AGENDA AND PAPER FOR THE NOVEMBER 20 MEETING

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85-01156R000100160012-7
• Release Decision: RIPPUB
• Original Classification: K
• Document Page Count: 25
• Document Creation Date: December 21, 2016
• Document Release Date: August 20, 2008
• Sequence Number: 12
• Publication Date: November 19, 1984
• Content Type: MEMO

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EXECUTIVE SEC ETARIAT
ROUTING SLIP
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CABINET AFFAIRS STAFFING MEMORANDUM
Date: 11/19/84 Number: 169092CA Due By:
Subject: Cabinet Council on Economic Affairs Planning Meeting -
November 20, 1984 - 8:45 A.M. TOPIC: Deposit Insurance System
Action FYI
ALL CABINET MEMBERS ^ ^
Vice President
State
Treasury
Defense
Attorney General
Interior
Agriculture
Commerce
Labor
HHS
HUD
Transportation
Energy
Education
Counsellor
UN
USTR
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EPA
NASA
OPM
VA
SBA
REMARKS:
RETURN TO:
Z13 stant to the President Associate Director
for Cabinet Affairs nH s .
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Baker
Deaver
Darman (For WH Staffing)
Mc Farlane
Svahn
Chapman
Executive Secretary for:
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There will be a Cabinet Council*on Economic Affaris planning
meeting on Tuesday, November 20, at 8:45 A.M. in the
Roosevelt Room.
The agenda and background paper are attached.
^ Craig L. Fuller ^ Don Clarey
A "Tom Gibson C3, Larry Herbolsheimer
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November 19, 1984
MEMORANDUM FOR THE CABINET COUNCIL ON ECONOMIC AFFAIRS
FROM: ROGER B. PORTERr-W
SUBJECT: Agenda and Paper for the November 20 Meeting
The agenda and paper for the November 20 meeting of the
Cabinet Council on Economic Affairs are attached. The meeting
is scheduled for 8:45 a.m. in the Roosevelt Room.
The Council will discuss the Deposit Insurance Study
which is being conducted through the CCEA Working Group on
Financial Institutions. A paper, prepared by Thomas Healey,
Assistant Secretary of the Treasury for Domestic Finance who
chairs the Working Group, is attached.
This brief paper presents an overview of the work
completed thus far. It focuses on:
1. The origins and development of the deposit insur-
ance system;
2. The current status of the insurance funds and the
industries they insure; and
3. The appropriate goals for a modern deposit insurance
system.
In the coming weeks the Working Group will finish its
review and present possible options for reforms.
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November 20, 1984
8:45 a.m.
Roosevelt Room
1. Deposit Insurance Studies (CM # 149)
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DEPARTMENT OF THE TREASURY
November 19, 1984
FROM: Thomas J. Healey
SUBJECT: Federal Deposit Insurance System Study
The purpose of this paper is to give the CCEA an overview
of the status and direction of the deposit insurance system
study. The final study will be organized into five chapters
and an appendix.
The first chapter discusses the creation of the current
system in the 1930's and highlights the major changes since
then. The second chapter illustrates the current status of
the underlying commercial bank and thrift industries and the
insurance funds. The third chapter lays out the two pri-
mary goals of the insurance system that continue to be rele-
vant today and describes principles to be applied in review-
ing the various reform options. The fourth chapter describes
all of the major reform options and analyzes them. A fifth
chapter of recommendations will be added after determination
by the CCEA of which options represent the best policy choices.
Finally, an appendix reviews recent proposals to change the
system made by the FDIC and the FHLBB.
Description of the present system
The deposit insurance funds continue to fit within a
broader program of government mechanisms for ensuring the
soundness of depository institutions. Three interrelated
programs form the current structure supporting financial
system stability. The first two -- the Federal Reserve's
lender-of-last resort capability, and federal deposit insur-
ance -- are designed to ensure the solvency and stability
of the entire financial system. The third, statutes and
regulations supported by periodic federal examinations and
enforcement authority, acts to reduce the likelihood of
failure of any individual institution. The deposit insurance
system study is necessarily cognizant of the role of the
other programs in providing systemic stability.
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While the current insurance system has satisfied the
goal of maintaining stability over the past 50 years, there
is concern that the economic changes and increasing riskiness
potential of large institutions may threaten the ability of
the insurance funds to fulfill their goals. Moreover, the
insurance system appears to treat large and small depository
institutions differently, raising substantial public policy
questions. These are the concerns that the CCEA Working
Group was asked to examine.
Origins of the System
The first chapter discusses the creation of the insurance
system in the 1930's and highlights the major changes in the
economic environment since then. The immediate impetus for
federal deposit insurance was the rash of bank failure's dur-
ing the Depression. In passing legislation to reduce the
number of bank insolvencies and to prevent resulting finan-
cial instability, the Congress focused on protecting against
the cause of most runs, by insuring the small depositor.
Similar treatment was accorded to thrifts.
Major changes since the 1930's
There have been significant changes affecting the; insur-
ance system since the 1930's. The most significant changes
affecting depository institutions were the advent of high
inflation and volatile interest rates at the same time as
technology permitted increased competition for funding sources
from nondepository institutions. High and volatile interest
rates resulted in increased consumer sophistication and
institutional innovation. Substantial external competition
from nondepository institutions is now occurring; today there
is no significant financial service provided by a bank or
thrift which is not also offered by less regulated competition.
