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FDIC’s New Role: Snake Oil Salesman

Actually, snake oil may have some medicinal qualities to it but those who did peddle snake oil used shady and misleading sales tactics - interestingly very similar to AIG.  The thought of snake oil salesman quickly came to mind after reading this NYT article: ‘No-Risk’ Insurance at F.D.I.C. .  One would think that we would have learned by now that there is no such thing as “risk free” in our current market situation.  So why is the Sheila Bair, Chairperson of the FDIC (Federal Deposit Insurance Corporation) trying to sell us on the idea that any guarantees or insurance that FDIC is issuing that relates to the bailout plan are “risk free”?

FDIC’s Mission:

The Federal Deposit Insurance Corporation (FDIC) is an independent agency created by the Congress that maintains the stability and public confidence in the nation’s financial system by insuring deposits, examining and supervising financial institutions, and managing receiverships.

FDIC’s mission has increased and it is now playing a vital role in Treasury Secretary Geithner’s financial conglomerate bailout plan - Public-Private Investment Program (PPIP).  FDIC will be providing guarantees or insuring Treasury’s low cost loans to private investors who will in turn buy “toxic loans” from the financial conglomerates.  Sounds great on paper but in practice there are several problems:

1)  Mission creep:  Andrew Ross Sorkin is absolutely correct in pointing out that this is mission creep.  FDIC’s main function has been to insure bank deposits and if a bank gets in trouble FDIC is responsible for a controlled wind down of that bank’s operations.  Now, under this crisis situation it has assumed the role of guarantor of debt or insurer for PPIP- very similar to AIG’s role in issuing credit default swaps (CDS).

How is this possible?  There is a provision in FDIC’s organization charter that allow for extraordinary steps when an “emergency determination by secretary of the Treasury” is made to mitigate “systemic risk.”  But as Andrew Sorkin points out this is in conflict with a very important provision that limits FDIC’s risk by limiting the amount of debt, guarantees or any other obligations to $30 billion.  FDIC is expected to insure up to $1 trillion possibly more with PPIP.  What gives?

It is a matter of interpretation.  FDIC considers its insurance/guarantees under PPIP as “contingent liabilities” meaning that it is a liability that may or may not occur in the future.  FDIC’s charter states: “The corporation shall value any contingent liability at its expected cost to the corporation.”  So guess what they value these “contingent liabilties” as - incredibly as zero.  That is right zero.  FDIC does not expect to lose money on these “contingent liabilities” so that is how, according to Andrew Sorkin, FDIC is getting around the very important $30 billion limit.

2) More leverage - More Risk.  FDIC’s mission is to provide stability to the financial system.  How do they further that mission by insuring/guaranteeing more debt?  Our financial system is incredibly over leveraged and adding more debt under PPIP only serves to provide more risk and potential instability to the system. Not only that but it is insane to jeopardize the balance sheet of FDIC at time when the demand for deposit insurance is increasing every week.  Unless, of course the risk of FDICs failure or bailout burden falls somewhere else.  Hint, hint - meaning us, the taxpayer.

Here is FDICs response to Sorkin:

It says it plans to carefully vet every loan that gets made and it will receive fees and collateral in exchange. And then there’s the safety net: If it loses money from insuring those investments, it will assess the financial industry a fee to pay the agency back.

WTF? That is an incredible safety net.  Did someone think about the circumstances under which this safety net maybe needed?  I don’t think so.

But think about this for a moment: if the program doesn’t work — and let’s hope it succeeds — the F.D.I.C. would be forced to “assess” banks it is hoping to save, possibly bankrupting them in the process. After all, if the F.D.I.C. starts losing money, it will probably be because the broader economic environment is deteriorating further. So those fees will a new burden at a time when key financial players can least afford them.

Yet, again this is a situation where we, the taxpayer, assume all the downside risk because if the economy tanks we will have to bailout FDIC, the financial conglomerates and we will the stuck with the worthless “contingent liabilities”.  I am sorry, I missed the part how this “risk-free”.  “Risk-free” to whom, certainly not us - definitely “risk-free” to private investors (hedge funds, private equity firms, etc.) and possibly to financial conglomerates.

I love they way Sorkin ended the article:

And these days, whenever anybody talks about risk-free investing, it’s not hard to hear the famous line uttered by Joseph J. Cassano of A.I.G. in 2007: “It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of those transactions.”

Ouch!  It is not good to be compared to AIG.  Sorkin is holding back a little bit.  Cassano and now Bair sound like snake oil salespeople.  There I said it.