10/16/2009 05:12 am ET Updated May 25, 2011

"Loss-Share": FDIC Offers Billions In Guarantees For Buyers Of Failed Banks

As the Wall Street Journal reports this morning, in what are called a "loss-share" agreements, buyers of failed banks are getting billions of dollars in government guarantees to snatch up the bank's bad assets. To entice buyers, the Federal Deposit Insurance Corporation is offering to cover around 80 percent of the losses associated with buying a bank. The result, the WSJ points out, is a massive subsidy to the private equity industry, and a huge risk to the American taxpayer.

As bank failures have mounted this year, much has been made of the FDIC's dwindling Deposit Insurance Fund. But, as the WSJ reports, the FDIC's potential risk through loss-share agreements "is about six times the amount remaining in its fund that guarantees consumers' deposits."

Though the WSJ doesn't go so far as to say the enormous guarantees are, in fact, sweetheart deals, it's hard to imagine a better scenario for bank buyers. (Except maybe the FDIC offering to guarantee 100 percent of the total losses associated with buying a failed bank.)

The FDIC, which first turned to loss share agreements during the S&L crisis in the early 1990s, maintains that the guarantees are much less costly than liquidating a failed bank's assets. Still, examine the WSJ's accounting of the sale of Alabama's Colonial Bank earlier this month:

"The FDIC, assuming its traditional role, brokered a sale of the bank's deposits to BB&T Corp., ensuring that customers wouldn't see any interruption. It also agreed to help BB&T buy a $15 billion portfolio of Colonial's loans and other assets by agreeing to absorb more than 80% of future losses. Under the deal, the most BB&T can lose is $500 million, the bank says, and that is only in the unlikely event that the entire portfolio becomes worthless. The FDIC is on the hook to cover the rest."

That's right, BB&T can only lose $500 million on a $15 billion investment. Which is why many buyers of failed banks are ecstatic over the details of these deals, even if it means taking on shoddy mortgages, commercial loans and other under-performing assets. To wit, this testimonial from Wilshire State Bank CEO Joanne Kim: "After we understood how [the loss-share] works, we were literally overjoyed."

At Credit Writedowns, Edward Harrison argued earlier this month that loss-share agreements socialize the banking industry's losses, while privatizing the gains. Here's Harrison:

"In my opinion, Sheila Bair, the head of the FDIC, is the best regulator in government these days (although not everyone feels that way). Her agency has taken on the workman's regulatory role in this crisis of identifying undercapitalized institutions, seizing them and putting their assets in new hands. These actions are a necessary part of capitalism. When a bank is reckless, it must suffer the consequences.

However, it is the distribution of the losses from failed institutions which I would like to discuss. Much of the loss falls on the FDIC and, hence, taxpayers. In effect, what is a necessary part of capitalism, the extinction of failed institutions, may in effect be a redistribution of wealth in disguise.

"It's what's known as a sweetheart deal," writes Harrison.

Read the WSJ's entire story here.

Get HuffPost Business On Facebook and Twitter!