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Outside of Social Security, the creation of the Federal Deposit Insurance Corporation (FDIC) might be the most important legacy of the New Deal. No other institution has done more to alleviate the bank panics that were so common from the birth of the nation to the Great Depression. Essentially, the FDIC guarantees deposits in member banks up to a government specified limit. The FDIC will monitor member banks as well to ensure that they can meet their obligations.
For instance, the FDIC places liquidity and reserve requirements on member banks. When a banks capital ratio (a ratio of banks capital to its risk) falls below 8%, the FDIC will issue a warning to the bank. If the capital ratio falls below 6%, the FDIC can force the bank to take actions to resolve the issue, including a change in management. Still, if a bank's capital ratio ends up at less than 2%, the FDIC will take control of the bank. This is FDIC receivership.
There are two types of receivership that a bank may find itself in: Purchase and Assumption (P&A) or Payoff. In a P&A situation, the FDIC will look for other banks to buy up the collateral from the failed bank. These include items such as bad loans or foreclosed properties. These are often purchased for pennies on the dollar. Still, the FDIC tries to recoup as much money as it can. In addition to the "bad items", the FDIC looks for other banks to buy the remaining pieces of the failed bank. This is why many refer to the process as "preprivitization" rather than "nationalization". The FDIC runs the banks for a short period, but this is done only long enough until all the pieces of the bank can be returned to market ownership.
The other type of receivership is the Payoff method which occurs when the FDIC finds itself unable to execute the P&A method. In this case, the FDIC will payoff all of the failed bank's depositors with funds in insured accounts. Typically, the P&A method can be executed for most banks.
The TARP program seems to be an attempt to avoid FDIC receivership for our largest banks. Still, every Friday lately has seen a number of banks taken over by the FDIC. It's a trend that everyone expects to continue.
