Newspaper article THE JOURNAL RECORD

Issac: Study of Nation's Bank Insurance Fund Flawed

Newspaper article THE JOURNAL RECORD

Issac: Study of Nation's Bank Insurance Fund Flawed

Article excerpt

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 their techniques.

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 experience.

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. …

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