The bank bailout plan makes the F.D.I.C. well positioned to survive

TO BE NOTED: From the NY Times:

"How to Conjure Up $500 Billion

By FELIX SALMON

AS recently as October, all it took to get a bailout bill through Congress was a few pieces of strategically placed pork. Back then, the Bush administration could insert into its stimulus bill a tax exemption for a wooden arrow factory in Oregon, and the votes would magically appear.

The Obama administration must wish it were still so easy. Congress is in no mood to pass anything now, pork nuggets or no. The executive branch has to make do with what it’s got. In the case of the bank bailout plan, that means a combination of some leftover funds from last year’s Troubled Asset Relief Program bill along with a rather ingenious use of guarantees by the Federal Deposit Insurance Corporation.

The F.D.I.C. was created to do what its name implies: insure deposits. Deposits are loans of a kind: when you make a deposit at the bank, you’re lending the bank your money, normally at a very low rate of interest. The F.D.I.C. exists to make sure that whatever happens to the bank, you’ll always get your money back — up to a limit of $250,000.

Now, however, instead of insuring garden-variety bank deposits, the F.D.I.C. is going to insure extremely risky loans to curious new entities called public-private investment funds. And while banks can always borrow money somewhere, these funds wouldn’t be able to borrow at all were it not for that F.D.I.C. guarantee.

Imagine going to your local bank and asking for $10 billion to gamble at the Toxic Asset Casino. The bank would say no — until you showed it a letter from your Uncle Sam saying he’d guarantee the loan. Then, the bank would lend you as much as you’d like. The F.D.I.C. has never taken on this kind of risk before.

It’s not the first time that Treasury has magicked billions of dollars from some hidden back pocket, just to avoid having to ask Congress for the money. In 1995, with Robert Rubin recently installed as Treasury secretary, Lawrence Summers, the deputy secretary, along with Tim Geithner, a deputy assistant secretary, wanted to bail out Mexico in the face of Congressional opposition. They found something called the Exchange Stabilization Fund, originally intended to stabilize the value of the dollar on world currency markets, and managed to repurpose it for another use entirely.

It’s possible to step back and admire the statecraft in the present case — there’s a certain elegance with which Treasury managed to transform $100 billion in TARP funds into more than $500 billion in cash to inject into the banking system, all the while avoiding any fight on Capitol Hill. It makes the $20 billion found for Mexico all those years ago look like pocket change.

Yes, it’s easy to find serious economic weakness in a plan that puts enormous amounts of government money at risk even as it promises billions of dollars in profits for private investors. But the economics don’t exist in a vacuum, and Tim Geithner doesn’t live in a world where he can simply do whatever makes the most economic sense.

Mr. Geithner needed the cooperation of the F.D.I.C., but few federal agencies ever object to an idea that involves expanding their budget and making them more important. In this case, the F.D.I.C., and its chairwoman, Sheila Bair, had particular reason to want to grab as much power as possible: the Obama administration is about to embark on the largest overhaul of the American regulatory infrastructure since the Great Depression.

America’s patchwork quilt of financial regulators is looking decidedly frayed around the edges, as financial firms dance around what regulations do exist. American International Group, for example, managed to get itself regulated by the toothless Office of Thrift Supervision after buying a Delaware thrift for just that purpose.

Chances are that the Federal Reserve, rather than the Securities and Exchange Commission or any other agency, will end up regulating the entire financial system, including banks, brokers, hedge funds and insurers. Then, the Office of the Comptroller of the Currency, the National Credit Union Administration, the Commodity Futures Trading Commission and any number of other obscure regulatory animals risk being killed off.

The bank bailout plan makes the F.D.I.C. well positioned to survive. Not only will it be an integral part of the new bank bailout, but it is also likely to be put in charge of taking over any failing financial firms that pose a systemic risk — be they banks, hedge funds, private-equity shops, insurers or even large corporations like General Electric.

This could be the most far-reaching unintended consequence of Congress’s stubborn opposition to any bailout plan. Treasury ended up being forced to find its own way — and that meant a suboptimal bank bailout scheme, and a vast swath of new powers for the F.D.I.C.

Felix Salmon is the finance blogger at Portfolio.com."