FDIC v. BOA: When Government Intervention Gets Messy

Remember back in June when Bank of America reportedly reached an $8.5 billion settlement with large investors over souring mortgages? We learned earlier this month that some pretty big players weren't on board with the settlement, as AIG sued the bank to recover losses related to mortgages BOA-Countrywide had created. The bank's settlement plans with those other large investors also apparently came as a surprise to one of the biggest regulators in the U.S.: the Federal Deposit Insurance Corporation. This could get messy.

The FDIC has formally taken note of the settlement, asserting that it wants additional information. Does it fear that such a large loss write-off could endanger the bank's stability? Maybe, but that's not the concern reported today by Matthias Rieker and David Benoit at Dow Jones Newswires. They explain:

The FDIC objected as an investor rather than as a regulator of the Bank of America. It said it owns securities that would be covered by the settlement because it took over banks that failed during the financial crisis. "The reason for the FDIC's objection is that it does not have enough information to evaluate the Settlement," it said in the notice.

Let's think about all of the dimensions of this situation. First, the FDIC has bank assets it has swallowed by winding down other institutions. Some include mortgage securities that rely on loans issued by BOA-Countrywide. So a settlement will provide the FDIC with some monetary damages as it plays the part of investor.

Second, the FDIC must worry about the financial stability of Bank of America. If it were to fail the FDIC could experience a potentially gigantic loss, as its deposit insurance costs would be enormous if the bank's assets were insufficient to cover its millions of accounts up to $250,000.

Third, the FDIC is also now the non-bank resolution authority. When wearing that hat, it has to decide if the bank is in such dire straits that it must be quietly taken over and quickly resolved. Some speculated that the FDIC could be eying BOA for this reason its share price plunged by more than 35% from July through last week (but has risen since it began adding to its capital).

In each of these roles the FDIC might have a different view of how a settlement should look. As an investor it wants a big settlement. As an insurer, it would worry about a big settlement. As a resolver, it might actually have some control over the size of a settlement.

In theory, different groups at the FDIC might be involved in each of these processes. They may talk, but given the above internal conflicts it's more likely they'd be arguing. Under which situation are taxpayers better off -- if the settlement is a) large or b) small? It's hard to know for sure. But presumably a BOA failure would make the FDIC and broader U.S. economy far worse off than a big settlement.

Read the full story at Dow Jones Newswires.