Wednesday, October 7, 2015

Dean Baker Sends Mixed Message On Bailing Out Banks

Unfortunately I seem to be unable to provide functionng links to Dean Baker's Beat the Press, and I am overwhelmingly most of the time on board with him as beats the press for its many  errors and sins.  However, today he seems to have gotten himself confused in a post aimed not at the press but at Ben Bernanke and statements in his memor, entitled "Of course Ben Bernanke could have saved Lehman," which very accurately argues that indeed Bernanke and the Fed could have saved Lehman in September, 2008 but did not do so.  I have not read Bernanke's memoir, but I shall take it as true that Bernanke indeed makes this false claim.  So, so far so good for our usually intrepid Dean.

But there is a problem here, which several commenters on his blog have pointed out.  For years he has beaten a drum that there should have been no bank bailouts, especially not TARP.  His favored outcome was to let whatever big banks were in deep doo doo to go down, to fail, with their depositers being paid off.  Now to pay off those depositers would have certainly made the FDIC go bankrupt, but indeed probably Congress would have come through, if perhaps with some lag, and paid off all those depositers. This would have indeed probably at a minimum led to the careless and venal managements of those big banks being removed, if not necessarily being sent to jail as both Dean and Ben Bernanke also say they wished had happened (as have many of the rest of us as well).  Dean has also regularly dismissed the concerns of Bernanke that failing to bail out the big banks would lead to any further failures of banks or other problems in the financial system that might have led to a 1931 style outcome, which Bernanke feared, an outcome that did give us Adolf Hitler and all that followed (uh oh, have I broken Godwin's Rule, or whatever that is? note official self hand slap).

Now one clear reason why it might not have been as bad as 1931 was indeed that we now have the FDIC, which was not put in place until 1935.  The wave of bank failures after Fall 1931 (and before as well) wiped out the savings of many people who were not at all insured.  Probably the scale of wipeouts would not have been nearly as bad.  OTOH, the degree of interbank connectedness now around the world is much greater and more opaque when the shadow banking system is taken into account than was the case in 1931.  That global financial collapse took many months, having started in May with the failure of the Creditanstalt in Vienna, then spreading across Germany and France over the summer to UK by end of summer and finally to the US by Septermber (and on to Japan later).  It remains not widely reported, although I think Dean knows it (in fact I think he and I have personally discussed this), that the really serious thing that was going on that September was the Fed bailing out the ECB, which was having trouble propping up top German and Franch banks that were threatening to go under due to their exploding AIG problem.  This was truly an enormous mess, and the threat to the full global financial system appears to have been extreme, with all this brought on by the fall of Lehman, which Dean now says should indeed have been propped up.  I guess maybe if it had been propped up, we would not have had to prop up the rest, but who knows?

One final trivial note.  TARP ended up making money for the US Treasury.  A massive bailout of depositers in failed banks after an FDIC bankruptcy would have certainly cost the Treasry and taxpayers money, as was the csse with the S&L bailouts of an earlier decade.  But this is trivial compared to the possible losses that might have occurred if there were no bailouts of the big banks.  In any case, I think Dean has a bit of an inconsistent story going on here, whether or not Ben Bernanke did well or ill.

Barkley Rosser

6 comments:

blissex said...

«His favored outcome was to let whatever big banks were in deep doo doo to go down, to fail, with their depositers being paid off. Now to pay off those depositers would have certainly made the FDIC go bankrupt,»

That «FDIC go bankrupt» is a very big mistake, because the FDIC is a government agency that administers a mutual insurance arrangement, the FDI scheme.

Money paid to depositors under the FDI scheme comes not from the FDIC but from member banks, that have unlimited liability for the deposits of any other member.

The FDIC administers a fund where member banks *advance* money to be paid to depositors of failing banks, but the fund is in effect just a "petty cash" bufferm, to ensure the speedy payment in case of small failures, and member banks remain liable for any additional money to be paid to depositors.

The FDI scheme is backed solely by all the capital of all member banks and becomes unable to pay only if all member banks become bankrupt.

The FDIC has no liability for depositor money at all; to the contrary the FDI scheme is liable to the FDIC for its running expenses.

«but indeed probably Congress would have come through, if perhaps with some lag, and paid off all those depositers.»

Current law of course does not provide for any payment into the FDI scheme by the federal government, but I agree that probably if there were large payments to be made Congress would enact a law to pay federal money into it, to prevent the capital of all member banks to be transferred to the FDI.

What happened a few years ago is that rather than paying into the FDI federal money to resolve bankrupt banks, Congress, plus the Fed Board, decided to handout to the shareholders and managers of those bankrupt banks a large amount of free capital (probably much larger than the amount needed to pay off depositors), both overtly and covertly, to make them no longer bankrupt, largely to avoid them entering the FDIC administered resolution process in which their management would have been fired.

blissex said...

«member banks, that have unlimited liability for the deposits of any other member»

Just to be sure, that should be more precisely «for the [insured slice of the] deposits of any other member».

rosserjb@jmu.edu said...

blissex,

I do not think you are quite right on this. Back during the Savings and Loan crisis, it is my understanding that the FSLIC, the equivalent of the FDIC for that sector, went bankrupt, and in fact has never been put back in to business, with Savings and Loan banks as such basically ceasing to exist and the mortgage business getting taken over by more conventional banks, meaning the burden has shifted to the FDIC.

