FDIC Debt Program Proves as Good as Tarp, Without the Baggage

WASHINGTON — While the Treasury Department aggressively tries to unload its much-publicized ownership stakes in commercial banks, another crisis-era stabilization program is winding down with relatively little fanfare.

Both the Troubled Asset Relief Program — which still includes Treasury investments in more than 300 banks — and the Federal Deposit Insurance Corp.'s guarantee of financial institutions' corporate debt were credited with calming a chaotic market in 2008 and 2009.

But whereas Tarp will likely always be the notorious poster child of the government's unprecedented intervention in the banking industry, the FDIC's debt guarantee — which expires for good at the end of this year — has engendered little controversy.

"It was run similar to" the FDIC's "bank-failure resolutions: very quietly and very efficiently and didn't cause any fuss," Christopher Whalen, senior managing director of Tangent Capital Partners in New York.

Not only did the debt coverage — part of the Temporary Liquidity Guarantee Program — simply get less attention, but the fees participants paid to fund the voluntary program shielded it from the same criticism that dogged the Tarp's taxpayer-backed $787 billion price tag. (The TLGP also included full temporary coverage of noninterest bearing checking deposits in transaction accounts.)

The FDIC reported just this week it had started moving unused TLGP reserves — primarily made up of fees from the debt guarantee — into the agency's more recognizable Deposit Insurance Fund, much to banks' delight. Barring any failures over the next eight months of issuers covered by the guarantee, the combined program — including both the debt and deposit guarantees — stands to finish up essentially with more than $8 billion in net profit.

Perhaps most important, though, is the comfort bondholders received from the FDIC's backing, helping shore up liquidity in the tensest days of the crisis until institutions felt secure enough to issue debt without the federal guarantee.

"We're pleased that the program was successful in helping to calm the markets along with other measures taken by the government. We got the program up in relatively short order," said Arthur Murton, director of the FDIC's division of insurance and research. "There were challenges in doing that.

"We would like to think that the fact that we were transparent in setting up the program helped with its credibility. It was important for the market to understand and be confident in the guarantee that we were providing."

As of March 31, the program still covered $140 billion, but that was from only 28 issuers — including just six banks.

"If you assess the advantages and disadvantages of the two programs, and include the political costs of Tarp, you can reasonably decide that the TLGP was a more successful program and therefore will be a model for the future," said Kip Weissman, a partner at Luse, Gorman, Pomerenk & Schick.

"It had an unintended benefit of not really being in the press as much as TARP but it arguably had as powerful an effect. It was industry-funded and showed that if given time the industry can take care of itself without really needing more help from the taxpayer."

At the FDIC's April 23 update on the status of the Deposit Insurance Fund, agency officials said that with the completion of the debt guarantee approaching, $2.7 billion in funds originally earmarked for potential TLGP defaults had been moved into the DIF at the end of 2011, boosting the balance for the agency's more traditional deposit-coverage fund. The FDIC signaled that $5.7 billion in additional funds set aside for the TLGP would be transferred when the program was completed.

"The TLGP was a gigantic success. It calmed the market without creating political headaches and it will make money for the FDIC. It can't get better than that," said Jaret Seiberg, senior policy analyst at Guggenheim Partners' Washington Research Group. "The sooner the DIF gets back to the statutory requirement the sooner premiums can fall. This will get you $8 billion closer."

While the agency has indicated no drop-off in deposit insurance premiums for the industry as it seeks to restore the DIF to pre-crisis levels above 1% of insured deposits, industry representatives were still encouraged by the development.

James Chessen, chief economist for the American Bankers Association, said the FDIC could have moved more between the two pots of money.

"That's a huge boost for the Deposit Insurance Fund and it moves forward the recapitalization and the time when premiums can be reduced," said James Chessen, chief economist for the American Bankers Association. "We thought they could have been more aggressive moving reserves from the TLGP into the DIF. They need to have some reserves in there for the possibility that bonds default."

Of the debt guarantee, Chessen added, "It was the industry providing the backstop for each other. It's always the industry that pays the expenses for the FDIC and so it was a unique program for that reason."

The TLGP was launched in the fall of 2008 along with the first round of Treasury's capital infusions into the biggest banks. Before the Dodd-Frank Act in 2010 revamped limits on government assistance for troubled institutions, the FDIC was able to launch the TLGP without legislation, thanks to longstanding authority at that time to provide extraordinary aid if the whole system was at risk. The program included a cap on the amount of an institution's debt that could be covered. If the FDIC lacked the funds to cover losses, the agency under prior law could have charged a special assessment on the industry.

