Akkam’s Razor

At the very bottom of recent stories announcing the need for expanded staffing at the FDIC by 60%, with an emphasis of recruiting S&L Crisis veterans (WSJ, subscription required), was a sentence stating the following:

There are 76 banks on the FDIC’s “problem institutions” list - which would equate to about 10 expected bank failures this year. About six banks fail per year on average, FDIC officials said.

While this number is drastically lower than those during the Savings and Loan crisis in 1991 (1430 institutions listed as ‘problems’, with 502 failures over 3-years), the current number (76) of banks is a 69% increase over last year (2007), with some analysts believing that as many as 150-200 banks may fail in the short term. In a typical year, FDIC officials state 6 banks will fail; 5 failed in calendar year 2007. The FDIC believes as many as 10 institutions may fail this year. A total of 30 banks have failed since 2000.

Is there a ‘moral hazard’ in naming the banks that are ‘problem institutions’ according to the FDIC, and are in danger of failing? The prevailing wisdom is that by specifically naming the institutions involved, depositors will lose confidence in them, and paradoxically lead to the bank-run that the FDIC hopes to avoid. My ethical dilemma is furthering the obfuscation of the data helping or hurting the situation?

Given the understanding that any depositor with accounts under $100,000 is fully insured under the FDIC, the assumption may be that the risk to individuals is small, although getting access to your funds at a failed institution is not as simple as walking up to an ATM. Generally, depositors can access their funds within days, but other assets may take years of court wrangling until the banks business is unwound. The greater risk is that local banks are heavily involved in construction loans, where corporate defaults are rising, and the implications for the housing market and economy at large. It also appears that the FDIC has less than 2% of total funds insured available to provide their insurance, although their ratio is better than it was at the height of the S&L crisis:

As of December, the FDIC was covering $4.3 trillion in insured deposits with a fund of $52.4 billion, for a reserve ratio of 1.22 percent. That sounds scant.

But take a deep breath, because the FDIC’s reserve ratio sank as low as a negative 0.25 percent in 1991, and depositors with accounts at failed banks were still covered.

The FDIC assesses banks an insurance rate, based on how risky it judges the banks to be. The existing rates range from 0.05 percent for the least risky to 0.43 percent for the most risky. Should the FDIC need to, it could increase those rates.

Just last week, the FDIC’s staff recommended that it maintain the existing rates, saying that 99 percent of the institutions it insures are well-capitalized — that is, they were not considered too risky (there are some 8,000 institutions).

The FDIC does let you search for an individual bank, but there’s no handy metric available to the depositor to ascertain risk. Searching for said list elsewhere will prove fruitless – no such list exists. But a careful reading of the FDIC’s methodology and a search of private databases (more here) gives up a list of institutions, as determined by their methodology and metrics, sorted by geography. The two items used are the UBPR (Uniform Bank Performance Report) and CAMELS (Capital Adequacy, Assets Quality, Management, Earnings, Liabilities, and Sensitivity to Risk). Bankrate’s resource uses a modified version of CAMELS, omitting the ‘management’ portion, with the number of stars (5-through-1) being inverse to their CAELS ratings (1-through-5), with a higher CAELS equating to fewer stars (worse).