homeowners, health, or life insurance for 10 years ——-simply because you had no losses. Does some one need to have a Ph.D. in Insurance and Risk to know that’s not prudent?

Yet, James Chessen, chief economist of the American Bankers Association, said that it made sense at the time to stop collecting most premiums because “the fund became so large that interest income on the fund was covering the premiums for almost a decade.” There were relatively few bank failures and no projection of the current economic collapse,” he said. Anyone else wondering what value economist[s] add? Can we export economist[s] to [C]hina?

There should be some distinction drawn between blaming the FDIC as an institution and blaming the individuals at the FDIC. The people working at the FDIC saw this problem coming, but the institution itself carried this flaw. They didn’t have the authority to collect additional premiums. I found this bit on Deposit Insurance (DI) reform from 2001 (DRR = designated reserve ratio, the size of the deposit insurance fund divided by deposits insured):

We have emphasized that the most important goal of DI should be to enhance macroeconomic and financial stability. The current system, however, always strives to maintain a DI fund equal to 1.25 percent of deposits; hence, it stops collecting significant insurance premiums once that target DRR has been attained. Instead, if losses stemming from bank failures drag the funds below the 1.25% DRR, the FDIC now imposes an ex post settling up mechanism that could cause banks to pay high premiums during periods of financial distress. This design feature of the current DI system could cost financial institutions billions of dollars in extra premiums and raise the cost of deposit gathering during business cycle downturns.

The same people arguing for that reform suggested using a risk-based premium. While this sounds good, the idea was large banks that invest in AAA securities (such as these fancy mortgage-backed securities) should be charged less. You can infer how that would have worked out. On balance, these suggested reforms would have probably resulted in a better FDIC. It’s also worth mentioning that this wasn’t the only vision offered by the FDIC at the time. Still, someone saw the flaws in the system before the consequences were realized.