The FDIC expansion explained

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1

Regarding the expansion of the FDIC powers to include guaranteeing the senior debt of banks and their holding companies...in reviewing the details, I think I figured it out.

Here's the text:

The Secretary of the Treasury, in consultation with the President and upon the recommendation of the Boards of the FDIC and the Federal Reserve, has invoked the systemic risk exception of the FDIC Improvement Act of 1991. [Edit: love the name]
This action will provide the FDIC with flexibility to provide a 100 percent guarantee for newly-issued senior unsecured debt and non-interest bearing transaction deposit accounts at FDIC insured institutions subject to the terms outlined below.

Scope of Eligible Entities

Eligible institutions would include: 1) FDIC-insured depository institutions, 2) U.S. bank holding companies, 3) U.S. financial holding companies, and 4) U.S. savings and loan holding companies that engage only in activities that are permissible for financial holding companies to conduct under section 4(k) of the Bank Holding Company Act ("Eligible Entities").

Not all companies are eligible, but "bank holding companies" are eligible.

Hmmmm...seems that I recently heard something about somebody switching from being an investment bank to a bank holding company recently...who was that? Oh. Here it is.

On Sept. 21, in a move that fundamentally changed the shape of Wall Street, Goldman and Morgan Stanley, the last major American investment banks, asked the Federal Reserve to change their status to bank holding companies.

Goldman would now look much like a commercial bank, with significantly tighter regulations and much closer supervision by bank examiners from several government agencies.

Yes, I remember being confused by this move at the time as it made no sense. At least the explanations did not smell right. We were told that GS and MS "asked" to be placed under "significantly tighter regulations and much closer supervision by bank examiners from several government agencies."

That would have been a first.

It is now clear to me what happened. The government guarantee of all senior debt was already in the works some time ago, and GS and MS hopped on that gravy train. At every turn, GS has been there with a slightly better seat at the table and better inside information than its competitors. The Treasury Secretary happens to be a former GS CEO. Just an unfortunate coincidence, I'm sure.

As always, in this never-ending looting operation, the rules are bent and modified willy-nilly to support a favored class of institutions and individuals.

We now have an openly two-tiered system.

 

This is a companion discussion topic for the original entry at https://peakprosperity.com/the-fdic-expansion-explained-2/

2

What are the critical numbers/levels to watch for in the TED spread? What other variable would indicate a thaw of the credit markets?

Thank you for your hard work,

Ron

3

I must be loosing it as I thought I posted this comment earlier…

Would love peoples thoughts, but one of the untintended consequences I can see is Treasury securities loose - why would someone want to buy a government backed treasury yielding from a dismal .03% yield all the way up to a whopping 4.2% for a 30 year treasury when you can buy a "government" backed senior debt from one of the choosen firms at a minimum of twice the yield!!! This seems to simple to me that I must be missing something. If I am correct, we will be at a credit crisis at the Federal level soon when the world realizes this… maybe Goldman can come the rescue of Uncle Sam!

4

Mark,

I made that point in the prior posting.

You are exactly right and I cannot think why one would not immediately pile out of treasuries and into the highest yielding senior debt of FDIC-insured institutions out there.

Here’s what I wrote:

This is another gross marketplace distortion of the highest order. It
means that sharp investors will now scramble for the highest yielding
junk debt of the most troubled institutions so as to grab all that
extra free yield. Suffice it to say that moral hazard has just been
kicked up a notch. Instead of poorly performing banks being shunned,
as they should be, they are now advanced to the front of the pack by
virtue of offering a higher "risk free" yield than their more cautious
competitors.

Grab it while you can…the advantages of government subsidies have a habit of not lasting long.

Best,
Chris

5

OK, now just hold on one minute. Morgan Stanley and Goldman Sachs conveniently ask the Federal Reserve for a change of status from an investment bank to a bank holding company just a mere 23 calendar days ago and now voila they reap a 100% debt guarantee from the FDIC in a just announced move today October 14, 2008?

This is clearly actionable. The veil is off and the mystery is OVER. This corvair is DANGEROUS and unfit for the road.

 

6

Ron,

nope, no particular levels…the TED spread has historically sat between 0.3% and 0.5%. Today it is around 4.3% indicating that stress remains int he banking system.

Also keep an eye out for the LIBOR swap spreads.

 

7

Great what does this all mean?

I suppose banking confidence has been restored.

I suppose that the world governments are now getting deflation under control.

I suppose the amount of money/credit being injected is only enough to control the deflation so inflation will not occur.

My deposits are now protected - the banks did not have a holiday! The stock markets were open! So all is well and recovery is just around the corner.

The rich get richer and I retire on fixed income in 2 years.

I’m happy! Right?

