The FDIC expansion explained

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21

DS-

You have a good point about "newly-issued" debt. It would have to be at substantially higher rates than treasuries as the cost of issuing the debt is as follows according to the press release

Participants will be charged a 75-basis point fee to protect their new debt issues, and a 10-basis point surcharge will be added to a participating institution’s current insurance assessment in order to fully cover the non-interest bearing deposit transaction accounts.

If the Bank is to make any profit on issuing this debt - it is only logical that the coupon would be higher than current treasuries. I was to quick in my comment on the % above because I was thinking of current corporate paper. But the point still is valid, even if it is only 50 basis points higher, which I think is unlikely that it would be that low, given the same risk why not get more return…

Thanks for pointing that out…

On a side note, I think this quote from King Henry is very telling… (from the Wall Street Journal)

A final deal between regulators was hashed out in Mr. Paulson’s office Sunday afternoon. For Mr. Paulson, who had spent a career as an investment banker, the decision marked a reversal. Just weeks earlier, he said that injecting capital directly into banks would appear to be a sign of "failure."

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[quote]
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![/quote]

I see you don’t fully grasp the magic of double dealing.

Say you have two entities. The first ABC, a ‘new’ banking enterprise. It has no cash, but since it is a "bank" all of its senior debt is protected. This bank then gets an infusion of cash (say, $5 billion) from DEF bank. This is issued as ‘Senior debt’, so its 100% protected (by your tax dollars).

Because this ‘new’ bank ABC is created by former executives from DEF the terms are rather favorable, and the debt has a very high interest rate. In exchange ABC buys up all sorts of Junk bonds on the cheap in the hopes they don’t default, but to be frank no one cares because the executives will pay themselves insane salaries either way.

If the junk bonds don’t pay out, ABC ceases to exist DEF gets its money back – and depending on the exact rules the interest added to the principle as well… – and the process is repeated again. If successful, DEF still gets lots of cash on a really expensive debt. The executives of ABC and DEF make out like bandits, the companies merge, and everyone is happy.

There, you see how there will always be ‘expensive debt’ now?

As I said earlier, this goes past moral hazard and straight to pure insanity.

–

Steve

23

I¨m from Argentina, I know very well what a holyday banking is… Here we had the pilot test, so that afterwards it coud be implemented all around the world…

I would like to know what does this graphic of the Federal Reserve means? http://research.stlouisfed.org/fred2/series/BOGNONBR?cid=123

24

Two things:

a) The 75 bp surcharge does not apply during the first 30 day grace window

b) Because a bank can roll its senior debt by calling the old and issuing new then the old debt has an embodied "put" option unless the company is too stupid to roll its debt before going under. During the first 30 days it can do this with no surcharge and after it is with a 75 bp charge. Given the spreads out there, and the 8 month window, there is a lot of embodied value in this government subsidy. It will be taken advantage of.

25

did it? Isn’t that what they did this for, is to have banks use it? Guaranteeing interbank debt is what they saw as a solution to getting the capital to flow from the gov’t’s subsidies/bailout/TARP to the public. Is it permanent? No… does it help? Yes… Will it cost a lot? Maybe… Net net, without knowing the ‘Maybe’ and focusing on what IS… I’d say this is a Net Net positive. You can whine later, the gov’t is too busy trying to save this country… again, if anyone has suggestions, I’m sure they’d like to hear it or perhaps help and try to get Chris on more speaking engagements where maybe he’ll be heard but he better be ready to offer solutions, not just criticism.

26

[quote]did it? Isn’t that what they did this for, is to have banks use it?
Guaranteeing interbank debt is what they saw as a solution to getting
the capital to flow from the gov’t’s subsidies/bailout/TARP to the
public. [/quote]

Uh no. guaranteeing debt has everything to do with capital flight fears, and is primarily driven by the fact that Europe has done something similar. It is also an exceptionally crude and poor way to do it.

A bare minimum better solution would be to declare only existing debt protected. That’d at least stabilize the system without introducing massive moral hazard and gaming of the system.

No, but 3-years is way too long. That’s plenty of time for lawyers to corrupt the system to hell and back. I’d have been very leery about extending this system more than 3-months. Better that all the banks and the market is constantly on their feet. Long enough to restore short term lending, but not long enough to risk massively gaming the system.

Yes it will. Corruption will be on a massive scale. The taxpayers will be robbed by at least 100+ billion dollars, more likely 500+ billion. This is way to easy to abuse, and that’s only at a glance. Massive corporations with years to get a feel for the system, and armies of lawyers to hunt down all the nooks and crannies will soon be robbing us blind.

