You, Me, and the FDIC

The acronym FDIC stands for Federal Deposit Insurance Corporation. It is better understood as the Federal Deception Illusion Corporation.

Its goal since its founding in 1934 has been to create public deception regarding the looming insolvency of individual banks. In the name of protecting depositors, it protects bankers.

It has done its job very well. But now it is in trouble. Therefore, so are bankers.

There is serious speculation in the mainstream press that the FDIC will run out of funds to repay depositors in failed banks. It may have to borrow money from the U.S. Treasury to keep from going under.

This has happened before. In the 1990—91 recession, the FDIC had to borrow from the Treasury in order to maintain its program. It borrowed about $15 billion. The FDIC repaid the Treasury the next year.

By law, the FDIC has the right to borrow up to $30 billion from the Treasury. The FDIC has posted this law on its site.

The FDIC has about $45 billion in reserve now. This reserve is held in the form of Treasury debt certificates. It had $50 billion prior to the bankruptcy of IndyMac in July. It expects to lose $8.9 on IndyMac. Its original estimate was $4 billion to $8 billion. Eight other banks have gone under this year. IndyMac was the largest.

It is worth noting that IndyMac was not on the FDIC’s list of troubled banks.

A Reuters story reports on the assessment of the FDIC’s chairman, Dr. Sheila Bair.

“I would not rule out the possibility that at some point we may need to tap into (short-term) lines of credit with the Treasury for working capital, not to cover our losses.”

Another factor in the FDIC’s looming problems is this: the number of banks on its problem bank list has increased by 30% to 117 in just one quarter.

We should keep this in perspective. In the Savings & Loan crisis of the 1980’s, about 1,500 banks were on the list. Today, there are about 8,500 banks insured by the FDIC. So, things are not in panic mode yet. Regulators are hoping that the worst is behind us. The problem is, things keep getting worse. The residential real estate market continues downward with no end in sight. Commercial real estate is now beginning to follow. Local banks are more deeply invested in commercial real estate than residential.

The FDIC does not publish the list of problem banks. Why not? Because the FDIC does not want to create bank runs. A brief mention of IndyMac’s problem by Senator Schumer of New York triggered the run that busted the bank.


The bank run today is not the bank run of the Great Depression. In the Great Depression, people withdrew currency from suspected banks. They hoarded some of this money. This caused a reversal of the fractional reserve process. It caused deflation.

But, ultimately, people spend currency. Times were tough in the Great Depression. People had no reserves other than currency. So, they spent it. When a store takes in currency, it deposits it is a local bank at the end of the day.

The possibility of this kind of currency-based bank run is minimal today. We live in a world of digital money. Most payments are made by credit card or check. People in advanced economies do not use currency very often. They pay with digits.

What busted IndyMac was demand by its depositors to transfer their funds to another bank. They came down to get cashier’s checks. This was all it took. The bank could no longer make loans. It had to call in loans. It could not call in mortgage loans. It was borrowed short and lent long. This was a replay of the S&L crisis two decades ago.

The FDIC insures individual banks. If one goes under, the FDIC must cover the losses to depositors of $100,000 or less. If the FDIC ever fails to do this, other banks will experience runs. Everyone at the end of the line in front of a busted bank will experience 100% losses. This will lead to more runs. Fear will spread.

So what? A few hundred American banks out of 8,500 go under. Other than depositors, who cares?

Under today’s circumstances, the money supply will not shrink. The money supply is based on how much debt the Federal Reserve System has in its reserves: the monetary base. The fact that depositor A in busted Bank A has lost his money does not shrink the money supply. Another depositor, who was paid by borrower B (e.g., a mortgage borrower) at Bank A, still has his deposit in Bank B. The banking system does not lose money. But doubts spread about the economy. People start moving their portfolios toward near-cash assets. They start selling stocks so that they can buy Treasury bills or T-bonds.

This has been going on all year. The 90-day T-bill rate is under 2%. It fell before the Federal Reserve announced its reduction in the federal funds overnight market. The FED has trailed T-bill rate all year. The FED gets credit for lowering rates, but this has been an illusion in 2008. The FED has been playing catch-up with the T-bill rate. It announces what T-bills have already achieved: lower rates.

Doubts about individual banks create widespread doubts about the current economy’s ability to continue the boom. This is the problem facing policy-makers in Washington. Doubts about the economy will lead to increased saving.

Is this bad? Not for an Austrian School economist. For all other economists, it is terrible.


In Keynesian economics, increased saving is bad because it supposedly cuts consumer spending. It does not cut consumer spending, so this analysis is nonsense. But this nonsense is the heart, mind, and soul of Keynesianism. Increased thrift cuts consumer spending marginally — very marginally — on retail consumer goods that have been favored by non-savers, but it does not cut consumer spending as a whole, or “in the aggregate,” as Keynesians love to discuss.

When you save money, you still spend it. You spend it by depositing it in a bank, or buying a money-market fund, or investing in a mutual fund. But you do not go to the bank, pull out currency, and hoard it. Even if you do, not many people do.

Saving changes the fortunes of companies that have produced goods and services for consumers who were not savers. The companies lose sales. But other companies that serve those consumers who work in the thrift industry do well.

Saved money does not go to heaven. The money supply stays the same unless the central bank inflates. It is merely reallocated. Some producers lose. Other producers gain. So what? This is free market competition. Losers are allowed to fail.

Keynesian economists see this process of failure as a disaster. They hate the free market because the free market lets people decide what to do with their money. They want State bureaucrats to direct the economy at the margin.

