FDIC Rule Change Ends Too Big to Fail

Lately, I have been thinking about exactly what it is that modern banking has evolved into. It is no longer about safety and security, instead focusing on speculation and trading. It has become impervious to the normal political process; it has consolidated to the point of being anti-competitive, with an enormous size advantage held by the top 10 banks versus smaller and/or non depository competitors.

Then, the solution dawned on me –  all it would take is the right person (with the support of their board) sending a simple letter.

I slipped off to the near future, and grabbed a copy of a fascinating letter. It ended Too Big to Fail, eliminated taxpayer liability for reckless speculation, freed Hedge funds and investment banks from onerous regulations, and made the entire financial system safer and more stable. I was able to sneak it back home to 2012.

Here is that letter from the office of the Federal Deposit Insurance Corporation’s chairman, circa 2015:


May 23, 2015


Dear Banker,

Thank you for your cooperation in our most recent series of bank stress tests. We had hoped that these would not be required, but following the credit crises of 2007-08 and the more recent banking crises of 2014, the FDIC simply had no choice.

The results of these tests are in, and they are unfortunately much worse than we had hoped for. The recent losses of billions of dollars in trading has made it apparent that nearly every major depository bank is in far worse financial condition than previously believed. The majority of top 20 banks never fully recovered from the earlier crisis, and have insufficient capital to withstand any further pressure. This is especially a concern if the economy takes another turn for the worse, or if Housing begins its third leg down.

Capital reserves are insufficient to support the trillions in deposits of yours that we guarantee. Ever since leveraged speculation has become the primary business of these banks, we have grave concerns about the promises you have made to your depositors. The recent turmoil in Europe, the wild currency swings around the world, and that recent unfortunate incident in China has made the current state of banking extremely risky.

Following the most recent bank failures, the Federal Deposit Insurance Capital Reserves have fallen to perilously low levels. This pool of capital is the guarantor of public monies deposited in demand accounts in the actual bank divisions of your firm. We cannot sit idly by while this becomes exhausted due to your speculations, thus putting taxpayers monies at great risk. Nor can we assume unlimited liability in guaranteeing deposits at firms that were once depository banks but now have morphed into giant derivative trading casinos with potential liabilities measured in the trillions of dollars.

Therefore, as chairman of the FDIC, with the full support of my Board of Governors, we have decided upon the following changes:

1. Effectively immediately, we have increased the FDIC deposit insurance for any US bank that engages in ANY trading of derivatives or underwriting securities or other investment banking activities by threefold. This 3X fee increase goes into effect immediately. It applies regardless whether these trades are hedges for proprietary trades or are made on behalf of clients.

2. Effective in 90 days, we are LOWERING the insured maximum insured deposit liability to $100,000 per account for derivative trading firms. Effective in 180 days, the insured maximum insured deposit liability drops to  $50,000 per account.

3. Effective in 1 year from today, on May 23, 2016, we will no longer offer deposit insurance for any firm that engages in derivative trading, underwriting securities or engages in Investment banking.

4. Any bank with fewer than 10,000 depositors or less than $5 billion in assets may apply for a discretionary waiver of these rules.

It is not our position to tell you what sort of non depository banking activities you may engage in. Those are business choices you and your firm are free to make. However, it is also our position not to engage in foolish insurance underwriting. We have elected to be more conservative in ourrisk management and assumptions,  and therefore cannot guarantee the kinds of risks that your firms have been undertaking.

This action should delight many of you. In the recent speeches of several bank CEOs,  many of you have longed for a return to the days of less regulation and a truer free market. Once you no longer qualify for our insurance due to your other businesses, you will be freed up from all of the onerous bank reviews and regulations that are part and parcel of FDIC insurance.

As a bonus, without the intervention of government guarantees, those of you who continue to have depositors will finally be able to compete in a free and open market. Without FDIC insurance, your depositors will be making their decisions based on your reputation, and their assessment of the safety and security of your operations — and not Uncle Sam’s willingness to continually bail you out.

You have the FDIC’s best wishes for success in the future — just not our insurance.

If you have any further questions, feel free to contact my office.
Thomas Hoenig

Chairman, Federal Deposit Insurance Corporation

This post originally appeared at The Big Picture and is posted with permission.

4 Responses to "FDIC Rule Change Ends Too Big to Fail"

  1. AndrewMGarland   May 24, 2012 at 4:11 pm

    Rather than set arbitrary limits and fees (3X current fees and investment restrictions), let's eliminate deposit insurance supplied by governments and the politicial distortions which always result.

    Any good effect of government deposit (investment) guarantees has to be balanced against the costs and the systemic bad effects. The FDIC is in trouble and has cost $100+ billion from time to time above the insurance premiums which it collects from banks.

    Consider, would anyone loan money to a bank (make deposits) without the government guarantee? I wouldn't. I would find a pure vault and checking services institution and pay them $100 per year for the service. Of course, banks might devise a private system of deposit (investsment) insurance which would meet the demands of risk depositors.

    One could argue, this shows that the guarantee is absolutely necessary. I say that it shows the primary instability of US banking and the fundamental fraud that keeps banks going in their current form.

    If you want interest on a loan, then there is risk. Banks have transfered their risk onto the government to the extent that their FDIC premiums are not sufficient to pay for bank failures. They have transferred a lot of risk. Worse, each bank is encouraged to take excess risk both to meet political pressure and to make extra profits. Heads they win, tails we lose.

    Government is not merely intermediating, that is enabling a voluntary market which might not otherwise exist. Instead, government is subsidizing an industry where the depositers are ignorant of what is going on. The depositors do not really want to "invest" their money and take risks. The bank dearly wants to make money from lending out these deposits, but does not want to bear the full costs of doing this.

    So, have two types of account,
    • Checking: The money is in the back room and the bank handles checks or debit cards for the depositers for a fee.
    • Investment: (Dont' call it savings) The bank accepts your money on terms that match its investment portfolio and you recieve interest, dividends, gains, and losses as earned, like a mutual fund.

    Under this system, everyone would get the results which they expect and there are no bank runs or bailouts. Yes, there would be much less investment through banks. The availability of capital would match the preferences of depositors, and government would not be a shadow investor commandeering resources to support a favored industry.

  2. sierra7   May 26, 2012 at 9:35 am

    Too much "verbiage".
    I would suggest: "You have failed the most recent banking stress test(s) and are no longer backed by the FDIC. (Period)
    We seem to forget why the FDIC was created in the first place. We need (another) a new firewall between the human behavior/competition for shareholders of speculative (capital) bankers and the hard earned savings of the ordinary citizen. The sooner we wake up to that the sooner we will start to climb out of this mess.
    If I buy an IPAD, I don't necessary need to know how it really works, I just need it to function properly and not blow up in my hands. So the same with banks….TRUST…have we forgotten that word??? Obviously we have……no longer trust, banks, politicians, or any other "wall street" business….all appear to be just so much "snake oil."

  3. guesty   June 1, 2012 at 6:04 am

    Sheila Bair is doing her hair RIGHT NOW in anticipation of this announcement. Why, she'll be on the 6 o clock news for heavens sake. wonderful.