So it has come to this. According to the NY Times, regulators are "seriously considering a plan to have the nation's healthy banks lend billions of dollars to rescue the insurance fund that protects bank depositors. That would enable the fund, which is rapidly running out of money because of a wave of bank failures, to continue to rescue the sickest banks."
The rationale is ostensibly to avoid the makings of another populist revolt via further taxpayer bailouts, as well as sparing Sheila Bair the humiliation of going hand in cap to Treasury Secretary Tim Geithner for more money. Of course, had we used the FDIC as we should have done in the first place, by downsizing "too big to fail" financial institutions, while putting in place new regulations and supervisory practices to attenuate the tendency to produce a fragile financial system as the economy recovers, it would have never come to this. But there is no need to compound the error by making the FDIC a mere adjunct of current (and misguided) Treasury policy.
Sheila Bair's reluctance to approach Secretary Geithner is well-founded. The FDIC should be allowed to do its job without any assistance by Treasury, given the latter's cozy relationship with Wall Street. Apart from funding any expenditures which facilitate the FDIC's existing role, Treasury should butt out. The sole purpose of any Treasury funding should be to ensure that the FDIC is free to take over any bank it deems insolvent, and then either sell that bank, dispose of the bank's assets, reorganize the bank, or any other similar action that serves the public purpose of government participation in the banking system.
The notion of having the FDIC implement higher insurance charges on the banks, as many have suggested, is wrong on many grounds. For one thing, it is grossly unfair to force well-run banks to pay higher premiums to pay for the sins of Citi, Bank of America, or Wells Fargo. For another, the higher premiums will simply induce the banks to pass on those costs to the consumer, thereby increasing the marginal cost of credit.
The reality is that banks already have loans outstanding priced in relation to current FDIC premiums. Consequently, raising those premiums retroactively on liabilities already in place is unfair confiscation from shareholders. This is counter to public purpose, as public purpose is presumably currently best served by a zero interest rate policy to keep the cost of credit down. All a bank-wide tax (or increase in insurance premium fees) does is increase the rates charged by the banks, which raises the cost of credit to the economy.
Having healthy banks to shore up the shorter-term liquidity needs of the fund by lending to the FDIC is probably a less onerous option than higher insurance fees, insofar as the loans to the FDIC are government-guaranteed, and therefore pose little risk as far as the banks' lending activities go. They actually can make a profit here.
To read the rest of Marshall Auerback's argument, visit NewDeal2.0