Q&A of the Day – How the FDIC is Funded & Functions
Each day I feature a listener question sent by one of these methods.
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Today’s Entry: @brianmuddradio How is the FDIC bailing out banks not a government bailout!?
Bottom Line: With the FTX fraud, The Signature Bank failure and sudden collapse of Silicon Valley Bank, there are more questions than answers with a lot of what’s happening in the US financial system right now. The question you’ve asked is answerable and it’s a good time to have the conversation about what the FDIC is, how they get their money and as you’ve asked, how an FDIC bailout differs from the bailouts of banks in the 2008 financial crisis.
The FDIC is one of the most visible government agencies, and most people know they’re there to protect our bank deposits, but where does their money come from? It’s not from you, at least directly, which is why FDIC bailouts are different than the taxpayer-led bailouts of fifteen years ago. The Federal Deposit Insurance Corporation is an independent government agency created by the Banking Act of 1933 in response to the collapse of the financial system during the Great Depression. Given that it is a federal agency, you might think it’s federally funded, but it’s not. The FDIC’s operating budget last year was $2.3 billion which supports the operations of the 5,660 agency employees. But if taxpayers aren’t funding it, who is? Its member supported.
At last reporting there were just over 5,200 FDIC member institutions. In order to qualify for FDIC backing an institution must be sufficiently capitalized, as determined by regulators, and must pay premiums to the FDIC’s Deposit Insurance Fund. That fund supplies the revenue for the agency’s operating budget and to pay out any losses. So yes, in effect, we do pay for what the FDIC pays out – however it's through our banking activities as opposed to taxes. During the 2008 banking crisis, the taxpayer funded bank bailout was known as the Emergency Economic Stabilization Act. Proposed by federal regulators, it was quickly passed by Congress and signed into law by President Bush as the bottom was falling out of the financial markets. The law created a pool of up to $700 billion of congressional funding to backstop banks known as the Troubled Asset Relief Program, or TARP. Over the life of the TARP program, a total of $426.4 billion was paid out to financial institutions. All institutions which accepted funds were to pay it back with interest. While some recipients eventually failed, producing losses at those institutions, the net effect of the TARP program was profitable for taxpayers. A total of $441.7 billion was recovered overtime from recipients. Thus, the program turned a $15.3 billion profit for taxpayers.
So back to the FDIC situation and what just happened with Silicon Valley Bank and Signature Bank deposits. As the FDIC stepped in taking control the US Treasury Department said, “no losses will be borne by the taxpayer”. Instead, whatever losses there may be from the unwinding of these banks will be assumed by the FDIC’s Deposit Insurance Fund. But here’s the thing that has me concerned about that approach. As of the FDIC’s most recent reporting, the Deposit Insurance Fund balance was $125.5 billion at the end of 2022. According to initial estimates, 95% of deposited funds at these institutions were above the FDIC insured limit of $250,000 – yet the FDIC said they’d back them anyway. While that’s great news for those individuals and companies, it’s potentially concerning news for everyone else. Prior to the run on these two banks, there were $338.59 billion in deposits in these banks. It’s unknown where exactly those numbers landed when the FDIC assumed control, other than it’s lower than that total. However, it’s all but certain that in backing the non-FDIC insured deposits, the FDIC has assumed risk which has the potential to exhaust all of their reserves. That will be determined by how asset sales go as those two banks are liquidated. Maybe it goes as well as possible and there aren’t any losses. But if it goes poorly, it will leave little room for error if there are failures at other banks. What’s more, any losses assumed by the FDIC are paid for through special assessments on the remaining member banks which obviously raise costs at a time of potential stress for the remaining financial institutions.
While the philosophical debate over whether the federal government should risk taxpayer money to attempt to stabilize the financial system was the debate of 15 years ago. The philosophical debate should currently be whether the FDIC can justify backstopping all deposits, 95% of which aren’t eligible for their protection, at these institutions, while potentially raising costs on all remaining banks – which of course are passed on to consumers – and at worst could put them at risk of falling short in meeting obligations at other banks. So that’s the deal and that’s what’s worth watching as this plays out.