Banks Want Another Hidden Bailout

The New York Times reports that unnamed “senior regulators” are considering a plan to have healthy banks pay to bail out the sick ones.  I suspect this is a trial balloon – leaked to selected reporters so the administration can gauge reaction before actually doing anything. Read the NYT article if you want the rest of this post to make sense.

There is no doubt the Federal Deposit Insurance Corporation is running out of cash to pay the depositors of failed banks.  Its insurance fund had only $10.4 billion as of June 30.  While ostensibly a private entity, FDIC has a $100 billion line of credit from the U.S. Treasury.  But since we’re all against bailouts, isn’t it better to let the industry pay to save itself?  Yes, but that’s not what is being proposed here.

Where to begin?  First of all, there are no healthy banks.  They differ only in the degree of their sickness.  Fractional reserve banking is at best a kind of managed instability.  The reason FDIC is running out of money is that banks as a group made stupid business decisions motivated by greed.

Now if we had an actual free market economy, mismanaged businesses would be liquidated.  Banks, however, are not subject to this discipline.  Quite the opposite: they routinely reap huge rewards while sticking taxpayers with the bill if losses get too big.

The plan described by the Times is not a way for the banks to save themselves.  It is a cleverly-disguised way of transferring money from the general public to the managers, creditors and shareholders of certain politically-favored banks.  Here’s how it works.

First, the banks borrow money from the Federal Reserve at near-zero interest rates.  We don’t know how much they borrow or their exact terms because the Fed won’t tell us.  Second, the banks will give this money to the FDIC.  Third, the FDIC will give the banks government bonds in return, at an unknown interest rate that will almost certainly be more than zero.

What happens then?  The FDIC will have cash to bail out failed banks, the remaining assets of which will be sold to larger banks at deeply discounted prices.  The banks pay each other interest on the government bonds they got from FDIC.  They also get to count those bonds as risk-free capital.  Bankers will get bonuses.  Bank bondholders will get paid.  Common bank shareholders will get what’s left.  Taxpayers will cover any losses.

Exactly how does this differ from having the Treasury simply give money to FDIC so it can do its job?  Depositors get paid off either way.  The Treasury is still deeper in debt either way.  The difference is that the new debt will be processed through banks in such a way as to let them make more money.

The audacity of this idea is breathtaking.  Will they get away with it?  Maybe, maybe not.  For the most part, the people who actually comprehend what is happening are the same ones who will benefit the most from it.  Organized opposition will be scarce.  Once again, banks win and you lose.