GAO: More Stress Ahead For FDIC

A Federal Auditor Gives The Numbers Behind The Bank Insurer’s Busiest Year In A Decade

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June 10, 2009, 8 p.m.

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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