When the FDIC took extraordinary action and it paid off

Tom Temin: And this was the Silicon Valley Bank debacle. I mean, what was going on here? The FDIC stopped in and how do they take this extraordinary measure?

Michael Clements: You had two banks fail over a weekend. As you mentioned, Silicon Valley Bank failed on March 10th. And then shortly thereafter on March 12th, Signature Bank failed. During this time, there were concerns about the positive outflows that other banks, which ultimately led to what you were discussing before this systemic risk exception decision.

Tom Temin: Right. So if a given bank fails because it’s a crummy bank, but every other bank in the area is fine, then the FDIC can only cover the deposits that are insured by the FDIC under normal circumstances. What made this situation abnormal?

Michael Clements: That’s right. Since 2020, there have been 12 bank failures. And you had these two where the systemic risk exception was put in place. Unlike many banks, these were slightly larger banks. It also precipitated the agencies view runs on other banks that depositors were pulling uninsured deposits from these other banks. You’re right. In the typical arrangement, FDIC can resolve banks in a couple of manners. One is essentially a deposit pay off and an asset sale, essentially liquidating a bank. That said, the most common approach is what’s known as a purchase, an assumption where another healthy bank will acquire some or all the assets, some or all the deposits. But you’re correct in that deposits that are covered are up to $250,000 per account. In this case, this systemic risk exception, because, again, the concerns about depositors pulling money from other banks through the decision with the treasury secretary, FDIC was able to cover all deposits, including uninsured deposits.

Tom Temin: So FDIC can’t do this on its own?

Michael Clements: That is right. Again, this is an approach to limit systemic risk, but there are controls in place to ultimately do this. The FDIC board and the Federal Reserve Board must both vote by at least a two-thirds margin to recommend to the treasury secretary that the secretary invoke the systemic risk exception and the treasury secretary have to act on those recommendations, along with consulting the president before making a decision.

Tom Temin: Right. So the FDIC kind of generates the need, but then they have to run it up the flagpole, you might say?

Michael Clements: Correct. The FDIC cannot do this on its own. This dates back to 1991. Some of your listeners may remember the savings and loan crisis of the late 80s, early 90s when Congress ultimately had to step in and provide funding for the deposit insurance fund that covered savings and loans. Congress decided they want to do that again and it’s a two-tiered approach where if that the FDIC is going to resolve a failed institution, it has to do it in the approach that would minimize the loss, the deposit insurance fund. The only way to get around that is with the systemic risk exception.

Tom Temin: Got it. So, yeah, so it’s almost a 30-year-old rule or capability that doesn’t get invoked very often?

Michael Clements: It does not, no.

Tom Temin: We’re speaking with Michael Clements. He’s director of financial markets and community investment at the Government Accountability Office. How often does it happen? I mean, it happened. They got the authority for these situations in 91 that it happened during the 2008 housing crisis, which I guess affected banks also.

Michael Clements: There was an exception during the financial crisis. So in fact, the report we did this year, we did a similar report back in 2010. In that again, it didn’t happen until we got to Silicon Valley Bank and Signature Bank here in March of 2023.

Tom Temin: Right. And normally FDIC covers up to $250,000 in cash deposits. Uninsured means the bank was not an FDIC bank or does that mean that it was FDIC, but the agency will cover or the government will cover more than 250,000?

Michael Clements: These were accounts in FDIC-insured institutions. Both Silicon Valley Bank and Signature Bank were at the FDIC-insured institution. It’s simply that the dollar amount to the account exceeded that. In many cases, these are businesses, right. Businesses have revenues come in, expenses go out. They’re likely to carry business of any size. It’s likely to carry an account greater than $250,000, for example, to be payroll or pay its vendors.

Tom Temin: Right. And banks, just as a reminder, pay into a fund every year to maintain that insurance fund.

Michael Clements: That’s correct. There’s what’s known as a deposit insurance fund that banks pay into and then it does cover the costs associated with failed banks. In these instances, as of last year, the cost of the deposit insurance fund was about $22 billion from these failures. That’s obviously abnormal. The bank failed back in January of this year in Illinois, cost was $29 billion. But ultimately, invoking that systemic risk exception meant that other depository institutions were going to have to make up that $22 billion.

Tom Temin: Right. So the taxpayers then, in theory, are off the hook?

Michael Clements: Correct. The requirement was that if the systemic risk exception is invoked and FDIC has covered these unincurred deposits, that there will be a special assessment charged banks to cover that cost.

Tom Temin: And just again, to clarify, if Silicon Valley Bank had not been a systemic risk, people would have lost their deposits above that $250,000 level?

Michael Clements: They would have lost some portion of that. That is correct. And that was initially what was taking place. The Federal Deposit Insurance Corporation initially set up an arrangement known as deposit insurance national bank. It simply was going to cover the insured deposits, provide some level of coverage for the uninsured deposits, but the uninsured deposits that would have been waiting until ultimately the bank was fully resolved to find out the ultimate amount that they were going to receive. They would have received some amount of that uninsured deposit, but it’s not clear how much.

Tom Temin: And what does GAO look for in assessing this occurrence that it was done right?

Michael Clements: Yes. So we look at three things. First off, we look at how did they go about making the decision to follow the required processes? What were the basis for doing that? We talked a little bit about withdrawals at other institutions. Next, we look at what were the immediate effects of FDIC’s actions. And then finally, we look at the longer term unintended consequences of doing this, both for depository institutions but also for uninsured depositors.

Tom Temin: And so everything looked kosher?

Michael Clements: The institutions followed the processes, right. Again, they identified various bases for taking its action. The most critical one was simply deposit outflows at other institutions. You had smaller institutions. You had institutions that were similar to SBB at Signature where the agencies were seeing depositors pull money. That became an ultimate basis because those outflows end up causing further problems down the line, such as reduced credit to households and businesses.

Tom Temin: And by the way, I forget, did somebody take over Silicon Valley Bank at that time?

Michael Clements: Both institutions were said to be acquired by other institutions.