The FDIC has funds paid by the member banks in the form of premia. It does not have some unlimited right to access deposits of member banks. So, it can go bankrupt, just as did the FSLIC, and if the scale of failures of major banks had happened that many feared, it would have, although it is possible that I am misinformed on this.

blissex said...

«The FDIC has funds paid by the member banks in the form of premia.»

It is a technicality but a big one, one that matters in extremity: those are not "premia" as in insurance, they are advances on future "assesments". The FDIC can "assess" *retroactively* any amount whatsover from member banks (up to their capital) if that is required to cover depositors. Since there is a steady stream of smallish bank failures the FDIC is empowered to ask member banks for advances on future assessments, and puts them in a "buffer account" for the purpose of paying out insured deposits quickly. There is/was a 100 billion of federal money at risk, but that's because it is a bridging loan facility in case the "buffer account" runs out.

http://www.fdic.gov/news/news/speeches/archives/2009/spoct1409.html
«In the FDIC's view, requiring that institutions prepay assessments is also preferable to borrowing from the U.S. Treasury. Prepayment of assessments ensures that the deposit insurance system remains directly industry-funded and it preserves Treasury borrowing for emergency situations. Additionally, the FDIC believes that, unlike borrowing from the Treasury or the FFB, requiring prepaid assessments would not count toward the public debt limit. [ ... ] The FDIC's proposal requiring prepayment of assessments is really about how and when the industry fulfills its obligation to the insurance fund.»

If there was a big failure, and the amount to be paid out to depositors exceeded that advanced by members in the "buffer account", the FDIC would "assess" member banks whatever sum, down to the last cent of their capital, were needed to pay out the insured deposits, and then would pay depositors. The FSLIC operated in the same way. But given the sordid history of that industry a lot of obfuscation has been deployed...

blissex said...

«It does not have some unlimited right to access deposits of member banks.»

Indeed it does not, but as I wrote it has an unlimited right to access the *capital* of member banks, but of course only to pay out insured deposits. This is from the FDIC itself during 2008:

http://www.fdic.gov/news/news/press/2008/pr08084.html
«As per our authorizing statute, any money we might borrow from the Treasury must be paid back from industry assessments.»
«The fund is 100 percent industry-backed. Our ability to raise premiums essentially means that the capital of the entire banking industry - that's $1.3 trillion - is available for support.»
«The FDIC receives no federal tax dollars - insured financial institutions fund its operations.»
«And again, any money we borrow from the Treasury Department must be repaid through industry assessments.»

A number of federal schemes operate in the same way, for example federal unemployment insurance, which gives employers the incentive to fire employees for cause, so they don't get it, as that keeps their future "assessments" lower (employers pay the unemployment insurance of their ex-employees).

As in the extended unemployment case, Congress can vote to make *voluntary* donations to a mutual insurance fund. There has been frantic lobbying by bank interests to extract a legal commitment that Congress will donate enough capital to banks to always bail them out, but this has been staunchly resisted because it would mean that bank losses would actually become contingent liabilities of the Federal Government and would have to be carried in its accounts. The best the bank lobby was able to do was to get a "SENSE OF CoNGRESS" declamation during the S&L fraud epidemic:

www.fdic.gov/regulations/laws/rules/4000-2660.html
«SEC. 901. REAFFIRMATION OF SECURITY OF FUNDS DEPOSITED
IN FEDERALLY INSURED DEPOSITORY INSTITUTIONS.
(a) FINDINGS.--The Congress finds and declares that--
(1) since the 1930's, the American people have relied upon Federal Deposit insurance to ensure the safety and security of their funds in federally insured depository institutions; and
(2) the safety security [sic] of such funds is an essential element of the American financial system.
(b) SENSE OF CONGRESS.--In view of the findings and declarations contained in subsection (a), it is the sense of the Congress that it should reaffirm that deposits up to the statutorily prescribed amount in federally insured depository institutions are backed by the full faith and credit of the United States.»

"SENSE OF CONGRESS" declamations are pure rhetoric and are non-binding, and the drafters of the section above protected it twice by making sense of Congress a reaffirmation of the backing, not the backing itself, which does not exist.

blissex said...

BTW the "buffer account" in mutual insurance schemes run by the Federal Government can be quite huge: the OASDI (Social Security) schemes are also entirely mutual (that is entirely funded by members, with no contribution from the Federal Government), and their "buffer account" is the Social Security Trust Fund, which currently has a lot in it, as baby-boomers have been prepaying for decades.

The big difference between the FDI and the OASDI schemes is that in the OASDI case contributing members are not liable for fully paying out to receiving members: once the "buffer account" has run out the payments to receiving members are cut until the total paid out is as the total paid in, it is strictly pay-as-you-go.

I guess that the main reason why all these schemes are technically entirely funded by members and merely administered by government agencies is to avoid their contingent liabilities counting as government liabilities under existing accounting rules.