Insurer of Last Resort

When the FDIC takes over a failing bank, it winds up selling off its assets (to see what's available, take a peek at www.fdic.gov/buying/index.html). The once sleepy federal agency now may be involved in an asset sale of a different kind--taking toxic assets from troubled, but too-big-to-fail banks and placing them into a "bad bank." That will allow the Bank of Americas and Citigroups of the country to keep their nontoxic assets in a "good bank," thus making their management and shareholders happier (remember, we're now all shareholders of those banks) by returning them to fiscal health, thawing the credit freeze, and prompting the good banks to start lending again.

As advertised, it's a win-win-win: The banks get clean, the assets get sold (proceeds return to the Treasury), and as a side benefit, credit is unfrozen for the benefit of all.

In a series of talks in mid-March, Sheila Bair, the chair of the FDIC, said the proper term for this private/public "bad" bank should be "aggregator bank," and that the program would be administered under TARP. She also predicted that Treasury Secretary Geithner would announce such a plan "within the next few weeks." The plan would likely require additional federal funding and would affect the competitive fortunes of those banks that didn't take on heavy mortgage-related risks, so it's unclear whether such a plan will ever see the light of day.

As it turns out, the FDIC itself needs some propping up. On Feb. 27, it proposed a one-time, 20-basis point special assessment on all banks to refill the coffers of its Deposit Insurance Fund (DIF) after the DIF reserve ratio had fallen to 0.4%--meaning it had only enough reserves to cover that percentage of insured deposits. The original proposal prompted fierce pushback from member banks, so now the FDIC is said to be asking for only a 10 bps assessment; comments on the proposed rule are due by April 2.

In a related move, on March 5 Senators Chris Dodd (D-Conn.) and Mike Crapo (R-Idaho) introduced the Depositor Protection Act of 2009 (S.541) that would give the FDIC the temporary authority to borrow up to $500 billion through the end of 2010 to shore up the DIF.

James J. Green (jgreen@investmentadvisor.com) is editorial director of Wealth Manager.