Federal Deposit Insurance Corp. Chairman L. William Seidman yesterday said the insurance fund that protects deposits in U.S. banks is "under considerable stress" and "would be in trouble" were the nation to suffer a serious recession.
An "ordinary recession" would not pose a threat to the banking system or the FDIC, Seidman said on CBS News's "Face the Nation." But "if it were a long, a deep recession, then we would be in trouble."
The deposit insurance fund, created after the Great Depression to restore confidence in the banking system, is "at a low point in history as a percentage of what it's insuring," Seidman said.
The FDIC insures deposits up to $100,000 in commercial banks. It is a separate fund from the one that insures deposits in the savings and loan industry, which experienced widespread failures in recent years as a result of adverse economic conditions, fraud and an excess of risky investments.
Seidman stressed that the nation's banks do not face the kinds of problems that led to the $300 billion rescue of the savings and loan industry.
"We can handle anything we can foresee right now," Seidman said on the program. "But if things come along, major failures that we're not able to foresee at this time, that would be another story."
"The system is under stress," he said, "there's no question about it and our insurance fund is under stress."
The U.S. economy has been growing slowly in recent months and economists fear that it could slip into a mild recession. But few economists anticipate the kind of severe recession that Seidman said would cause the FDIC serious problems.
During recessions, when the output of goods and services declines, there is an increase in the number of businesses, individuals and other borrowers who have trouble paying their loans on time or do not pay them at all. Most banks have sufficient reserves to absorb such losses.
But in a serious, long recession there might be so many companies going out of business and such high unemployment that a large number of banks would be unable to cope with loan losses. In such a serious economic downturn, there could be so many bank failures that the FDIC would run out of money ensuring that customers in those banks don't lose their deposits.
The Federal Reserve, the nation's central bank, Friday took steps to lower interest rates in an attempt to prevent even a mild recession.
Seidman's comments were his most negative public assessment of an issue that is lurking in the background of the growing political furor over the costly S&L debacle. The Bush administration and Congress are studying ways to revamp the deposit insurance system to prevent the kinds of abuses that caused a wave of failures in the S&L industry, the most costly financial scandal in the nation's history.
The General Accounting Office is nearing completion of a study of the health of the FDIC and by early fall expects to issue a report on the soundness of the insurance fund. "It's a concern and a valid one," said Robert Gramling, GAO's director of financial audits.
The FDIC has lost money for the last two years because of the worst series of bank failures since the Depression. It now has $13.2 billion to protect depositors in nearly all the nation's commercial banks.
The agency expects another $2 billion loss this year that will shrink its fund to only a little more than $11 billion, leaving the FDIC with less than 60 cents in reserves for every $100 in deposits it insures -- roughly $1.9 trillion. That is less than half the cushion against losses that Congress wants the FDIC to maintain and the lowest level of reserves in the FDIC's history.
Economists hired by the Congressional Budget Office and the House Banking Committee to analyze the soundness of the deposit insurance system predict that to strengthen the fund the government will have to raise the premiums that banks pay for deposit insurance. They said the government might be forced to ask the taxpayers to pick up the tab for bank failures.
"We are clearly at a point in which, in relatively short order, the taxpayers may have to make a contribution to the closure of insolvent banks," Stanford University economist Dan Brumbaugh, widely known in the financial industry for being one of the first to see the savings and loan crisis coming, said in an interview before Seidman's television appearance.
The House Banking subcommittee on financial institutions has commissioned a study of the soundness of the FDIC fund by Brumbaugh, Robert Litan of the Brookings Institution and James Barth of Emory University.
Litan and Brumbaugh warned Congress a year ago that banks have hidden losses that if made public would wipe out the FDIC's reserves. Professor Edward Kane of Ohio State University, a consultant on deposit insurance to the Congressional Budget Office, made a similar assessment.
Once you subtract expected losses from the FDIC's assets, "their net reserves are probably around zero," Kane said in an interview last week.
Rep. Frank Annunzio (D-Ill.), chairman of the banking panel that commissioned the study of the FDIC's soundness, plans to examine ways to replenish the insurance fund.
The FDIC insures all bank deposits of up to $100,000 by law. But when large banks get into trouble it pumps in enough cash to protect all depositors. The deposit insurance is financed by a small tax levied by the government on bank accounts, currently 12 cents for each $100 deposit.
The tax is described as an insurance premium, but the deposit "insurance" is not really insurance but a government guarantee that depositors will be paid if their bank fails, said banking consultant Bert Ely. Unlike conventional insurance, the deposit insurance premiums are not based on any mathematical calculation of how much it will cost to cover expected losses.