Originally, Treasury wanted the FDIC to offer a guarantee on all outstanding debt, but the FDIC ultimately agreed only to back new issuances. The agency at one point had proposed a 10% haircut on covered debt, but that idea was not part of the final plan.

Initially, senior unsecured debt for eligible participants could be covered for anywhere between 50 and 100 basis points — depending on maturity — if it was issued from mid-October 2008 through June 2009. The guarantee was to last until the end of June 2012, and that is still when the first round of bond issues will lose their coverage. Later, a limited extension allowed institutions to issue guaranteed debt before April 2010 for a higher fee, with coverage lasting until the end of this year.

With about eight months left in the debt guarantee, the program so far has made $35 million in payouts to cover debt of failed issuers, and has $117 million in additional obligations. The claims are for covering debt at six issuers who were covered by the program.

(The other TLGP component — the transaction-account guarantee for certain deposits — is still intensely debated. Technically, "TAG" has expired, but Dodd-Frank extended such coverage through the end of 2012. Some community banks want a further extension.)

At the end of the second quarter of 2009, nearly $340 billion in outstanding debt — from 97 issuers — was covered under the debt program.

But like other programs in the 2008 bailout, the protection — which was available not only to banks but to their affiliates as well — meant a huge subsidy for a financial sector deemed responsible for its own problems.

On Thursday, former FDIC Chairman Sheila Bair, who had backed away from Treasury's initial proposal for the FDIC to cover all of the industry's debt, said the specific scope of the debt guarantee was justified.

"It was a successful program for what it was designed to achieve," she said in an interview. "It was less controversial because we weren't using taxpayer money. We were charging a fee for it. Any losses would be assessed against the industry. And it was liquidity support; it wasn't taking ownership stakes in banks.

"With all of these programs, we wish we hadn't had to do them. But if we ever again get into a situation where the entire financial system is seizing up, where even healthy and well-managed banks are having trouble accessing liquidity, I do think this is a good model to use."

Overall, the reaction to the TLGP — as well as certain liquidity programs created by the Federal Reserve Board in response to the crisis — pales in comparison to the still-present outrage sparked by Tarp.

"The TLGP certainly didn't have the baggage that Tarp had, which is a good thing obviously. … But the Fed made an enormous impact in the programs they created," said Chessen. "It was all part of a series of programs by the agencies to provide liquidity."

Political careers have ended for lawmakers who supported the legislation authorizing Treasury's bailout program. Banks that could do so paid back their investments without hesitation. Treasury continues to face scrutiny from the special inspector general overseeing the bailout for how Tarp is being unwound.

Whalen said a key difference between the programs was that the stated goal for Tarp was changed after Congress authorized it. Originally, the bailout program was created to buy up banks' troubled assets, which seemed more palatable than what it became.

"Tarp was a problem because it started as an asset purchase program and then they started to put capital in the banks," he said. "TLGP was always narrow in scope and that wasn't contentious because they didn't change the mission of the program."

Observers said the industry's backing of the FDIC program — similar to how deposit insurance is funded — also made a difference in how it was perceived.

"In Tarp, if the banks didn't pay it back, it was pretty obvious who was on the hook: taxpayers. In the case of" the TLGP, "the FDIC was going to take the first loss," said James Wilcox, a business professor at the University of California Berkeley.

"The chances that the taxpayer would have to support these bond guarantees was much, much lower. Given that lower probability and way lower visibility, you ended up with less stomach acid being generated by the FDIC program."

Yet he added that the debt coverage could have faced more criticism if it had not been overshadowed by other programs in the public debate. "If a candidate would get up today and start publicizing what was going on with this bond guarantee program, there would be some public ire there."

Following passage of Dodd-Frank, which limited the government's ability to bail out institutions going forward, some said future regulators could still consider something like the FDIC's debt-coverage program in future crises.

"I've always differentiated between situations where you have a system-wide crisis that is impacting even healthy banks and situations where institutions are in trouble because they were mismanaged. We had both during the 2008 crisis," Bair said. "In that kind of situation, coming in with generally available liquidity support can be justified for the solvent institutions. But Dodd-Frank rightly bans any kind of one-off bailout assistance for an insolvent institution."

Under the law, the Fed can only lend to institutions on a "broad-based" scale — not individually — and the FDIC can back emergency funding to help solvent institutions on a similarly broad scope but must get authority first from Congress.

"It was effective the first time, and we may need something like this in the future," Weissman said.