Matt Levine / Money Stuff: Banks Want a Break From the FDIC

Old_Joe

A lot of this spring’s US regional banking crisis can be explained this way:

• 1) Banks bought a lot of Treasury bonds and other US government-backed securities when interest rates were low, paying roughly 100 cents on the dollar for them.
• 2) Interest rates went up a lot, driving the prices of those bonds down to, say, 85 cents on the dollar.
• 3) Banks had big losses on those bonds, eating through a lot of their capital.
• 4) People noticed, stocks went down, deposits fled, some banks failed and others have looked shaky.

One solution to this crisis would be that, if the bonds magically went back to being worth 100 cents on the dollar, the banks would mostly be fine again. That seems improbable, though I guess one interesting mechanism would be if the banking crisis caused enough of a recession to drive long-term interest rates back to where they were in 2020. Then the bonds would be fine, though probably the banks would have credit losses.

Another solution to this crisis would be that, if the US government just bought the bonds from the banks at 100 cents on the dollar, the banks would mostly be fine again. Of course then the government would have paid 100 cents for stuff worth 85 cents, which seems bad. But through the magic of held-to-maturity accounting, you can sort of wave your hands and pretend that it’s not bad. If the government paid 100 cents today for a bond worth 85 cents, and then held it until it matured, it would get back 100 cents. (Plus interest, though not very much.) In some accounting sense, the government would not lose any money: It would get a below-market rate of interest on its money for the next few years, but it would technically get all of its money back.

And in fact this is kind of how the banks thought of these bonds: They were often in the banks’ held-to-maturity portfolios, meaning that they didn’t need to be marked down when they lost value due to changing interest rates. It’s just that, when people notice this stuff and deposits flee, you can’t hold the bonds to maturity, because you have to sell them, at a loss, to pay back depositors. But the government is not funded by short-term deposits, so it really can hold the bonds to maturity.

And in fact this is kind of, a little bit, a solution that the government hit on: In response to the failure of Silicon Valley Bank, the US Federal Reserve announced a new Bank Term Funding Program that would lend the banks 100 cents on the dollar against bonds worth 85 cents on the dollar. This is not the same thing as buying the bonds at 100 cents on the dollar — the banks, rather than the government, are still economically on the hook for the losses — but it is motivated by the same sort of thinking. “Eventually these bonds will pay out 100 cents on the dollar, so it’s fine to lend 100 cents on the dollar against them, even if they are worth 85 cents today.”

But nobody has actually embraced a program of “the government will just buy the bonds back at par to make the banks healthy again,” because it is kind of an extreme transfer of losses from banks to taxpayers, even if you can wave your hands a bit and pretend it isn’t. But here’s this from Andrew Ackerman at the Wall Street Journal:

Banks have spent the past week or so testing what would be a clever gambit: Paying billions of dollars they collectively owe to replenish a federal deposit insurance fund using Treasurys instead of cash.

The idea—floated to regulators and lawmakers by PNC Financial Services Group and supported by others—could allow banks to take securities that are currently worth, say, 90 cents on the dollar, and give them to the Federal Deposit Insurance Corp. at full price. That would effectively shift losses clogging the banks’ balance sheets to the FDIC, according to people familiar with the proposal. ...

Proponents say nothing in the law says FDIC fees have to be paid in cash, so the agency could change its rules. They say the move, if greenlighted by the FDIC, would help the banking system address the way rising rates over the past year have saddled lenders with billions in losses on their portfolios of bonds. Those losses helped sink Silicon Valley Bank in March, sparking turmoil across the banking sector. …

Supporters say the government would hold the securities until maturity, allowing them to recover principal and interest on the debt. The government would suffer no losses, they say.

The FDIC has spent billions of dollars on its bank rescues — which is also a transfer of losses from banks to the government to make the banking system more solvent — but it is getting the money back by charging a special assessment to be paid by about 113 big banks. If the banks pay the assessment with Treasuries that are worth 90 cents on the dollar, but that count for 100 cents on the dollar, then they get a little discount on the assessment and get to move unpleasant assets off their balance sheets.

Why stop there? They should pay their taxes in Treasuries. Really what they should do is pay executive bonuses in Treasuries: “We’re giving you a $1 million bonus, technically it is only worth $850,000 but if you hold it to maturity it’s a million.”