When consumer fears about the economy lead them to switch their spending patterns, this affects profit and loss in those firms that lose favor with consumers. But it simultaneously increases cash flow for sectors that are now favored.

Keynesians are always looking at those sectors that are taking a hit from newly fearful consumers. They don’t look at the increasing revenues in those markets that are geared to thrift.

The anti-thrift bias of Keynesians leads them to call for more government spending. But where does the government get money to spend? There are only three sources: (1) taxes; (2) borrowing from the non-banking public; (3) borrowing from the Federal Reserve (counterfeiting). Every non-counterfeit dollar that the government spends has been extracted from the private sector.

There are no free lunches. The only tooth fairy is the central bank. It exchanges counterfeit money for IOUs.

Keynesians trust government, especially the national government. They think that money spent by the national government will be more productive than money spent by savers and investors who invest in capital formation. This is why Keynesians refer to government spending as “investing.”

In college textbooks on economics, government spending to overcome recessions is never discussed as spending that is necessarily offset by a reduction of spending by taxpayers and T-bill investors. This offsetting phenomenon is never in non-Keynesian textbooks, either. Why not? Because textbooks are written for departmental committees. The publishers know that if a textbook mentions this offset process — that which should be obvious — the Keynesians in the department will veto the adoption of the textbook. This has been going on for six decades.

The textbooks describe the anti-recession policy of the government as injecting new purchasing power into the economy, but without ever mentioning the process of either pulling purchasing power away from taxpayers and buyers of government debt or the counterfeiting operation of the central bank.

There are two deceptions in every college-level economics textbook: (1) the deception of “money from heaven” (taxes and government debt); (2) the deception of counterfeit money from the central bank and fractional reserve banking. Break ranks on these two deceptions, and your textbook will not be assigned. Your manuscript will be rejected by every mainstream textbook publisher.

Self-interested professors catch on fast.


The FDIC has been around since 1934. Its number-one task is to keep depositors from finding out which banks are at risk. When it is successful, the threat of withdrawals keeps poorly run banks safe.

There are periods, such as today, when the deception begins to be called into question by the capital markets. The share prices of poorly run banks begin to fall.

The FDIC’s job is to conceal what is happening. It refuses to reveal the names of suspect banks. The other banks go along with this, because they do not want to be hit by waves of doubt. Customers may buy T-bills rather than bank CD’s. Bankers are never sure which bank will be hit by runs and which will benefit. For the sake of continuity, they support the FDIC. They don’t want to rock the boat.

Reality is now intruding. Bank profits are falling rapidly, according to an August 26 report on Bloomberg. “FDIC-insured lenders reported net income of $4.96 billion, down 87 percent from $36.8 billion in the same quarter a year ago.”

Second-quarter earnings fell from $19.3 billion in the previous quarter, driven by higher provisions for loan losses, the FDIC said. It was the second-lowest net income reported since the fourth quarter of 1991. . . .

“The results were pretty dismal, and we don’t see a return to the high earnings levels of previous years any time soon,” Bair said.

Funds set aside by banks to cover loan losses more than quadrupled to $50.2 billion from $11.4 billion in the year-earlier quarter.

Banks on the problem list have assets of $80 billion. In the first quarter, this was $26 billion. The total value of the deposits at risk keeps rising.

How did this happen? Why didn’t the FDIC sound an alarm? Because the FDIC was itself deceived.

In an August 27 story in The New York Times, we learn that in 2006, after the housing bubble had peaked, the FDIC bought a data base from the private sector that monitored the banking industry’s loan performance. Lo and behold, the industry had lent hundreds of billions of dollars to mortgage borrowers who were bound to default. The “Times” quotes Dr. Bair.

“By the fall and winter 2006, we were looking at this market pretty hard,” she said. There were very low down payments, loans that never verified the borrower’s income, poor disclosure and huge payment shocks. “It was pretty eye-popping, some of the stuff we were seeing. We couldn’t believe it.”

This is sometimes referred to as the shock of recognition. The FDIC should have been monitoring this after 2000. But it did not have a data base to do this.

The Times says that she began warning Treasury, but Treasury Secretary Henry (Goldman Sachs) Paulson resisted. He said the subprime mortgage problem had been contained.

The deceivers have all been caught flat-footed.


That was a great song by the Carpenters. It was originally a bank commercial theme for Crocker National Bank in California, long since merged into oblivion. Today, the phrase still applies well to the banking industry across the boards.

The mortgage crisis is nowhere near over.

The recession is nowhere near over.

Commercial real estate has barely begun to decline. Local banks are heavily invested here. An August 22 story in The New York Times reported that this may be the next stage in the downturn of the economy.

The mainstream media are just beginning to catch on.

The Comptroller of the Currency, John Dugan, sounded the alarm in April. He delivered a speech in which he said this:

Right now, too many community bankers are having too hard a time coming to grips with the problems that have emerged in their commercial real estate portfolios. These bankers are reluctant to charge off obviously troubled loans or even to flag problems to their examiners. While this resistance to recognizing problems at the beginning of an economic downturn may be human nature, it’s not healthy, because denial is not a strategy. It won’t serve anyone’s interest in the long run. In fact, it only assures that problems get worse and harder to resolve.

He said that denial is not a strategy. Of course it is a strategy. It has governed the FDIC ever since 1934. It is basic to all government agencies. But, in the private sector, it gets exposed by falling stock prices for deceivers. It takes time, because investors want to believe good news, but eventually reality intrudes.


The FDIC will keep its doors open. The banking industry wants it. Congress wants it. Depositors want it. Owners of shaky banks want it.

If you have more than $100,000 in an account, divide it up among several banks. You can get an account that does this here.

August 30, 2008

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

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