Source:  Wall Street Journal, August 2009

 http://online.wsj.com/article/SB125166830374670517.html

To encourage banks to pick through the wreckage of their collapsed competitors, the Federal Deposit Insurance Corp. has agreed to assume most of the risk on $80 billion in loans and other assets. The agency expects it will eventually have to cover $14 billion in future losses on deals cut so far. The initiative amounts to a subsidy for dozens of hand-picked banks.

Through more than 50 deals known as "loss shares," the FDIC has agreed to absorb losses on the detritus of the financial crisis -- from loans on two log cabins in the woods of northwestern Illinois to hundreds of millions of dollars in busted condominium loans in Florida. The agency's total exposure is about six times the amount remaining in its fund that guarantees consumers' deposits, exposing taxpayers to a big, new risk.

As financial markets heal and the economy appears to be pulling out of recession, the federal government is shifting from crisis to cleanup mode. But as the loss-share deals show, its potential financial burden isn't receding. So far, the FDIC has paid out $300 million to a handful of banks under the loss-share agreements.

The federal government is on the hook for billions of dollars in bank losses if the economy doesn't recover. It will carry that burden for a long time. Many of the loss-share deals will be in place for up to 10 years. 

In most cases, the FDIC agrees to cover 80% of future losses on a big portion of the assets, and 95% on the rest. The FDIC says it doesn't anticipate facing the 95% loss-coverage scenario on any deal. 

Some industry officials worry that bankers might tire of the partnerships with the FDIC and put little effort into reworking the soured loans because the bulk of losses will fall to the government. FDIC officials maintain that because banks still have a "material" exposure, they will be reluctant to do this.

"There is certainly an incentive for the banks to play fair and do right, but there is never a limit on the ability of the private sector to shift cost to the government," says John Douglas, a former FDIC general counsel who now advises banks as a partner at the law firm Davis, Polk & Wardell LLP.

Blog comments:

We continue to see the effects of these sweet heart deals given to lenders with inside connections to the government, especially in the case of IndyMac which is now OneWest Bank.  Investor's behind OneWest Bank include Obama supporters George Soros, Michael Dell, JC Flowers, John Paulson).  Lenders have no incentive to give loan mods where the government has agreed to insure the any losses suffered in foreclosure.  Furthermore, OneWest Bank bought up the first mortgages for 75 cents on the dollar and HELOCs for 58 cents.  OneWest, like many other banks, makes money on foreclosures.  Don't forget, your tax dollars will fund the deficit that the government is creating.  Thank you, FCIC.