FDIC reforms to stabilize and strengthen banking

The recent failures of Silicon Valley Bank and Signature Bank set off a firestorm in financial markets, which the government acted quickly to resolve in to reassure the public. This was the right thing to do — but, as former chairman of the Federal Deposit Insurance Corporation (FDIC), I have serious concerns about the methods used.

I propose five much-needed reforms in the laws governing the FDIC, created in 1933 to cover smaller depositors and calm the then-existing panic. Initially the FDIC offered $5,000 insurance coverage per depositor, and $250,000 today.

While I didn’t realize it when President Carter appointed me to the three-member board of the FDIC in 1978, the FDIC was about to be truly tested for the first time since the Depression. Beginning in the 1960s, federal budget deficits and monetary policy were out of control, causing severe inflation much like today, particularly hurtful to lower-income and fixed-income Americans.

To his eternal credit, Carter appointed the great Paul Volcker as chairman of the Federal Reserve and charged him with eradicating inflation. Volcker knew this would require restricting the growth in the supply of money, which would result in much higher interest rates, recession and, potentially, massive failures of banks and S&Ls, likely accompanied by failures of businesses, farms and real estate ventures. Altogether, the country endured two serious recessions from 1978 to 1992 and experienced the failures of some 3,000 banks and S&Ls, including many of the largest across the U.S.

The FDIC had to grow and better train its staff quickly — the FDIC grew from 3,000 people in 1978 to around 20,000 in 1992 and built a state-of-the-art training center. We also significantly enhanced compensation and benefit programs to attract and retain the best staff possible. We learned and changed a lot during this massive crisis. But recent events suggest that many of these lessons have been forgotten. It is past time that we learn from the past, discard some ineffective and burdensome newer laws and regulations, and implement very important new reforms.

Initially, I propose two urgently needed reforms, long overdue. First, stop bailing out all depositors when a bank fails as this destroys depositor discipline and simply leads to more and larger failures. The FDIC should protect smaller depositors fully and impose limited but much-needed losses on larger depositors. Second, we must improve and better target deposit insurance coverage for larger depositors. Let me explain.

Even when the FDIC fully covers deposits up to $250,000 per depositor, bank failures can be very disruptive and negatively impact the communities near the failed bank.

Nearby businesses likely have payroll and other important accounts at the failed bank with deposit balances in the millions of dollars. If a business receives only $250,000 coverage from the FDIC, thousands of employees will lose their incomes, perhaps permanently, and all the businesses and people those employees support will likely suffer.

An important solution to this serious problem is to routinely use the Modified Payoffs we developed in the 1980s, specifically to resolve the notorious failure of Penn Square Bank. Penn Square was replete with fraud, poor management and had very large depositors far beyond the FDIC insurance limit. So, we paid all depositors up to the limit. For large depositors over the limit, we distributed receivership certificates equal to 80 percent of their uninsured claim, which is the minimum amount the FDIC generally recovers in failed bank receiverships. The Federal Reserve banks agreed to purchase those certificates at a small discount so the holders would receive the bulk their funds promptly. The Fed’s advances were ultimately repaid by the FDIC as it collected on the failed bank’s assets.

We can and should go even further in protecting some depositors with a third reform: covering 100 percent of all non-interest-bearing checking accounts held at failed banks. This reform will:

1) Substantially reduce instability in banking

2) Increase the base upon which the FDIC collects its assessments

3) Allow the Fed to target its increases in money supply to the areas that most need it

Fourth, I would make sure that nothing unnecessary is impeding efficient operation at the top of the FDIC. When I was chairman, the FDIC’s board consisted of a chair from the president’s party, an appointed member from the opposite party, and the comptroller of the currency. After I left the FDIC, Congress added two new members: the head of the new Consumer Financial Protection Board and another appointed member. I would either eliminate those two positions or replace the head of the CFPB with a member of the Federal Reserve Board. The CFPB does not appear to add any meaningful expertise and certainly not anything close to what a member from the Federal Reserve would bring.

The final reform I recommend is that Congress remove the requirement that the president and secretary of the Treasury must authorize the FDIC and Fed to bailout banks deemed systemically important. First, the reforms suggested above will make it far less necessary to implement such a rescue. More importantly, the Fed and FDIC are structured as independent, non-partisan agencies. Those agencies and their highly experienced staffs will certainly consult elected political leaders, including Congress, but it is essential that we keep politics as far out of bank supervision and resolution as possible.

The way we are currently resolving bank failures is poorly handled and must be fixed immediately. Let’s stop pretending that Congress can fix these problems by piling on more senseless regulations or, worse yet, by providing 100 percent taxpayer protection to all depositors all the time.

William M. Isaac is former chairman of the Federal Deposit Insurance Corporation and Fifth Third Bancorp. He is chairman of Secura/Isaac Group and a global adviser to financial institutions and governments.