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Refuting the "Bianco-Kotok Hypothesis" on FDIC assessments and the effectiveness of FOMC policy
Over the past several months, I have been debating with my good friend and mentor David Kotok of Cumberland Advisers over the impact of the new FDIC insurance assessments on the money markets. David as well as another friend, Jim Bianco, insist that the imposition of the new deposit insurance assessment on all bank liabilities net of capital is blocking Fed monetary policy. I totally disagree.
I have written about this issue on Reuters.com, “Did the FDIC really kill the repo market?” (June 27, 2011). Most recently, David wrote a comment, “FDIC, Fed Funds & Leen’s Lodge,” (August 6, 2011), which I have posted on Zero Hedge. This essay is a rebuttal of what I have referred to in the past as the “Bianco-Kotok Hypothesis” (or BKH).
Let’s start with some basic numbers for reference which are lacking in the BHK analysis and which can be found in the memo by Arthur J. Murton, Director, Division of Insurance and Research in presenting the new deposit insurance assessment schedule to the FDIC Board. File attached below.
Under the Dodd Frank law, the FDIC’s goal was to determine a rate schedule that would generate approximately the same revenue as that generated under the rate schedule that was in effect in the second quarter of 2010. The memo from Mr. Murton states:
“While the rule is overall revenue neutral, it would, in aggregate, increase the share of assessments paid by large institutions, consistent with the express intent of Congress. Based upon September 30, 2010 data, the share of the assessment base held by institutions with assets greater than $10 billion would increase from 70 percent to 78 percent, as mentioned above, and their share of overall dollar assessments would increase commensurately from 70 percent to 79 percent. The share of the assessment base held by institutions with assets greater than $100 billion would increase from 49 percent to 58 percent, and their share of overall dollar assessments would increase commensurately from 48 percent to 57 percent.”
The FDIC raises about $12 billion per year in insurance assessments. So what we are talking about here is the shift in cost of FDIC insurance onto larger banks of about $1.2 billion or 10% of the total annual deposit insurance assessment each year. Proponents of the Bianco-Kotok Hyposthesis believe that this shift in the cost of the deposit insurance base onto larger banks has dampened activity in the REPO market and is, in effect, blocking federal reserve monetary policy. I am not buying it.
While the realignment of the burden of deposit insurance costs may have some effect on bank behavior, a point I have conceded to David in past comments, the impact of the BKH is way, way down the list of factors blocking the effectiveness of QE 2 and ZIRP by the Fed. While the increase in the effective cost of funds has grown for many large banks, this increase does not even begin to explain the very troubling behavior of banks in the short-term money markets.
Kotok argues in his most recent essay:
“The Bank of New York has imposed a fee of 13 basis points (13/100ths of 1%) on large deposits. With this policy, the Bank of New York is essentially stating if you put your money in our bank, we will charge you an interest rate for the privilege of depositing with us. At the same time, the Federal Funds Rate, which is applied in the exchange of overnight reserves between and among banks, traded at +7 basis points. It is here we find the spread of 20 basis points. Why would the Bank of New York impose such a cost on depositors? Simply put, it was losing money. How was it losing money? It has to pay an asset-based fee to the Federal Deposit Insurance Corporation, and the excess reserves on deposit at the Federal Reserve are counted as assets in the computation of the fee.”
Kotok argues that BK and other lenders are imposing a fee on customers to offset the cost of the new FDIC insurance assessment. Since we are able to estimate and calculate the FDIC assessment fee using The IRA Bank Monitor, let’s take a look at BK:
1) The assessment base for BK in 2010 was $78.7 billion and increases to $193 billion using the average assets method for calculating the new assessment base.
2) The total base assessment rate or TBAR calculated for BK by The IRA Bank Monitor is 14 bp as of Q1 2011 vs. 8.8bp for Q4 2010 or an increase in TBAR of 6bp.
3) The total cash assessment rate estimated for BK is $51 million in Q1 2011 vs. $31 million in Q4 2010.
So, do you think an increase in the expenses of BK to the tune $20 million is the most significant factor behind the decision to impose a 13 bp fee on large deposits? No, it is not. In fact, net of the particular FDIC assessment increase, BK is actually making more money than before. Why? Because the 13 bp fee is more than 2x the increase in the deposit insurance premium by the FDIC for BK in these periods. But there are many other factors at work in the world bank deposits.
BK is typical of most large banks, BTW, with a 6-8 bp assessment increase Q4 2011 vs. Q1 2011 as a result of the new FDIC assessment base. And keep in mind that with the FDIC assessment adjustment for debt liabilities, BK and other large banks are still paying less insurance assessments, dollar for dollar of assets, than do smaller banks, which tend to have little or no debt funding.
What Kotok refers to as a “wedge” in the money markets is in fact a tax paid by all FDIC insured banks to support the Deposit Insurance Fund. Dodd Frank is not an abnormal development, as Kotok suggests in his writings, but a long-overdue restoration of equity to smaller community banks.
The reason for the anti-depositor behavior viewed by Kotok and other observers is the absolute level of interest rates. Professor Carmen Reinhart calls Fed low rate policy economic oppression. As I argued in Reuters last month:
“First and foremost, the state of the money markets is due to the Fed’s zero interest rate policy. Large U.S. banks are literally forcing deposits out of the system as interest rates fall. In the Fed’s zero rate world, cash has no value. Steven Hanke, Professor of Applied Economics at Johns Hopkins University, argues the Fed should raise interest rates to get the economy moving. Ditto.”
