Speculation about the health of the nation's bank insurance fund in
the past two months has caused former Federal Deposit Insurance
Corp. Chairman William Isaac to examine the temperature-takers and
His diagnosis: analysis of the fund by Stanford University's R.
Dan Brumbaugh Jr., Andrew S. Carron of First Boston Corp. and the
Brookings Institution's Robert E. Litan was flawed.
Isaac's second opinion found Brumbaugh, Carron and Litan failed
to properly measure the fund's future exposure to potential bank
failures and said they looked at the fund's future exposure without
inspecting its expected income stream.
The fund, part of the FDIC, was weaker than official reports
admitted and displayed some disturbing parallels to the savings and
loan insurance fund, the three professors found. At the end of last
year, the fund had $14.1 billion in reserves, or 0.8 percent of U.S.
insured bank deposits. But the professors concluded earlier this
year that its reserves should be written down to about $4 billion.
They found 226 banks with about $1 trillion in assets were
inadequately capitalized, having a less-than-6-percent risk-adjusted
capital ratio. The professors expected about 40 of those banks to
fail, costing the bank insurance fund $10.3 billion. Testifying
Oct. 5 before the Senate banking committee, the professors updated
their analysis and said failing banks will cost the bank insurance
fund reserves about $7 billion, not $10 billion.
Isaac doesn't argue with the updated estimated cost to the
insurance fund, but he does find fault with some of the analysis.
Most of the institutions the three professors expected to fail
already had failed by the end of 1988 or were in holding companies
the FDIC had squirreled away loss reserves for in 1988. Those
losses were counted twice in the professors' analysis, Isaac said.
The professors also over-estimated the cost to the FDIC of
larger bank failures, he said. Losses to the FDIC from smaller bank
failures have averaged about 26 percent of the banks' total assets,
but for larger bank failures, losses have been lower, Isaac said.
The FDIC, in its 1988 annual report, estimated its ultimate losses
at less than 5 percent of total assets at Continental Illinois
National Bank, 9 percent at First City Bancorp. and First
RepublicBank Corp. and 13 percent at MCorp., Isaac said.
The former FDIC head said the assumption that banks with
risk-adjusted capital between 0 and 3 percent would produce ultimate
losses of 10 percent of total assets was arbitrary and not based on
Though the Financial Institution Reform, Recovery and
Enforcement Act raised premiums for bnak insurance, the professors
failed to account for the fund's future income.
Instead, Isaac proposes measuring the banking industry's and
fund's health by calculating the number and assets of banks with
more nonperforming loans than primary capital, a statistic Isaac says
is moving south.
The yardstick might not be accurate for banks with lots of loans
to less developed countries or highly leveraged transactions, such
as leveraged buyouts, but it does determine the fund's exposure at
any given time, Isaac said.
The exposure to problems with developing country loans can be
calculated by subtracting banks' reserves from those loans and
dividing that figure by the banks' equity. Exposure through loans
to highly leveraged transactions, measured by dividing those loans
by banks' equity, is moving south along with the exposure to loans
to lesser developing countries, Isaac said.
Finally, the bank insurance fund is expected to generate income
of $3.4 billion this year, before the premiums on domestic deposits
rise from 0. …