During my tenure as Chairman of the FDIC, the practice of money brokers bundling vast sums of money from investors and placing those funds in high-risk banks and S&Ls paying the highest interest rates cost the FDIC and taxpayers tens of billions of dollars in losses. The FDIC had a similar experience with brokered funds during the most recent crisis. It was my honor to participate in an FDIC Roundtable on this subject on March 18, 2011. The agenda of that Roundtable is below followed by my opening remarks. After my remarks, I have included my testimony on the subject at four different Senate and House hearings during 1983 and 1985. Thirty years after this problem surfaced, Congress has yet to deal effectively with this abuse of the deposit insurance system.
WILLIAM M. ISAAC
FEDERAL DEPOSIT INSURANCE CORPORATION
A ROUNDTABLE HOSTED BY THE
FEDERAL DEPOSIT INSURANCE CORPORATION
ON CORE AND BROKERED DEPOSITS
March 18, 2011
Chairman Bair, Vice Chairman Gruenberg and other distinguished members of the FDIC board it is my pleasure to participate in this important Roundtable discussion on brokered deposits. I’ve been asked to provide some historical context as this is a major issue we struggled with mightily during the banking and thrift crises of the 1980s.
I’ll keep my opening remarks as brief as possible but I am submitting for the record of this Roundtable four statements I presented on brokered deposits to Senate and House Committees during 1984 and 1985. Those statements provide good description of the problems we faced with brokered deposits and our attempts to address them.
Extraordinarily high interest rates during the late 1970s and early 1980s, during which the prime rate reached 21.5 percent, caused a massive outflow of deposits from banks and thrifts into money market funds, Treasury bills, and other investments paying higher interest rates than banks and thrifts. We were forced to eliminate deposit interest rates controls on banks and thrifts to prevent a meltdown of the industry.
Deregulation of deposit interest rates gave rise to the practice of money brokers raising vast sums of money from individuals, businesses and even depository institutions such as credit unions and placing those funds in the banks and thrifts that paid the highest rates. The banks and thrifts paying the highest rates were those that had the highest risk profile.
As the bank failure rate began its dramatic rise, we found an increasing number of failed banks had large amounts of fully insured brokered funds. The Congressional statements I’ve submitted list the bank failures, the percentages of brokered funds and the sources of those brokered funds.
We felt we had to take strong actions to stop this massive abuse of the deposit insurance system, which was intended to protect relatively small, unsophisticated depositors, not institutions sweeping up vast sums from investors to fund the reckless growth of high risk banks and thrifts.
We addressed the problems on every front available to us, including publicizing the amount of brokered funds in each failed bank and naming the brokers that placed those funds. We took enforcement actions against banks making excessive use of brokered funds.
Our strongest and most controversial action was to adopt a regulation eliminating “pass-through” deposit insurance coverage on deposits by brokers. In short, we treated the broker as the depositor, not the broker’s customers. This meant that if a money broker placed $200 million in a bank, the broker was limited to $100,000 of insurance coverage.
Our intention was to allow the free market to operate. The brokers were sophisticated firms that were perfectly capable of analyzing the condition of the banks and thrifts in which they were placing vast sums of money. They could weigh risk vs. reward, unlike the smaller depositors that the FDIC was created to protect.
Money brokers contested the FDIC’s new regulation through every available means, including an intense media campaign and litigation. Regrettably, the Court of Appeals for the District of Columbia sided with the money brokers and ruled that the FDIC did not have the authority to interpret its law in this manner.
The flood gates were open. Money brokers raised tens of billions of dollars, collecting fees from investors. They placed the money in troubled banks and thrifts, collecting placement fees. Then they asked or required the recipient banks and thrifts to purchase junk bonds issued in corporate takeovers arranged by the money brokers and their friends.
It was the worst taxpayer scam in history, at least to that point. We do not have accurate data because the FDIC stopped collecting the information after I left the agency at the end of 1985. But I have no doubt that the brokered deposit/junk bond scam needlessly cost taxpayers tens of billions of dollars in the S&L fiasco.
It did not need to happen. We saw the problem coming, and we reacted to it quickly and strongly. We pleaded for help from Congress and got none.
After taxpayers footed the $150 billion bill for cleaning up the S&L mess, Congress finally addressed the brokered deposit issue. It restricted the use of brokered funds by banks and thrifts that fell to unsatisfactory capital levels. In other words, Congress allowed the regulators to close the barn door after the horses were gone.
Here we sit nearly 30 years after this problem surfaced and after it again caused very substantial losses to the FDIC in the latest crisis. When are we going to summon the courage to solve this problem?
I know that the usage of brokered funds has become more sophisticated and complex in the past decade, but surely we can find ways to substantially curtail the abuses. With the deposit insurance limit now set at $250,000 there is even less justification to allow schemes to further expand the coverage.
I commend the FDIC board for holding this Roundtable and truly hope that this will be the beginning of the end for the abuses stemming from brokered deposits. Thank you for inviting me to participate today. I’m honored to be here.
- Testimony WMI – Brokered Deposits – House Banking Committee 10.27.83
- Testimony WMI – Brokered Deposits – House Government Operations Committee 3.14.84
- Testimony WMI – Brokered Deposits – Senate Banking Committee 6.5.85
- Testimony WMI – Brokered Deposits – House Banking Committee 7.16.85