This is extremely dangerous.

The net positive is that it massively reduces the risk of lending to another party. This will encourage banks to lend large sums of money, and may even shatter the frozen credit markets.

It also prevents capital flight.

Unfortunately, it’ll also tend to stop the healthy deleveraging of the system and encourage some entities to increase leverage to even more absurd levels than in the past. Can we do 600:1, Hell yeah! Provided, of course, they can scare up the funds.

[quote]You can whine later, the gov’t is too busy trying to save this
country… again, if anyone has suggestions, I’m sure they’d like to
hear it or perhaps help and try to get Chris on more speaking
engagements where maybe he’ll be heard but he better be ready to offer
solutions, not just criticism.[/quote]

Suggestions:

1) Establish in the FDIC a banking debt insurance system. Create a premium that can be paid so that any debt can be government guaranteed. Require the FDIC reviews the nature of the loans and limit this service to well known conservative lending practices. Make sure the contract stipulates that corporations that break these conservative requirements will have their insurance revoked and won’t get their premiums back.

2) Don’t guarantee any banking debt. Instead, just stand off to the side and remind everyone that the government still has $450 billion dollars of capital injections, and isn’t afraid to use it if a bank is going under. Given this, there should be zero concern about banks defaulting anyway. At least until the government runs out of cash.

This also has the added benefit of making total losses more visible, and more immediate. We won’t know the damage under the current system until years after it has been done.

 

Take note, all this that took me a couple of minutes. I can’t think of any reason that an army of government "experts" with a weekend to spare shouldn’t be able to come up with something far better.

Steve

27

…the bus is too full and going too fast.
…the driver lied
…look there is another loosening wheel nut
…dear me! a whole wheel came off
(after Leonard Cohen)

Will black humour save us?

Chris love "the job". Brave of you to put up the Elizabeth Kubla Ross thingy - shame it isn’t getting more talk

28

This has nothing to do with the FDIC expansion but do you guys believe that US Treasury bonds are the next bubble to collapse?!

29

Steve, (srbarbour)

I took the liberty of using your text in an emailed note to Paul Krugman at the Times just now:

email to Paul Krugman:

Is it not the case that under the expansion of the FDIC powers to include guaranteeing the senior debt of banks and their holding companies, the following scenario is likely?
Say you have two entities. The first ABC, a ‘new’ banking enterprise. It has no cash, but since it is a "bank" all of its senior debt is protected. This bank then gets an infusion of cash (say, $5 billion) from DEF bank. This is issued as ‘Senior debt’, so its 100% protected (by your tax dollars).
Because this ‘new’ bank ABC is created by former executives from DEF the terms are rather favorable, and the debt has a very high interest rate. In exchange ABC buys up all sorts of Junk bonds on the cheap in the hopes they don’t default, but to be frank no one cares because the executives will pay themselves insane salaries either way.
If the junk bonds don’t pay out, ABC ceases to exist DEF gets its money back – and depending on the exact rules the interest added to the principle as well… – and the process is repeated again. If successful, DEF still gets lots of cash on a really expensive debt. The executives of ABC and DEF make out like bandits, the companies merge, and everyone is happy.
Will you please write about the moral hazard created by this latest government action?
(source of scenario text: poster on
www.PeakProsperity.com , in Blog, under "The FDIC expansion explained")

P.S. Thanks too, BTW, for your excellent responses to Xflies’ "Of course it will be taken advantage of… why do you think"

30

Has it occurred to you that Paulson's actions in wiping out

shareholders of 'rescued' companies are deliberate: that the aim is to collapse the banking sector into Goldman Sachs & Morgan Stanley while elmininating their rivals. Along the lines of JP Morgan 1907?

31

awesome post… good rebuttal with actionable suggestions. Thanks! The only thing I’d add is that before I make the assumption that these guarantees will last 3 years is still left to be seen and the cost to taxpayers will only be incurred if defaults come to fruition

32

You are correct. I never considered a scenario such as you described.

However, now that you describe it, I think it is brilliant. I’m thinking that I should establish a new banking corporation to carry out this type of arbitrage in order to recoup some of my tax funds the government is using for this plan. J

33

Chris,

 

 

Is the FDIC like the Federal Reserve? Privately owned by the banks and private individuals? Where does the profit go from the money they collect off of interest or investments? Are they like a private insurance company with the facade of a Federal institution like the Federal Reserve?

 

 

 

TIA,

 

 

 

 

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Rescuing the Banks