The premiums have historically covered all losses, but if the fund does not have enough money, the taxpayers must put up the money to keep the government's promise to protect depositors.
That is what happened with the Federal Savings and Loan Insurance Corp. fund, which ran out of money -- leaving taxpayers to pick up an estimated $300 billion tab for the failure of hundreds of thrift institutions.
Although many banking experts disagree with their analysis, Kane and Brumbaugh contend that the depletion of the bank deposit insurance fund parallels the early stages of the collapse of the funds maintained by the Federal Savings and Loan Insurance Corp. to back deposits in savings and loan associations.
"We are in the midst of reliving the S&L crisis in the commercial banks," said Brumbaugh. "The stage we are in is about the same as 1984 and 1985 with the thrifts" when the problems at many savings and loan associations were far more serious than their financial reports revealed.
"We are moving down the same road" as the thrifts, said Kane, "but the road is not so steep and we are not so far along."
But FDIC officials and many private banking experts vigorously reject the comparison of the banking industry to the savings and loan industry.
"The thrift crisis is not a precursor to a bank crisis, the situation is very different," said Karen Shaw, head of the Institute for Strategy Development, a Washington consulting firm.
"The FDIC is a long way from a FSLIC-like problem. I don't subscribe to the theory that we have a crisis," said William Ferguson, president of Ferguson & Co. a Washington and Dallas firm specializing in analyzing bank finances.
Ferguson's firm provided much of the data on which Brumbaugh and Litan based their conclusion last year that the FDIC is nearly broke. Ferguson said, "I looked at the same data and came to a different conclusion."
The most important difference between the bank and thrift situations, the analysts agreed, is that the three bank regulatory agencies -- the FDIC, the Office of the Comptroller of the Currency and the Federal Reserve System -- are far tougher than the Federal Home Loan Bank Board, which was considered so weak that Congress abolished it last year.
In addition to lax regulation, which allowed many savings and loans to make risky investments, the S&Ls were burdened with billions of dollars of low-interest mortgages on which they suffered huge losses when interest rates jumped after deregulation in the early 1980s.
FDIC officials challenge both the mathematics and the methodology of the studies suggesting the bank insurance fund is in trouble. Seidman has denounced previous research of Brumbaugh and Litan in congressional testimony and FDIC staff members have prepared a point-by-point rebuttal to comments made by Brumbaugh recently in the American Banker, the daily newspaper reporting on the industry.
"We disagree quite strenuously," said Seidman's deputy, John F. Bovenzi. "There's a big difference between concerns about weakness and stress on the system and a finding that it's insolvent."
Less than two months ago, Seidman said, "The decline in problem banks over the past year or so and fewer bank failures so far in 1990 suggest an improvement in the fund overall in 1990, provided no large bank failures occur."
But two weeks ago in a question-and-answer session following a speech, Bovenzi raised the possibility of another $2 billion drop in the fund this year. The $2 billion decline is "a possibility, not a prediction," he said in an interview Friday.
FDIC officials will not discuss their projections for bank failures this year, but the General Accounting Office is believed to be pressing the agency to set aside more funds to handle bank failures this year.
As Seidman stressed in the television interview yesterday, the fund has plenty of money to pay for all the bank failures now foreseen by the FDIC. The fund was never meant to be able to handle a repeat of the Great Depression, Bovensi said, but "I don't think anybody sees that happening now."
Before taxpayers would be called upon to pay off bank depositors, "our economy would be in such bad shape that would be the least of our problems," said Edward Yingling, a top executive of the American Bankers Association, the largest industry trade group.
Yingling said the bankers group believes Brumbaugh and Litan exaggerate the industry's ailments and has complained to Congress that they should not have been hired to research the soundness of the FDIC. By picking Brumbaugh, Litan and Barth, Yingling said legislators "are preordaining what the study will say" because the economists "have already testified that the FDIC fund is broke."
The ABA and two other bank lobbying groups -- the Independent Bankers Association of America and the Association of Bank Holding Companies -- said there is no need for additional increases in the premiums banks pay for deposit insurance. The premiums are already going up under provisions of the S&L cleanup law passed by Congress last year, from 8 cents for each $100 of deposits to 12 cents this year and to 15 cents next year.
The law says that if the bank insurance fund declines for two years in a row -- as now appears likely -- the FDIC can boost the premiums another 7.5 cents per $100 each year and can keep raising them until it builds up a reserve of $1.25 for each $100 of insured bank deposits. FDIC officials said they have not decided whether to raise the premium.
These rates are substantially higher than banks traditionally have paid. Until the early 1980s, the effective rate was less than 4 cents per $100.