This story was originally published on
at 8:30 A.M. on Monday, April 27.
Let's wade once more through the alphabet soup of crisis-initiated federal programs. This time, let's examine the Temporary Liquidity Guarantee Program (TLGP).
This is the FDIC program established to help financial institutions borrow in the capital markets when activity had frozen. Note that while markets are seemingly on the mend, we are still trying to find the new "normal," so the program is useful for getting credit markets flowing and has been extended until the end of October. Of all the programs launched since last September, this could arguably be one of the most valuable and least controversial.
However, Andrew Bary, Floyd Norris and others have been critical about these FDIC loan guarantees, whether or not these are a "sweet deal" for banks, whether or not these loans should be paid back and mature in order to "de-TARP" and so forth.
This may be as misguided as those who view the
intervention as nothing more than a straight cash transfer to counterparties rather than fully seeking to understand the transactions beyond the sound bite. (
My previous piece on that received a lot of comments, both positive and negative. I particularly enjoyed the letter that said "Die!" -- received on Easter Sunday, no less.)
The criticism has been that banks are still benefitting from government largesse with regards to being able to issue debt at advantageous costs, given the FDIC guarantee. To a certain extent that is true -- there is no denying that banks are able to issue debt at a cheaper cost than would be otherwise available; however, the relationship is much more symbiotic than parasitic.
What people seem to gloss over is that the banks are
paying an insurance premium
to be able to participate in this program. The fees raised by the FDIC through the TLGP project to nearly $6.9 billion through April 13.
This figure is worth mentioning because this is money that, if not needed to make good on the TLGP guarantee, will benefit the Deposit Insurance Fund. The DIF is what backs all of our bank deposits, so the funds raised through the TLGP can potentially help support the FDIC's larger mission.
Win/Win Situations Are Not Fantasy
Consider how insurance companies work. They collect premiums in excess of what they expect to pay out. They collect a lot of premiums particularly from healthy people who are not accident-prone. Healthy people pay premiums to get the intangible benefit of peace of mind. These premiums are used to offset the payments that go out to the sick -- without the healthy paying premiums, an insurance company wouldn't be in business too long.
Hence why discussions of paying back debt to be fully free of the shackles of TARP are a little misguided. Don't we want that premium, particularly if paid by a relatively healthy institution? Why would we want a healthy person
to pay insurance? That just seems like bad business.
There are times when, yes, you can actually get a win/win situation. We'll stick with the insurance theme for a minute -- I am going to hark back to professor Richard McKenzie and consider employee benefits. Can an employer offering benefits to an employee be win/win? Let's say a typical widget-maker's salary is $50,000 a year, but with no benefits. Without a group plan, workers must buy insurance out of pocket as individuals for $10,000 a year. So the employee is taking home $50,000, but spending $10,000 of that on insurance.
Now let's say an employer can buy a group plan for $5,000 per employee. Let's say this employer sets salaries at $44,000 a year but with health insurance benefits. The employee can look at this arrangement as a net plus -- he gets insurance and takes home $44,000. For the employer, the all-in cost per employee is $49,000 as opposed to $50,000. Here, both sides receive something valuable.
Of course, in all of these programs, there is always the greater debate as to whether any of them should have existed in the first place. That is a really legitimate debate -- whether the government should have intervened at all to head off systemic risk. If that is the argument, fine -- I have no problem with a broader philosophical debate. But let's stop trying to jump to conclusions without considering all of the facts of a particular program.
The whole concept of an FDIC and providing insurance on bank deposits does bring back the question of why we got rid of Glass-Steagall. Maybe it wasn't such an outmoded idea after all...
The TGLP provides insurance on debt issuances for banks and certain financial holding companies on
that run through the end of 2012. The program has been extended to cover debt issued until Oct. 31, 2009 (with the final maturity no longer than Dec. 31, 2012). The premiums paid are based on the maturity of debt issued -- basically split between short term (less than one year) and long term (greater than one year).
The first premium charge is known as the "assessment," and it is set at 50 basis points for short-term debt and 100 basis points per annum for longer-term maturities. In addition, there is a "special assessment" of another 10 basis points tacked on for holding companies with less than 50% of their assets deemed as banking assets.
These assessment premiums are set aside in order to help defray the cost of making good on the insurance should the need arise. If there is money left over, or if the money is not needed, that money will flow into the FDIC's Deposit Insurance Fund when the program expires.
The second set of premiums is a set of surcharges that were put in place in March. These surcharges are for debt issuances longer than one year, and for the second quarter (April 1 through June 30) are set at 10 basis points and 20 basis points, with the 20 basis points surcharge going to holding companies that pay the "special assessment."
After the second quarter, these surcharges will step up to 25 basis points and 50 basis points. These step ups are meant to wean issuers away from the program before the Oct. 31 cutoff. These surcharges go directly into the Deposit Insurance Fund.
This is to illustrate the calculus for a debt issuer to compare its all-in spreads of issuing under TLGP and issuing without. Clearly a bank will "arbitrage" the difference if it is in its favor and forgo the program if it is not. If I am a bank, right now the break-even is 110 basis points in spread (100 basis points assessment plus 10 basis points surcharge), and if I am in the special assessment bracket, that number is 130 basis points (100 basis points assessment plus 10 basis points special assessment plus 20 basis points surcharge). These numbers will step up to 125 basis points and 160 basis points on July 1.
Of course, if a financial institution wishes to issue debt with a maturity beyond Dec. 31, 2012, it must do so without the guarantee -- this was meant to facilitate liquidity on a temporary basis to get the credit markets flowing again.
At the time of publication, Oberg had no positions in the stocks mentioned.
Eric Oberg worked in fixed income, currencies and commodities for Goldman Sachs for 17 years before retiring as a managing director.