The government may guarantee nearly $2 trillion in U.S. banks' debt and deposit accounts for more than three years in an effort to break the crippling logjam in bank-to-bank lending.
That's the equivalent of about 20 percent of the national debt, which recently blew past $10 trillion, and roughly 14 percent of U.S. gross domestic product — the economy's total output of goods and services.
The temporary guarantees for banks by the Federal Deposit Insurance Corp. are in addition to the new $250 billion plan announced by the government Tuesday to directly buy shares in U.S. banks.
Among the initial banks participating in that plan will be all of the country's largest institutions, including Citigroup Inc., Wells Fargo & Co., JPMorgan Chase & Co., Bank of America Corp. and Morgan Stanley.
Well over half of the roughly 8,500 U.S. banks and savings and loans are expected to tap the FDIC's guarantees. The agency will provide temporary insurance for loans between banks, guaranteeing the new debt in the event the issuing bank failed or its holding company filed for bankruptcy.
"The FDIC is taking this unprecedented action because we have faith in our economy, our country and our banking system," FDIC Chairman Sheila Bair said in a statement. "The overwhelming majority of banks are strong, safe and sound. A lack of confidence is driving the current turmoil, and it is this lack of confidence that these guarantees are designed to address."
Invoking risk to the financial system, it was the first time the agency called on special authority under a 1991 law to undertake a special guarantee program of industrywide scope. The new program doesn't rely on taxpayer funding, Bair said, because the banks will be charged special fees for the guarantees.
The FDIC will guarantee new senior unsecured debt that banks issue to each other between Oct. 14 and June 30, 2009. It would be insured by the FDIC through June 30, 2012. Senior unsecured debt does not have collateral underlying it but must be repaid before other classes of debt.
The debt guarantees could total as much as $1.4 trillion if all U.S. banks chose to participate in the program, the government estimates. All federally-insured banks and thrifts are automatically covered for 30 calendar days and will have to decide by then whether to participate in the program.
"I think it's fair to say that (banks') views are mixed ... (from) enthusiastic to angry," said Wayne Abernathy, an executive vice president of the American Bankers Association.
Though the debt guarantees expire in mid-2012, it may be difficult for banks to wean themselves off them at that point, and the absence of guarantees could cause interbank lending rates to rise anew, Abernathy suggested. "It acts much like a crutch," he said.
Some banks believe the new insurance for non-interest-bearing deposits could be helpful, at least in the short run, Abernathy said.
The FDIC also will guarantee deposits in non-interest-bearing "transaction" accounts by removing, through the end of next year, the current $250,000 insurance limit on them. Businesses often use the deposit accounts for processing their payrolls and other transactions.
A significant proportion of business accounts are said to be uninsured, forcing businesses to juggle funds among multiple bank accounts to remain under the $250,000 insurance ceiling.
If fully utilized, the government estimates that change would add $400 billion to $500 billion in FDIC-guaranteed deposits, out of a total of around $7 trillion in deposits nationwide.
As part of the $700 billion financial rescue bill enacted this month, the insurance cap for regular deposit accounts was lifted to $250,000 from $100,000, also through the end of next year.
Bair has not ruled out the possibility that the FDIC may have to use its credit line with the Treasury Department for a short-term loan to replenish the deposit insurance fund, though she insists it is not likely. Money borrowed from the Treasury would be repaid with assessments on the banking industry. The fund is now at $45.2 billion, below the target minimum level set by Congress. The guarantees to be provided under the new program won't affect the fund.
For the new guarantees on debt, banks will be charged a fee of $7,500 a year for each $1 million in debt they issue. For the non-interest-bearing transaction accounts, banks will pay 10 cents for every $100 of their deposits not otherwise covered by the existing insurance limit of $250,000.