I'm sure you can imagine exactly what would happen if State Farm suddenly decided that they would cover wind, water/flood and fire on every homeowner's policy that, up to this point, had excluded recovery in these categories. Since State Farm had been carefully collecting actuary data and setting rates (in those states that didn't impose strict price controls on residential insurance premiums) to extract their fairly thin margins, a sudden spike in expected payouts would require pretty drastic action.
Because a large portion of returns to insurance come from re-investment of collected premiums, insurance entities are incentivized to minimize required reserves and put the rest "to work." A sudden increase in potential claims liabilities is not an easy thing to adjust to. Combining that with a period in which the rate of new claims is more than likely to spike, this would likely be, at least in the world of commercial insurance, fatal. So if the FDIC is suddenly required to assume substantial new liabilities after having for years collected premiums that would be insufficient to cover even the regular default rate, well that's not good. Absent rather serious mis-management at the FDIC (we could realistically hope for this, actually) someone is probably going to have to inject a serious hunk of capital to keep the entity solvent.
Congress, White House Weigh Increase in Deposit Insurance [Wall Street Journal]
Posted by guest , Oct 01, 2008 8:50AM
The bailout is horseshit
http://www.atimes.com/atimes/Global_Economy/JJ02Dj02.html
Posted by guest , Oct 01, 2008 8:58AM
WTF are you talking about? The FDIC 'takeovers' are deliberate decisions by the FDIC to pull the plug on a bank. Your analogy would be something like this: State Farm, after a hurricane, learns of serious structural damage of its policyholder but determines that they can get by for a while with half a roof. Then a few months or a year later tells the policyholder to move in with his next door neighbor, who they give $100k to compensate for taking you in.
Posted by bittergreen , Oct 01, 2008 9:01AM
Yeah, well the FDIC is soon going to be flush with cash from the foray into Wachovia's distressed debt.
http://www.forbes.com/markets/economy/2008/09/29/wachovia-citigroup-update-markets-equity-cx_cg_0929markets22.html
Posted by onetwo , Oct 01, 2008 9:05AM
#2: apparently you missed the point. The FDIC charged premiums for 100k worth of coverage yet now is guaranteeing (or attempting to guarantee) 250k worth of liabilities. It's not about the takeovers (your "moving in" analogy), it's about under-pricing the risk of default...hmmm...where have we seen that...hmmm.
Questions: 1) Does the FDIC suddenly have 2.5x the cash available in reserves?
2) If 1, then what asshole has been managing the FDIC's funds to sub-optimally manage their cash reserves by 2.5x.
Posted by Master of None , Oct 01, 2008 10:10AM
EP - awesome post. Putting the issue into context will hopefully help others understand what to most sounds like a no-brainer good idea.
Posted by guest , Oct 01, 2008 10:11AM
The cost to the FDIC of providing the extra insurance is not going to be 2.5x. Most covered accounts have less than $100k so this change has no impact on them.
This is in part a huge publicity stunt and an attempt to stop the mini-runs on the banks (where small businesses move their payroll accounts, etc., from distressed banks so they aren't at risk). The idea is that stopping the runs will save the FDIC in the long run. Not such a bad idea.
True, there is an identifiable cost to the FDIC for this added coverage, but just like how State Farm changes their premiums after a disaster causes them to rethink their risk models, the FDIC will eventually pass this cost on to depository institutions.
Posted by guest , Oct 01, 2008 10:22AM
You do realize that the FDIC doesn't really have any "cash reserves," right? The FDIC's fund is just an accounting fiction. There's nothing stopping it from "dipping into the red" with the Treasury to cover any needed payouts.
Admittedly, that could prove to be inflationary (what with "printing" extra money to cover it), but considering that we may be facing some deflationary pressure it may not be too bad...
Posted by guest , Oct 01, 2008 10:24AM
Speaking of the FDIC, did you know they spend almost $1B a year? About $890mm of that is salaries.
http://www.fdic.gov/about/strategic/budget/expenses.html
The deposit insurance fund itself is (12/07) sitting on about $53B of Treasuries and cash. Their tax-free income comes from Treasuries ($2.5B last year) and premiums ($640mm in 2007, but just 32mm in 2006?!)