Confusion About FDIC Guarantees

Earlier this week I wondered why Libor hadn't fallen further since the FDIC guaranteed interbank-lending for free for 30 days (and thereafter at a cost of 75 basis points on an annualized basis). The amount guaranteed, which you'll need to know for reasons that will be clear further down, is 125 percent of senior unsecured debt as of September 30.

But things became a little clearer after reading the transcript of a conference call held on Thursday by the FDIC which had some 900 banks on the line. Here are three separate questions which convey a general lack of understanding about the guarantee.

Here's the first:

MODERATOR: We have a question from Michelle Brenig (ph).

Your line is open.

QUESTION: Thank you -- wanted to get into the Fed funds.

I understand that the -- the coverage is for -- when you talk about inter-bank -- is for Fed funds. Is that correct?

(UNKNOWN): Yes.

QUESTION: And then, so, going forward -- so -- so the first part of the question is: In the next 30 days, are all bank Fed funds guaranteed by the -- the -- the program?

(UNKNOWN): Yes.

(UNKNOWN): Is that all...

(CROSSTALK)

QUESTION: OK. Because that -- that -- that has not been very clear, really, to most of the public out there.

(UNKNOWN): Any...

(CROSSTALK)

QUESTION: So we -- we just need -- need a little bit more education there.

MODERATOR: You have a question from Susan Sturm (ph).

Your line is open.

QUESTION: Thank you.

I'd like to follow up on the prior questioner's comment about Fed funds, because I agree it's completely not understood by the public. What you said was that all fed funds are guaranteed for the next 30 days, if I heard it right.

And how do I know -- thinking about selling to, you know, some bank X, how do I know what their limit was on September 30th? How do I know how many other people they're buying fed funds from? How can I figure if my fed funds that I am selling to bank X is covered if it's a function of 125 percent of September 30th? They could be borrowing ten times that much in fed funds, and how do I know what side of the line I would be on?

(UNKNOWN): Well, I'll let my colleagues help out here. But we are -- we are going to require that there be good disclosures and that they monitor their cap, and when they are above the cap, they will not be able to continue to participate in this, and we will -- we will hold them to that and, presumably, we'll have very strict penalties for anything beyond -- issuing beyond the cap.

QUESTION: Were you done with your answer? I'm sorry. I didn't want to break in if you weren't done.

(UNKNOWN): No. Go ahead.

QUESTION: OK. So how do I -- having said that, which I appreciate, how do I protect myself against some institutions water desk either ignoring the limits or not knowing what they are or just being deliberately fraudulent?

I can understand that you would exercise penalties against the issuer, but as a potential seller, are you going to hold me harmless if they -- if the buying institution screws it up? Pardon my language.

(UNKNOWN): I think -- and, again, nothing is final. Our thinking is you would be covered.

QUESTION: OK.

FRITZ: I think it might be -- This is Steve Fritz. I think it might be a valuable exercise If there's any concerns in your mind. First of all, we will expect everyone offering debt that they believe has our guarantee and, certainly, that we would believe they have their guarantee, that they would represent that very clearly. And we expect them to have those conversations with us and their -- and their primary regulators about that.

And, also, I think if you have any concern or question, you need to be talking to us. And as we build the report can mechanism, I think there was a question there about what is enhanced. I think there will probably be some enhanced reporting that is required.

And I think, as -- by the time the 30 days expires for the optionality, we'll have a lot more formal overlay of systems and information that you can rely on.

QUESTION: OK. So in the interim, as I look at my responsibilities to my shareholders, it sounds like you're saying, all fed funds are guaranteed regardless for the next 30 days. And then we're going to go to the 125 percent system? Is that in writing somewhere that I can give my wire desk and say don't worry, the FDIC says it's all guaranteed for the next 30 days regardless. Is that how I should read what you're saying?

(UNKNOWN): No.

QUESTION: OK. I'm sorry. What is happening for the next however many days it is until you have this reporting mechanism in place so that people who are selling fed funds absolutely know on a given day, today, tomorrow, whether or not the fed funds that we're selling to so-and-so are guaranteed?

(UNKNOWN): I think when John said no, he was saying no to do we have a legal document for you right now.

QUESTION: OK.

(UNKNOWN): And the answer to that is no. But the answer to are fed funds safe during this 30-day period, the answer is yes.

QUESTION: OK. So it has nothing to do with the 125 percent calculated limit or any of that stuff?

(UNKNOWN): The borrowers are bound by that limit unless the FDIC, in consultation with their PFRs, increased it. But as a practical matter, we understand the problem that the lenders have. We're going to do everything we can to avoid having the question come up as to whether you're protected or not. We're going to -- we'll have some more definitive guidance, but I think the reality is as long as you're operating in good faith, you're trying to deal with responsible parties, that we would find -- we'd have to cover it.

But the limits very much apply to the borrower, and we expect that to be adhered to. And when we talked about enhanced enforcement or enhanced supervision, that's certainly a large part of that, trying to make sure the things need to be enhanced because we didn't have these programs before. They didn't exist. So now we need to enhance the programs to cover this to make sure people do comply on the borrowing side. (UNKNOWN): And I think it's certainly commercially reasonable in you're the lender, you would ask them what their amounts outstanding were as of September 30th, and they should tell you and you can calculate what their limit was and accept that, you know, their representations at face value unless you have some question or reason that you wouldn't.

And like I said, if there's any question in your mind, I think that would be something that you'd want to, with a counterparty, you might want to have a dialogue with us about.

QUESTION: OK. And do the people on the call know how to reach you once this is over?

(UNKNOWN): Yes. With that respect -- with specific institutions, I would suggest you call the -- our regional offices.

QUESTION: Oh, OK. You don't mean you. You mean the FDIC. I see. OK. I'm sorry to beat that one to death, but I really need to know what instructions to give the wire desk. And it sounds like if I give them a worksheet that says ask them what their September 30th was, multiply it by 125 percent, get a representation from who they're talking to that we are part of that 125 percent, as long as we don't know anything -- anything that should be alarm us to the contrary, then we're covered by the FDIC for the next 30 days?

(UNKNOWN): I think if -- what you're -- what we're trying to convey from this group is that the burden will largely -- for compliance -- on the -- on the borrower. And that's the way we intend to apply it -- the enhanced supervision will be there. We hope that institutions that are sellers will -- will be reasonably diligent. But the burden should be on the -- on the borrower side.

MODERATOR: We have a question from Kirk Wharf (ph). Your line is open.

QUESTION: Yes. Thank you. Some good questions.

The one I wanted to address a little further was the fed funds sold. We currently or typically sell your fed funds to a correspondent who then distributes those. Any amounts above $4 million, they distribute to as many other correspondents in up to $4 million amounts until they fully exhaust the amount of fed funds that we are selling.

And I'm trying to think from a practical standpoint based on some of your earlier questions -- we -- we don't even know who the fed funds are being sold to until the next day. And so how, from a practical standpoint, are we supposed to be assured that whoever they ultimately end up with has -- has, you know, complied with this 1.25 percent rule?

(UNKNOWN): Right. Yes, again, our thinking is that the burden is on the issuer to ensure that they are complying with the program, and there's also a burden on our supervisors to make sure they're complying. We're not trying to put the burden on you to validate their cap. QUESTION: Right. And our reluctance -- right now, all our money is sitting at the Federal Reserve because we're reluctant to rely on those parties because, you know, all the things that are going on. And I'm not sure the things I'm hearing are make me feel any better about that. But that's just a feedback on that.