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Wednesday, July 16, 2008

Moral Hazard Meets Hazardous Manners

by Tanta on 7/16/2008 08:14:00 AM

And the results are, of course, ugly. The LAT reports on police calls to restore order to lines outside some IndyMac branches yesterday. The surliness seems to have stemmed from actual or perceived instances of someone cutting in line.

And why are all these people spending days in line at a bank already operated by the FDIC? More than a few of them appear to have accounts over the insured limit. Perhaps. Sort of.

Take Mr. Bash (no, really, that's his name):

Todd Bash, a 43-year-old teacher from San Gabriel, was worried about IndyMac's viability after reading about its woes in the media, so he had gone into his branch in West Covina on July 8 -- three days before regulators seized the bank. He had two certificates of deposit, a savings account and a checking account, totaling more than $180,000.

Bash said he had been ready to pull his funds, but the teller told him that he could add beneficiaries to get extra insurance. He added his mother to one account and his sister to another.

But after IndyMac was seized, an FDIC hotline operator said the extra insurance wasn't necessarily valid, Bash said. That landed him in line Monday. After eight hours, the bank closed and he went home.

He went on the FDIC website again and used the system's deposit insurance calculator, which said all of his deposits were fully covered.

Bash returned to the bank Tuesday more confident, but when he finally talked to a teller, she showed him that more than $80,000 was missing from one account. Why? The teller didn't know. She referred him to an FDIC official in the branch, who also couldn't tell him what happened, he said.

"One person finally suggested that maybe there was a hold on my account, but when I asked if it was a hold, why wouldn't they just say there was a hold? . . . Nobody could give me any answers," he said.

FDIC spokesman David Barr said most of the problems stemmed from trust accounts that have been put on hold until the agency determines that beneficiaries have been properly named. In most cases, those funds will be released in full after the depositor confers in person with the FDIC, he said.

Frozen trust accounts also caused tellers to fail to credit interest payments to some borrowers. "We apologize for that," Barr said, adding that the FDIC is checking accounts where that may have occurred and will mail missing interest to depositors. "It may take us a few days, but we will get it out."
I love this little anecdote. It has everything in it.

The big moral hazard problem that existed back when deposit insurance was first invented was, of course, the nasty information asymmetry between depositors and the banks. The banks knew what ridiculous risks they might be running with your savings account, but you didn't. "Bank runs" start because the information about risk gets out suddenly (and often incompletely) to depositors at the moment of crisis, leading to depositor panic.

In the New Era here, Mr. Bash actually got information from the media about the riskiness of his bank before it managed to create widespread depositor panic. So he goes to the bank to withdraw his money--or at least that part of it over the $100,000 deposit insurance limit--but when the helpful teller points out to him that he can make perfectly meaningless changes to names on his accounts and get more "free insurance," he decides that makes more sense. His concern about the management of his bank and its risk tolerance does not extend to looking that gift horse in the mouth.

Then IndyMac compounds the "problem" by, you know, having to treat this sham transaction (adding names to an account just to get around insurance limits) by, you know, having to pretend like it's really a transfer of ownership of funds and putting the old perfectly usual "hold" on the account until . . . well, you know. Until the bank has verified that this is not a "fraudulent" transaction. Whatever that means in the current environment.

Mr. Bash is quite upset that the price of nearly doubling his deposit insurance coverage at no monetary cost to him is several days worth of red tape. Defeating the purpose of deposit insurance limits should, we all know, be smooth and flawless. For heaven's sake, this is 2008. Can't someone just type in some numbers and hit the "enter" key? It's one thing to read in the WSJ that your bank's lending activities may be jeopardizing its safety and soundness--to the point of Congress asking some nasty questions about it in public--and to remain calm enough to believe that the teller can fix your problem by adding your mother's name to an account. It is another thing entirely to get cruddy customer service from the damned FDIC.

Of course all the FDIC can do is abjectly apologize and pretend like anybody should really care about Mr. Bash's tribulations at this point. It has to: the rule of the day is No More Panic and FDIC officials and staffers manning those teller lines will have to play the whole "customer service" game until their back molars grind down to stumps and they've emptied all the bottles of Pepcid they keep next to the check printers. One cannot lecture people like Mr. Bash about moral hazard and the costs of free insurance in the middle of a bank takeover.

Not when the other "overinsured" are out front starting to throw their lawn chairs at each other, you can't.