Tuesday, January 27, 2009

New FDIC Regulations

The FDIC is issuing a new regulation that would limit the interest rates PAID by poorly capitalized banks on brokered deposits.  It is less then meets the eye -- but it is a start to prevent the absolute worst "zombie" behavior last seen in the S&L crisis.  That is, institutions doing a last gasp of lending, trying to lend their way out of insolvency.  It was a little different at the time, because S&L's had negative interest rate spreads on their older assets, so if they could only lend enough at positive spreads, it would work.  That is, their average interest rate margins would turn positive.   

The main points are:

1.  The term, zombie banks, that was used by Krugman last week is appropriate for situations where failed institutions that are kept alive by non market forces (S&L - via brokered deposits, Airlines via bankruptcy for example) lead a rush to the bottom and blow up the entire industry.

2.  Right now, banks have strongly positive net interest rate margins.  Their immediate problem are weak or bad assets and it isn't easy to see how this could be improved by a lot more imprudent lending.

3.  The idea of going from no regulation to some regulation seems like a big deal, even if it doesn't make a difference right now.

One other thing that has come up recently is the idea that regulatory forbearance has proven to cost money in prior bailouts.  The difference between today's problems and the S&L situation is highlighted by the fact that lack of credit and lending is now considered the major problem.  Not continued irresponsible lending.

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