The Backdoor Bailout for Banks and the FDIC

This morning, news hit that Florida's BankUnited has failed and will cost the Federal Deposit Insurance Corp ("FDIC") $4.9 billion -- the most of any failure so far this year. It likely won't be the last. But don't worry: the FDIC won't run out of money, even though it probably should. It, and consequently the banks it insures, has been bailout out.

Bair & co. have known for some time that their insurance reserve fund is in trouble. For that reason she scheduled a meeting for this afternoon to finalize a special assessment that she intends to impose on banks to increase the size of that fund. The meeting had been scheduled for a while; its occurrence on the same day as the largest failure of the year is only coincidence.

Originally, a 20 basis point per insured dollar assessment fee was proposed. For some banks, that amounts to a lot of money. Bank of America, one of the most troubled out there, has something like $880 billion in deposits. Not all those deposits are insured, but even if only $500 billion are, then that assessment amounts to $1 billion -- not chump change for an institution already struggling to stay afloat.

But fear not, this is the United States. So like every other financial problem, it can be solved with borrowing. The FDIC's borrowing authority was $30 billion -- until Wednesday of this week. That's when President Obama signed the "Helping Families Save Their Homes Act," which included a provision permanently raising that borrowing authority to $100 billion, and temporarily to $500 billion. That money comes from the Treasury, who also doesn't have that kind of cash lying around, but can also just borrow it from others. Like China.

The expanded borrow authority for the FDIC means the assessment finalized today will be much smaller, probably between 6 and 10 basis points. This does present some good news for banks. And by "good news," I mean "backdoor bailout."

A bank's depository base exists, at least in part, because of the insurance the FDIC provides. After all, who in their right mind would still have accounts with banks like Citigroup or Bank of America if their deposits were not FDIC insured? Insurance should not come for free, which is why banks pay a fee for those deposits to be insured.

But that fee was not enough, so the FDIC is borrowing money to cover what it should have been charging banks for depository insurance. The bailout here is that 10 to 14 basis points that banks will not have to pay on that special assessment, or the proper amount that should have been required to legitimately insure their deposits in the first place.

Like some of the other bailouts, this one probably falls into the "better than the alternative" category. The last thing the U.S. needs is a run on banks because the FDIC is insolvent. The bailout still deserves attention, however, because it would not have been necessary if the FDIC had properly priced the insurance it provides to banks.

In order to pay back the Treasury, once the economy improves, the FDIC will almost certainly have to increase the fee it charges banks for its insurance, or impose more special assessments. Unless, of course, the Treasury decides to forgive the loan. That might seem crazy, but with the insane bailouts, spending and other fiscal decisions we've seen out of Washington over the past 8 or so months, you never can tell.