8

Hi Chris

Why can’t this expanded deposit insurance have a deductible and/or cover only a percentage of the full amount at risk?

100% protection on existing FDIC insured accounts and 50% coverage of losses above and beyond the 50 or 100k cap.

Insurance always has a deductible and other limitations. Free, unlimited insurance is a total government give-away (welfare for billionaires).

9

what action are you proposing? and by whom?

10

Great Investigation.

11

I am not an attorney, however I am old enough to remember a funny little consumer advocate that forced a corporation to take ownership for safety issues in the name of the people. Seems to me the setting is right for another (?) to come along and hold Paulson accountable for the obvious insider information that was given which protected MS and GS.

 

12

Chris

I have been as confused as you since the GS/MS change in status was announced. Why would they have asked for more oversight? Even more troubling IMO, were the new rules they would have to live under as merchant banks. As Investment banks they would have access to many multipuls the leverage on deposit. Making the switch over to merchant banking regulations would significantly reduce their access to liquidity.

Yup…Something stunk about the change and sure enough such was the case.

Thanks for some great detective work. Another piece of the puzzle is in place.

13

as i understand it paulson was granted immunity. this is all "legal"

i saw that funny little consumer advocate a few weeks ago and btw he is running for president for the 5th time . and i am voting for him for the third time. i am voting right after i fight a few windmills.

this is a line from one of my favorite movies " eddie and the cruisers" it is an exchange between the bass player and the lyricist. this line by the bass player sums it all up for me." hey wordman guys like us …they discover oil under our garden…all we get is dead tomatoes"

i went to a sustainability conference on friday one of "my senators" was giving the opening remarks. i walked in and sat right in front and looked around and realized that if i did not get up immediately they would have to pull me off of him so i left.

i found one of his guys out in the lobby and let him know how i felt about the sellout. he was scared out of his wits (if he has any )

he lold me they are frightened in dc, they are building fema farme with razor wire around them. he told me there is a huge amount of ammo being sold. they are keeping a very close eye on the temperature out here. a rep from "my" other senator was there and he disappeared very quickly after i told him how i felt. this is not meant to stir up anyone’s emotions these are the facts as i experienced them last friday.

and now i sit here looking out at the rain falling on my dead tomatoes

14

now have a much lower risk of bankruptcy? if that’s the case, guys like DSL, NCC and a host of other small cap bank holding companies should be flying off this news, but they’re not… A temporary aberration? I’ll go buy some just for the option, they’re down nicely today but I’ll be definitely putting a stop limit order on these puppies just in case.

15

I keep hearing that the immediate problem is the interbank overnight rate- that banks won’t lend to each other, so, it seems to me, the governement seems to be trying to push a string - trying different things to get banks to trust each other. So can someone explain why the government doesn’t step in and take over the interbank loans directly (with due diligence of course). I realize the fundamental problems lie much deeper and there is probably no good solution, but it just seems attacking this problem head on would at least generate some short term relief and start getting some trust going again.

 

 

16

Will the yield come down on the junk debt now that it will be less risky?

17

http://www.financialsense.com/fsu/editorials/vaughn/2008/1014.html
Both video links within are funny - in a very pathetic way.
Everyday I realize that I am less concerned about a depression and more concerned with our democracy, or what is left of it…

18

In the seventies I studied a book by Jurgen Habbermas named "legitimation crisis". His theesis was that capitalism would end because government would behave increasingly in ways that contradicted or made no sense to the rationality of the general populace. He expected people to withdraw legitimacy (my spellings awful but u no wot I mean). There are lots of things he didn’t forsee but he seems so far to be at least half right.

I keep my posts small so they are easily skipped. Hows the Amish recruitment going Xflies?

I have so far resisted the temptation to quote from my favourite sources (Ayn Rand included) but here’s one anyway. Don’t know the source - found it on a Keith Jarrett record cover.

"Those that create out of the haulicaust of their inheritance, anything more than a convenient self-made tomb shall be know as survivors"

Don

19

down and out bank holding companies? Does this recent news, as much as you hate it, pose an opportunity for bank holding companies which are trading like they will go bankrupt? While the gov’t has said that they are prepared to let some institutions go bankrupt, do you think it will be in these smaller bank holding companies like NCC and DSL whose subs are regional banks? If they let these go down, won’t it spark another wave of confidence destruction?

20

This clause about insuring corporate debt applies to newly-issued debt (according to the original post). Therefore, we can’t "grab it while you can" because it won’t exist for a while. And when it is issued, why would the yield be twice the Treasury yield? By the time it is issued, the markets will understand that it has almost the same risk as a Treasury, so the yield will probably be nearly the same as a Treasury. Where’s the opportunity? Sometimes I think there is a little too much FUD here. However, I do appreciate the great content and research!