Here, then, is a modest proposal for bailing out the banking system.
The crux of this proposal is to use the FDIC and changes in FDIC policy to relieve the pressures on the banking system. First, Congress should allocate a huge block of money to assure full funding of FDIC. FDIC traditionally has about 1.25% coverage of insured funds. At the end of 2007, FDIC had about $52 billion to cover $4.3 trillion in assets (source - wikipedia.) Congress promising $100 billion to FDIC should go a long way towards alleviating fears of bank insolvency, while being far short of the $700 billion being asked for in the current plan. Further, such money might never be needed. FDIC should then increase the maximum insurance per account from the current $100,000 to at least $500,000, or better yet $1 million. This would decrease the pressure on banks from high-net-worth depositors withdrawing money.
Next, FDIC should temporarily lower its capital ratio requirements. According to Wikipedia, the current capital ratio requirements are as follows:
- Well capitalized: 10% or higher
- Adequately capitalized: 8% or higher
- Undercapitalized: less than 8%
- Significantly undercapitalized: less than 6%
- Critically undercapitalized: less than 2%
"When a bank becomes undercapitalized the FDIC issues a warning to the bank. When the number drops below 6% the FDIC can change management and force the bank to take other corrective action. When the bank becomes critically undercapitalized the FDIC declares the bank insolvent and can take over management of the bank." (Source, - wikipedia.)
I propose that for 6 months capital requirements be lowered as follows:
- Well capitalized: 8% or higher
- Adequately capitalized: 5% or higher
- Undercapitalized: less than 3%
- Significantly undercapitalized: less than 1.5%
- Critically undercapitalized: less than 0.25%
Yes, these numbers are drastic, but they would keep banks afloat temporarily. This would allow these banks to sell off assets or seek investors or take-over suitors in an orderly fashion. Since FDIC would be well funded and would be guaranteeing deposits up to $500K or $1M, there shouldn't be runs on these banks, even at exceedingly low capitalization.
One downside to this structure is that it would incent banks that are currently capitalized at 10% to lower their capitalization. Therefore, there would need to be a counter-incentive, which could be provided in the form of a larger spread in the insurance rate. Banks which have and maintain greater than today's 10% capitalization would be rewarded with a very low insurance rate. As capitalization decreases, the insurance rate would become more and more draconian. This would incent banks to maintain or increase their capitalization coverage, while not putting poorly capitalized banks immediately out of business. Well capitalized banks could buy out poorly capitalized banks, doing the math for themselves to see how the decrease in combined capitalization would impact their insurance rates. Similarly, poorly capitalized banks could sell assets or raise capital in a manner that balances their insurance rate with their capitalization costs. Well capitalized banks might find that it is worth their while to make new loans until their capitalization fell to 8%, thereby injecting liquidity into the system with no cost to taxpayers or shareholders.
Next, congress should mandate that all banks mark their assets to market, but would not require those banks to divest those assets. Some assets would be market down a little bit, others quite a lot, still others might be marked down to zero. Once this is done, if the bank's capitalization is below 0.25% (or negative,) FDIC would intervene and take over the bank. However, those banks that are liquid can continue to do business, and wont be required to divest those "toxic" assets. If banks were all required to divest these bad loans, or if the Fed were to take over those assets and put them on the market, the value of those assets would fall even further as there becomes an instant glut on the market. By allowing banks to continue to hold these subprime assets, but requiring them to mark them at their true market value, the marketplace is not overwhelmed and the banks can lend against their fair market value.
Finally, the bank's capital requirements would also temporarily be decreased - perhaps by as much as 50%. Capital requirement is a complicated piece of math, but where most banks have a capital requirement that works out to about 10%, lowering it to something like 5% temporarily would further give failing banks the breathing room necessary to recover or get taken over in an orderly fashion.
The benefits of this proposal are several. First and foremost, it requires no new governmental bureaucracy. Existing structures and institutions could be leveraged to solve this crisis. Second, it largely relies on the market to purge itself of this infection. Next, it keeps most banks in business and allows many banks to increase lending. Also, it should cost the taxpayer far less than the current $700B proposals - mostly this plan simply requires a promise to cover FDIC's insurance needs. Finally, it keeps the US government out of the business of owning and running banks.
I'd love to hear your thoughts.