The FDIC or the Federal Deposit Insurance Corporation, is the government agency that guarantees depositor money at banks, in case they fail. So if a bank that had my money was to fail, then the government would pay me my account balance up to $250,000. With the previous crises there was a huge number of failures that cost the FDIC a lot of money. The FDIC has paid out approximately $9 billion to cover depositor’s losses, loans, or to cover the assets at the approximately 165 financial institutions that failed or were acquired by larger more stronger banks. In order to reduce losses and prevent further damage to the financial system, the FDIC essentially entered into loss sharing agreements with a number of the stronger banks that acquired the failed banks. These loss-sharing agreements essentially protect the stronger banks from losses, if the failed banks they acquired cause more losses. In effect, banks get to keep all the upside or the potential profits from acquiring the failed banks, while the government is on the hook for a large share of the losses in case anything goes wrong.
That as of Jan. 31 the FDIC has paid out approximately $8.89 billion to banks under these loss-sharing agreements. These loss-sharing deals are in place at approximately 236 institutions, that hold around $160 billion problematic assets. The article goes on to say that the FDIC expects to pay out an additional $21.5 in payments, from 2011 to 2014 to cover these loss-sharing agreements. The FDIC expects to pay out approximately $6 billion in 2012. While these amounts seem quite large, the FDIC says these are actually smaller than the FDIC expected to have to pay out. Since, the costs to cover the bad loans that the failed banks had made, would be a lot more than the costs to cover the potential losses. In addition, with other banks agreeing to buy these failed banks, they are also agreeing to take some losses as well. As a result, the government is not on the hook for all the losses, just a part of them. The FDIC has also said that these estimates of how much they would have to pay out in the future, might change based on the economic environment and how banks perform.
In fact, the executives at the banks that acquired these failed banks, are saying that the assets they acquired from these failed banks are performing much better than they expected and that the losses are not coming in as high as they expected. As a result, the FDIC has been saying that the program has been working, and that the expected failures would have had a much bigger impact on local communities, had it not been for the loss-sharing agreements. The FDIC’s fund has been severely depleted though, the fund had a negative balance of approximately $7 billion on Dec.31 due to 350 bank failures that have happened since 2007. A large amount of the reimbursements have gone to BankUnited, with nearly $1.2 billion in reimbursements to its new private equity owners. According to the article, the FDIC has agreed to cover nearly 95% of the losses. But those were some of the best loss-sharing terms this year.
The FDIC has taken over and sold 25 failed institutions so far, in comparison to 30 at during the same time last year. In fact, of the 25 that the FDIC sold this year, 11 of them did not have any loss-sharing provisions. In order to get compensation from the government, bankers have to show detailed documentation about the bad loans and whether the banks made a serious effort to collect from the borrowers. Once the reimbursements are approved,the FDIC pays them out. The FDIC is not funded by taxpayer money, rather it is funded by required contributions from every bank or thrift that operates in America. This downside protection, gives banks a strong potential to make a profit from the bad assets they acquired. Especially, if the economy does better, making it easier for borrowers to pay back their loans. According to Ameris Bancorp’s executives, they didn’t think they would be able to make any money from the 6 failed banks that they acquired. But now they are saying that they might be able to clean up 70% of the bad loans by the end of the year. Ameris received $26 million from the FDIC to cover losses from the banks they acquired. BB&T corp, another big bank that bought a failed bank, got nearly $1.1 billion from the FDIC to cover the losses. As the article mentions, the bank that BB&T bought, was the 5th largest bank failure in American history.
However, even with these reimbursements, there are still a few financial institutions that have not been reimbursed at all under the loss sharing agreements. The biggest one is OneWest Bank which bought another large failed bank called Indymac, but the OneWest executives did not comment on the company’s loss sharing agreements with the FDIC. On the surface, these loss-sharing agreements might seem like they are not really letting the free market work like it is supposed to, but without the agreements, the damage to economy might be a lot worse. As a result, the government has to choose between respecting free market principles that might make the crisis a lot worse and drive the US economy back into a recession, or by engaging in these kinds of agreements that can protect local economies and the overall national economy. In the end though, banks are essentially supporting one another indirectly.