At the same time, communications technology has allowed
funds to be divided into insurable amounts and transferred
around the world in seconds, giving regulators little time
to respond to a run. These shifts in turn cause potential
severe liquidity problems at depository institutions.,
Environmental changes also affected the asset side of
the balance sheet. Borrower sophistication led to the' de-
velopment of the commercial paper market which reduces high
quality lending opportunities for commercial banks. At the
thrifts, new asset powers have led to the development 'of
adjustable-rate mortgages and new types 'of credit risk from
nonmortyage loans.
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Incentive for risk-taking
The current system of flat rate premiums provides neither
incentives for prudent management of risks nor for market
penalties for imprudent risk managment. To the contrary,
with low capital levels, the flat (and cheap) rate premium
system creates incentives for managers and owners to speculate.
They have everything to gain if they win their bets; the
insurer (and in the extreme case, the Treasury) pays if they
lose. For an institution with low or no capital, even tak-
ing modest risks might precipitate failure. But taking modest
risks would also be unlikely to restore financial health
quickly enough to avoid failure. Therefore, there is incen-
tive to take large risks which could lead to either rapid
recovery or rapid failure. Losses in excess of owners'
meager investments are borne by the insurer, while owners
reap all the rewards of winning bets.
Status of the underlying industries and the insurance funds*
The second chapter describes the current status of the
underlying commercial bank and thrift industries and the
insurance funds. It would be inappropriate to evaluate the
deposit insurance systems without also analyzing the status
of the industries they insure. Risk in their industries is
clearly a cause of concern for both funds. For example there
are 6 FSLIC-insured institutions and 13 FDIC-insured commer-
cial banks that each have deposits larger than the total
assets of their respective funds.
Commercial banks
The commercial bank industry is suffering from the
aftermath. of a long and deep worldwide recession. Banks
with credit exposure to the energy and agriculture sectors
and. third world borrowers have suffered the most. In 1984,
a modern record of 5% of banks were identified as problem
cases. However, available evidence indicates a growing
disparity between strong and weak banks under deregulation
which implies that the better banks continue to perform well
in a deregulated environment.
The biggest risk to the stability of the financial sys-
tem inherently lies in the largest banks. The gradual trend
toward increased concentration of assets in the largest banks
makes the stability of the largest banks even more important
*Sixteen charts illustrating the status of the bank and
thrift industries are attached to this paper.
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to stability of the entire financial system. The top ten
banks now control 25% of the total banking assets, compared
with 20% in 1958. Moreover, the largest banks tend to fund
their liabilities with more volatile and hence, riskier
funds on average than the industry. Banks with over $10 bil-
li-on in assets fund 60% with volatile liabilities, compared
with an industry average of 40%. The largest banks also
seem to have invested in some of the riskier loans. The 24
largest banks accounted for 76.9% of all U.S. bank foreign
loans. Yet the larger banks also have lower capital ratios
than smaller banks and therefore, less of a buffer for the
insurance fund.
Thrifts
Savings and loan associations and mutual savings banks
face severe problems of their own. Their long-term and his-
torically high quality mortgage assets are at interest rates
on the average much below the cost of their short-term
funding sources, most of which are now at market rates.
Fixed-rate and inexpensive passbook accounts have dropped
from 83% of total interest bearing liabilities in 1966 to
less than 9o-in June 1984. The effect of the rise in,inte-
rest rates on earnings and capital has been dramatic and the
number of problem thrifts has risen commensurately. At the
end of 1983 over one-third of all thrifts were reporting
losses. One of the results has been a reduction in equity
capital, the buffer for the insurance fund. The industry
average equity-to-assets ratio was 4.19% at year-end 1983.
However, excluding the effects of regulatory accounting
and goodwill, it was a meager 0.5%.
One of the results of the low or negative equity'capi-
tal is that there is increased incentive to invest in high
risk/high return investments. If the investment fails, the
owner/manager has little to lose because there is so little
invested capital, yet the insurance funds must pick up the
tab. If the investment flourishes the returns will be high
to managers and owners. Savings and loan associations'
average growth rate rose dramatically to 18% in 1983, in
part resulting from these high risk strategies which are
funded quickly through offering'above market interest rates.
Sharp recent increases in S&L growth rates, coupled with
riskier loans, exacerbate the potential problems for the
FSLIC.
Goals and principles
The third chapter lays out the two primary goals' of a
modern insurance system (the same conceptual goals as'were
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appropriate when the FDIC was started 51 years ago). The
two primary goals are: to assure the stability of the deposi-
tory system, and to protect small depositors.
Seven principles have been selected by which to judge
the appropriateness of changes to the present system.' They
are: (1) limiting distortions, (2) relying on market-oriented
arrangements, (3) encouraging market monitoring of risk,
(4) improving predictability, (5) promoting equity, (6) mini-
mizing taxpayer subsidies, and (7) ensuring future flexibility.
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SIZE OF ASSISTED INSTITUTIONS
(assets for FSLIC; deposits for FDIC)
$billions
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