Twenty-five U.S. banks failed in 2008, making it the busiest year in recent memory for the Federal Deposit Insurance Corporation — until this year, when bank failures are at 37 and counting.
As the FDIC has scrambled, so has the Government Accountability Office. As the FDIC’s official auditor, GAO is responsible for reporting on the agency’s fiscal health and transparency, and what it’s seen is an “unprecedented drop” in reserve funds over the past year, according to Steven Sebastian, the GAO’s director of financial management and assurance.
In a conversation with NationalJournal.com’s Michelle Williams, Sebastian talked about why 2008 was a particularly painful year for FDIC and how 2009 will be another challenging one. Edited excerpts follow. Visit the archives page for more Insider Interviews.
NJ: Was there anything that stuck out as an area of concern based on the FDIC’s balance sheets?
Sebastian: The big concern, and what we attempted to highlight this year, was the rapid deterioration and the condition of the financial services industry and the impact that had on the Deposit Insurance Fund’s reserves in just a one-year period of time.
The reserves of the fund… in December of 2007 were at about $52 billion. At the end of 2008, that number had shrunk to a little over $17 billion. And that was the result of a combination of the failure of 25 financial institutions during the calendar year, as well as estimated losses associated with banks or savings associations that the federal regulators believed were likely to fail over the coming year.
NJ: So 2008 was really challenging.
Sebastian: In fact, if you actually went back and looked at the previous year’s audit report, while we rendered a clean audit opinion on the Deposit Insurance Fund’s financial statements in 2007, we also included, as what we call a matter of emphasis paragraph, the deteriorating conditions, the economic conditions, and the fact that actually led to three bank failures in 2007, which, at that point in time, I don’t think we’d experienced a bank failure in the three previous years.
We noted that FDIC had estimated additional losses associated with likely failures in that coming year of a little over $120 million. And clearly, what happened in 2008 was even beyond their expectations in terms of how quickly the economic conditions had an impact on the insured financial institutions.
NJ: So how much did FDIC lose because of the bank failures?
Sebastian: Well, in total, if you’re going to count actual bank failures and expected failures over this year, the number is about $43 billion. If you talk about losses associated with just the 25 institutions that failed in 2008, the losses were about $18 billion….
A good portion of [the $43 billion], about $24 billion in fact, was set aside in reserves to cover likely bank failures that would occur in 2009. And thus far, at least through the end of last week, we’ve had a total of 36 institutions that have failed [a 37th has since failed] at an estimated cost to the Deposit Insurance Fund of a little over $10 billion. All of those losses were actually included in the reserve that is reflected on the Deposit Insurance Fund’s balance sheet as of the end of 2008.
NJ: How much has the agency borrowed from Treasury?
Sebastian: FDIC has had the authority to borrow from Treasury and up until very recently, it essentially could borrow up to $30 billion…. Within the last two weeks, legislation was signed that would increase their borrowing authority with the Treasury to up to $100 billion and, under special circumstances, it could further increase to up to $500 billion.
But the interesting thing here is through this date, the FDIC has only borrowed from the U.S. Treasury for a short period of time, and that was in the midst of the banking crisis of the early 1990s. I don’t remember the exact dollar amount that they borrowed. But I do know that it was repaid within 18 months, and that included interest. So far, with respect to the current crisis that we’re facing, FDIC has borrowed no funds from the U.S. Treasury.
NJ: Why, then, expand the FDIC’s ability to borrow up to $100 billion?
Sebastian: Well, there’s a couple of issues here. Number one, there is some expectation that they’ll continue to experience large bank failures over the next couple of years. The other thing is there’s a difference between amounts of cash that you need to borrow to actually resolve an institution and the real losses that you incur…. It may cost them more in terms of an up-front cash outlay to close an institution than the ultimate loss may be.
NJ: What future challenges do you foresee for the agency?
Sebastian: The organization has really downsized over the last decade, after we got through the mid-1990s and the last major crisis, when there were little, if any, institution failures…. They’re having to rapidly restaff up to provide the resources to effectively go in and close down these troubled institutions and then to actually service the assets associated with those institutions once they’ve been closed. So FDIC is in the process of bringing back re-employed annuitants, people that actually worked in the corporation back in the 1990s….
The additional challenge, quite frankly, is the extent to which the current economic conditions are continuing to cause distress for some of the financial institutions that are insured. To the extent that there are more bank failures, that would mean more losses incurred by the Deposit Insurance Fund, and the insurance fund is already well below its statutorily mandated capitalization level.
By law, FDIC is required to manage their fund balance, their reserves, to within a certain percentage of the insured deposits, and that percentage was a minimum of 1.15 percent. We were already down at the end of 2008 to 0.36 percent, and it has actually declined further in the first quarter… to about 0.27 percent.
NJ: Should the public be alarmed by this?
Sebastian: Yes, to some extent they should. I think the FDIC has done an extraordinary job of reporting and being pretty candid about the exposure facing the insurance fund. I don’t think this is a situation where they’re withholding anything from the public….
But certainly when you have a situation when the insurer of financial institutions had a fund balance, i.e. reserves, of $52 billion a year ago and at the end of the following year we’re down to $17 billion, that’s an unprecedented drop. I was involved in the work that we did at FDIC during the S&L and banking crisis. At one point, the bank insurance fund actually went insolvent. But it was over a period of several years. This is a dramatic jump in just a one-year period of time.
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