But to the point made by Bianco, Kotok and others, that the change in the distribution in the cost of FDIC insurance premiums is blocking Fed monetary policy, I must also disagree. You cannot even compare the negative impact on household liquidity of the modest increase in the cost of funds for large banks due to the FDIC premium calculation, a phenomenon that shifts less than $1.5 billion in additional costs onto the largest US banks, with the massive cost of the refusal of these same banks to allow tens of millions of US households to refinance their mortgages.
There are literally a couple of trillion dollars worth of residential mortgages in the US that are now “in the money” in terms of option adjusted spreads and should be refinanced. When you consider that housing finance has been the key conduit for the transmission of monetary policy since WWII, I have a hard time comparing the impact of the FDIC assessment with the hideous damage caused by the cartel behavior of Fannie Mae, Freddie Mac and the TBTF banks.
The impact of the FDIC insurance assessments changes on Fed policy is at least two orders of magnitude smaller than the negative impact of the behavior of the housing cartel on attempts by the FOMC to re-liquefy American households. As we wrote in The IRA, “Are the Housing GSEs and TBTF Banks Blocking the Economic Recovery?,” (July 21, 2011):
“In 2008, when the Fed again dropped interest rates to liquefy households and boost consumer demand, the GSEs responded by raising the barrier to home refinancing by changing the loan level pricing adjustment or LLPA. This move defeated the Fed's LSAP program to purchase mortgage securities and thereby drive a significant increase in home refinancing. Rich people got refinancings, but the vast majority of Americans how had the legal right to refinance in 2008 and 2009 were locked out by the banks and the GSEs, who did not want to see the high coupon, high SATO loans produced between 2002 and 2007 prepay. Again the reason, greed, both by banks and the GSEs. Remember that the biggest holders of these RMBS are the GSEs themselves and the Fed, followed by banks and private investors. But because of the actions of the GSEs to prevent Americans from exercising their legal right to refinance, the holders of the high coupon securities have been overpaid for years.”
Bottom line for me is that the proponents of the BKH are (1) mixing apples and oranges comparing the FDIC assessment with monetary policy and (2) ignoring far larger factors such as ZIRP and the cartel the controls the US housing sector that are blocking monetary policy.
Not only is the example used by Kotok with respect to the 13 bp fee increase for BK wrong in terms of the overall impact on the bank’s all-in cost of funds, but it ignores the larger point that all large banks and the investors who hold their debt have been free-riding on the backs of smaller banks long enough. As former FDIC Chairman Sheila Bair told me in an interview last month ("Exit Interview: FDIC Chairman Sheila Bair'," July 7, 2011): “Well, even if the change in the assessment had an effect, is that a bad thing?”
But leaving aside such questions of equity, the impact of ZIRP on all behavior in the money markets is the key issue, not the relatively tiny fiscal operations of the FDIC’s member banks. Raise the Fed funds rate to 1% and the discussion about the FDIC assessment regime and BKH will fade into irrelevance where it well and truly belongs. Or as Dan Alpert of Westwood Capital noted after reading Kotok’s comment:
“While the FDIC's computational algorithm may be highly flawed, it has nothing to do with the failure of QE2. Quantitative easing failed because we are in a supply shock relative to aggregate global demand. Monetary policy aimed at increasing the supply of capital has no effect as demand does not justify the employment of additional capital.”
Amen.
Chris
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putting aside all this double talk, what I hear the author saying is the Big banks are taking a red white and blue dick and sticking up the middle class families arse.
Fire Geithenr, Bernanke and shut the big banks down, dont give them a single farthing.
Give to the small banks who are the real economy. Screw the big banks.
Spot on.
I'd go one step further. Manipulating the value of financial assets and the level of interest rates (i.e., monetary policy) does not create capital (and indeed, negative real rates are actually vaporizing capital). Liquidity and solvency, though related, are not synonyms.
Perhaps the recent bank's assets have declined subsantially enough through stock depreciation in the past couple of months that the Fed and biggies could get away with more QE without crossing the FDIC increase rate thresh hold. Regardless further pumping is futile as the inflection point benefit/detriment has gone negative psycologically and economically as the relative theta burn of any additonal QE has shortened.
Amen indeed!
gs_
"The impact of the FDIC insurance assessments changes on Fed policy is at least two orders of magnitude smaller..."
Great analysis, as always. This was the money line for me.
this is an EXCELLENT article. obviously one need only look at Europe today and see the perils of no FDIC. I am speculating of course but if the United States is on the cusp of a substantial and significant second leg down in housing (and nothing the K street real estate baboons have done has prevented such a thing) it is absolutely critical for the government that the American people feel their deposits are not at risk. in effect relative to savers "banks are irrelevant" under such a scenario because simply put they do not represent a positive force for the economy going forward and instead represent basically "ball and chain" around which a recovery will be prevented. i imagine this is well known already as well so let us not dwell on all the "negativity" either.
http://www.youtube.com/watch?feature=player_detailpage&v=FcPKa-iwxq0
Thanks for that enlightening piece, Chris.