FDIC & Fed: more questions than answers
David R. Kotok
April 23, 2011
We thank readers for their kind words about Scylla and Charybdis (www.cumber.com). We also thank friends Dennis Gartman, John Mauldin and Barry Ritholtz for sharing the piece with their readers. There have been many questions and comments forwarded to us. They were specific to our articulated views about the FDIC and the Fed. Some answers are below.
Q. How do you estimate that the FDIC action is going to neutralize all of QE2?
A. When QE2 was announced, there were a number of estimates of impact. Ours and others centered on about 2 to 3 basis points for each $100 billion. QE2 is about $600 billion in size. At 2.5 basis points per each $100 bn, the total value of QE2 is about 15 basis points reduction in interest rates, contrasted with where the rates might otherwise be. The new FDIC fee action on April 1 creates a “wedge” by imposing a cost on the entire banking system. We estimate (as does Barclays) that the wedge is about 15 basis points. Thus, FDIC fees will offset QE2 in full.
Q. Will Bernanke address this in his press conference?
A. We do not know, but we hope that a reporter will ask him about it.
Q. Why did the FDIC do this?
A. They had no choice. This is one of the consequences of the Dodd-Frank legislation.
Q. Didn’t the Fed see this coming? Did they know about it when they announced and developed the QE2 policy?
A. We do not know if the Fed saw it coming, but we do know that the Fed was silent on this issue. In the comments on the proposed Dodd-Frank legislation, there is not a single word about the impact of the FDIC fee. It is hard to imagine, but it is true. We surmise that the comment period was directed to the Fed’s legal staff and that the impact of this issue was not thought about by the monetary economists. Furthermore, the monetary policy folks tend to think in macro terms, so this may have escaped their radar screen. Alternatively, they may have considered it and then dismissed it. There is no way to know. Perhaps Bernanke will clarify this, or some of the other members of the FOMC may do so in their speeches and comments.
Q. Doesn’t this hurt the smaller banks?
A. Absolutely. The regs are extensive and complex. From what we can see upon reading them, there is a bias toward a smaller fee rate based upon size. The range of fees is 2.5 basis points low to 45 basis points high. We are correcting a technical error in our original piece, in which we quoted the lowest fee at ten. There are numerous adjustments needed in order to get to the final fee base for each particular bank. Clearly, banks paying a large fee rate are competitively disadvantaged.
Q. Is the banking community reacting?
A. Yes. There are reorganizations taking place in larger banks in order to achieve a lower fee rate. Smaller banks are adjusting their business models where they are able to do it.
Q. Does this affect Munis?
A. We think the answer is yes. Many small Muni issuers are sole-sourced in banks for their capital. They issue bonds under the small-issuer, bank-qualified exemption. They deposit in the local bank and the local bank buys their notes and bonds. This FDIC fee does not exempt them. Thus, the cost of finance for the smaller Muni issuers has been increased by the fee rate assessed by the FDIC on the particular bank. The result is to raise the cost of finance for smaller Muni issuers at the very time they are retrenching in their budgets.
Q. What happens next?
A. It takes Congress to change the law. The unintended consequences are now starting to be revealed. The Muni case is an example. The impact on Fed policy is another. There will be many more. We expect a massive debate on how much damage Dodd-Frank is actually doing and how poorly it was conceived. This is typical of a Congress that rushes to pass a major piece of legislation without full vetting and comments. As the public learns more, they will protest to their representatives and the finger pointing will begin in Washington. With enough furor, the law will be amended.
David R. Kotok, Chairman and Chief Investment Officer