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George Kaufman is a Professor of Finance at Loyola University, Chicago IL.
“Too-big-to-fail” in the United States does not imply that the bank is not failed, but that it is “too-big-to-liquidate” or “too-big-to-impose losses on uninsured depositors” (Kaufman, 1990). This was recently reinforced by Federal Reserve Chairman Greenspan, who said, “the issue is that an organization that is very large is not too big to fail, it may be too big to allow to implode quickly. But certainly none are too big to orderly liquidate” (Greenspan, 2000, p. 14).
Nevertheless, casual evidence suggests that at least some depositors are concerned that they may find their deposits at failed banks temporarily frozen.
In those instances where no bank acquires the insured deposits and there are a large number of depositors, the FDIC will either arrange for another bank to act as its deposit transfer agent or the FDIC will mail depositors checks for the insured amounts.
Under the Depositor Preference Act of 1993, unsecured depositors at foreign offices of U.S. banks and other creditors, such as Fed funds sellers, have claims junior to those of domestic depositors and, unless the “too-big-to-fail” provision of FDICIA is invoked, will be paid the recovery value of their claims only as the bank’s assets are sold and all senior claimants have already been paid (Kaufman, 1997b).
Before FDICIA, the FDIC generally protected all depositors, including de jure uninsured depositors, particularly at larger banks, through merger (purchase and assumption) with another bank that assumed all deposits at par and received a payment from the FDIC (Benston and Kaufman, 1998 and FDIC, 1998).
Because the FDIC pays the full par amount of insured deposits, misestimates of the recovery values affect only the final allocation of its costs, not the total cost of these payouts.
Note holders at failed national banks were paid the par value of their notes immediately by the U.S. Treasury (FDIC, 1998b).
As reported by the Financial Times in November 2000, Nicaragua resolved its second bank in 100 days and guaranteed deposits of only less than 20,000 cordobas (about $1,500) at the second bank. But only 10,000 cordobas would be paid within five days; the rest would be paid as the bank’s assets were sold. “Angry customers gathered outside the closed branches of Bancafe yesterday shouting ‘thieves’ and ‘vampires’” (Financial Times, November 21, 2000). As discussed later, only two (Canada and Peru) of the 25 countries other than the United States that responded to a survey by the FDIC and that had experienced at least one bank failure since 1980 reported paying its insured depositors immediately.
Only three countries in the FDIC survey (Canada, Japan, and Slovenia) report having authority to advance funds to uninsured depositors at failed banks, but few countries responded to this question.