True Life: I am a boring person asked:

2) $500B through the end of 2010, which is either slightly over half over, or slightly over 3/4 over, depending on whether the bill is referring to the federal fiscal year or not.  Have they actually drawn down on this LOC, if it did pass?

unsolicitedanalysis responded:

2.)  Not to my understanding.  Remember that “special assessment” on bank profits?  I believe they’ve been operating on that for now.  They also received an exemption to normal reserve requirements if I’m not mistaken - the FDIC is air.

I’m a little late to the party, but allow me to clarify that the FDIC’s Deposit Insurance Fund has a negative balance, but that is due to accounting for losses that have not been paid out. That’s not quite the same thing as “air,” but a typical insurance fund would be forced to cover the gap. The FDIC actually has the cash on hand to operate, plus they think they have enough cash to handle all of the bank failures for the next five years. Their assessment memo from last month (pdf warning) spells out quite a bit. Also, if the fund were to run out of cash, the deposits are still backed by the “full faith and credit of the US Government.” This could mean they draw on a line of credit, but if push really came to shove, it would mean that Congress would have to hold a special meeting to figure out where the extra money would have to come from (or repeal the whole burrito). Otherwise, I suppose the US would be in a technical state of default. That would be bad.

A few tidbits from the memo:

1. Assessment rates were increased effective January 2011.
2. Banks prepaid half of the estimated assessments for 2010, 2011, and 2012, for a one-time boost of $46 billion back in 2009.
3. The FDIC estimates losses for the next 5 years at $60 billion.
4. Loss estimates were made before the $250k limit was made permanent and retroactive, so some wiggle-room adjustments are necessary.

Now, the FDIC has obviously had some bad forecasts in the recent past. They didn’t intend to run down their reserves. A negative fund balance is sort of a black eye. You probably need to discount a little there.

There are other problems, such as the fact that FDIC loss expectations are mitigated by reported profits, but these profits are in many cases accounting voodoo. Banks are draining their loss reserves and calling the transfer a profit. They are accounting for the drop in the price of their bonds as profit (theoretically, they could buy back their debt at a discount and have a net positive position to actually paying back the debt). But if insurance is for failure scenarios, having low loss reserves and a bad credit rating probably should not count in the banks’ favor. And since profits can be paid out in dividends, that means that actual capitalization can be falling due to these accounting games. Actual money is leaving some of these banks with only bookkeeping money taking its place.

You probably have a greater risk of not getting access to your money because a natural disaster has taken down your local ATM communication network than because the FDIC couldn’t pay out from the fund. The last line of credit made a bad scenario extremely problematic. The current line of credit requires true US Financial Armageddon to get the same level of pain. Fortunately, that should wait until 2012.