Creature From Jekyll Island by G. Edward

So a bill was passed directing the Treasury to guarantee up to $1.5

billion in new loans to Chrysler. The banks agreed to write down $600 million of their old loans and to exchange an additional $700

million for preferred stock. Both of these moves were advertised as evidence the banks were taking a terrible loss but were willing to yield in order to save the nation. It should be noted, however, that the value of the stock which was exchanged for previously uncollectable debt rose drastically after the settlement was announced to PROTECTORS OF THE PUBLIC

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the public. Furthermore, not only did interest payments resume on the balance of the old loans, but the banks now replaced the written down portion with fresh loans, and these were far superior in quality because they were fully guaranteed by the taxpayers. So valuable was this guarantee that Chrysler, in spite of its previously poor debt performance, was able to obtain loans at 10.35% interest while its more solvent competitor, Ford, had to pay 13.5%. Applying the difference of 3.15% to one and-a-half billion dollars, with a declining balance continuing for only six years, produces a savings in excess of $165 million. That is a modest estimate of the size of the federal subsidy. The real value was far greater because, without it, the corporation would have ceased to exist, and the banks would have taken a loss of almost their entire loan exposure.

FEDERAL DEPOSIT INSURANCE CORPORATION

It will be recalled from the previous chapter that the FDIC is not a true insurance program and, because it has been politicized, it embodies the principle of moral hazard and it actually increases the likelihood that bank failures will occur.

The FDIC has three options when bailing out an insolvent bank.

The first is called a payoff. It involves simply paying off the insured depositors and then letting the bank fall to the mercy of the liquidators. This is the option usually chosen for small banks with no political clout. The second possibility is called a sell o f f , and it involves making arrangements for a larger bank to assume all the real assets and liabilities of the failing bank. Banking services are uninterrupted and, aside from a change in name, most customers are unaware of the transaction. This option is generally selected for small and medium banks. In both a payoff and a sell off, the FDIC

takes over the bad loans of the failed bank and supplies the money to pay back the insured depositors.

The third option is called bailout, and this is the one which deserves our special attention. Irvine Sprague, a former director of the FDIC, explains: "In a bailout, the bank does not close, and everyone—insured or not—is fully protected.... Such privileged treatment is accorded by FDIC only rarely to an elect few."1

That's right, he said everyone—insured or not—is fully protected. The banks which comprise the elect few generally are the Irvine H. Sprague, Bailout: An Insider's Account of Bank Failures and Rescues (New York: Basic Books, 1986), p. 23.

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large ones. It is only when the number of dollars at risk becomes mind numbing that a bailout can be camouflaged as protection of the public. Sprague says:

The FDI Act gives the FDIC board sole discretion to prevent abank from failing, at whatever cost. The board need only make thefinding that the insured bank is in danger of failing and "is essential toprovide adequate banking service in its community."... FDIC boardshave been reluctant to make an essentiality finding unless theyperceive a clear and present danger to the nation's financial system.1

Favoritism toward the large banks is obvious at many levels.

One of them is the fact that, in a bailout, the FDIC covers all deposits, whether insured or not. That is significant, because the banks pay an assessment based only on their insured deposits. So, if uninsured deposits are covered also, that coverage is free—more precisely, paid by someone else. What deposits are uninsured?