William M. Isaac, outgoing chairman of the Federal Deposit Insurance Corp., said yesterday that if Congress does not reduce the federal budget deficit, proceed with deregulation of financial institutions and pass deposit insurance reform, the banking system will continue to have serious problems.
Isaac told reporters yesterday that the stability of the federal financial system is up to Congress. "If we proceed with sensible deregulation and deposit insurance reform, some of the regulatory reform that's in question and if the Congress will eliminate the deficits over a period of time . . . then I don't have any serious concerns. We'll have a very strong and stable financial system," Isaac said.
"If Congress continues to run up $200 billion deficits, does not proceed with deregulation, does not reform the deposit system, then we are in for continued instability."
Isaac also said that he could see the Maryland savings and loan crisis coming. "What happened in Maryland was anticipated, and was probably inevitable," he said. "I clearly anticipated it after" the Ohio S&L crisis.
Isaac has favored reform of deposit insurance to include risk-based premiums so that the institutions that take the biggest risks pay the highest premiums. He has also favored additional powers for banks, including insurance and real estate investments and interstate banking.
In other remarks, Isaac said that he is concerned about troubled financial institutions accepting brokered funds, and is considering taking enforcement action against those that do. He said $9 billion in brokered funds are held by troubled banks.
The FDIC is considering taking action against a "problem institution" at which one of the "major brokerage houses in this country" placed more than $60 million of fully insured brokered funds to enable the purchase of junk bonds, Isaac said.
"The FDIC is being asked to place its credit guarantee behind that action," Isaac said. Isaac would not say what institution and brokerage firm were involved.
"I just find it hard to understand," Isaac said. "We've been talking about the serious nature of this problem for over two years. Everybody knows that the FDIC is concerned about the practice of putting fully insured brokered deposits in problem banks."
Brokered funds are large deposits placed by brokerage houses or other intermediaries. To attract such deposits, institutions must pay extraordinarily high interest rates. To make money on such deposits they must get a higher return through investments such as junk bonds.
Junk bonds -- low-rated, risky corporate bonds -- pay 3 to 4 percentage points more than investment-grade bonds do. Investment-grade corporate bonds currently yield about 11 percent.
"Whenever we see brokered funds in troubled banks, we take enforcement action to stop it," Isaac said.