Taxing times for the FDIC

FDIC chief Sheila Bair has her hands full with a new job overseeing toxic asset cleanup.

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NEW YORK (Fortune) -- Sheila Bair's band of bank watchdogs is about to get even busier.

Under the toxic asset cleanup plan announced earlier this week by Treasury Secretary Tim Geithner, the Federal Deposit Insurance Corp. is about to move well beyond its traditional roles as regulator and deposit insurer.

The agency will oversee public-private investment funds bidding for troubled bank assets, analyze the pools of loans banks are putting up for sale, run auctions to draw out the highest bidder and provide guaranteed financing for the transactions.

Observers say the FDIC is a natural choice for the Geithner plan, given its experience in handling troubled bank assets. It also has access to a funding source -- fees paid by insured banks -- that isn't controlled by Congress, which has grown increasingly skeptical of more bailouts for financial firms.

The economic meltdown has also made Bair the rare regulator to have her praises regularly sung in Washington. House Financial Services committee chief Barney Frank and other Democrats have lauded her work in pushing for foreclosure relief.

But for all its advantages, the FDIC has its own battles to worry about, most notably loud complaints from banks about the higher premiums they are being forced to pay.

"The FDIC, perhaps more than any other agency, has their hands full," said Ken Thomas, a lecturer on finance at the Wharton School at the University of Pennsylvania.

The economic crisis has taken a toll on the FDIC's finances. The balance in the agency's deposit insurance fund dropped 64% last year to $19 billion, as the FDIC took over 25 failed banks, including giant Washington Mutual.

In 2009, the demands on the deposit fund are expected to rise further: 20 banks have already been seized by the FDIC so far this year. Bair told the Independent Community Bankers of America in a speech last week that the deposit insurance fund's balance "will approach zero" if the agency doesn't get more money from its members through higher assessed premiums.

Those members aren't in a giving mood, though. Cam Fine, the president of the ICBA, called the FDIC's plan to raise fees -- and to make a special one-time assessment -- "crippling" for community banks.

In the bailout-decrying spirit of the times, he went on to note that small banks haven't been responsible for the signature ills of the economic crisis, such as ill-advised bets on derivatives and loans to subprime borrowers.

In response, the FDIC said it would slow the pace of rebuilding the fund. One of the reasons the fund was depleted in the first place is because, thanks to congressional actions a dozen years ago, many banks weren't required to contribute to it earlier this decade -- a time when profits were booming and few institutions were failing.

Bair dangled another carrot when she said the FDIC might reduce the planned one-time assessment if Congress passes a bill that would give the FDIC the authority to borrow as much as $500 billion from the Treasury.

But that bill has yet to be debated in committee, let alone considered by the full Senate. Meanwhile, Bair said last week that the FDIC isn't expected to reach a final decision on assessment levels until late May.

Regardless of what happens, the costs for member banks are going up, and the economy is showing few signs of an imminent recovery. That's one reason the prospect of more financial obligations for the FDIC doesn't have everyone doing cartwheels.

"Surviving banks are going to be footing the bill," said Tom Bailey, CEO of Brentwood Bank in suburban Pittsburgh. "The more money I have to pay in assessments, the less I have to lend."

Talk of higher assessments is doubly painful since it comes at a time when the industry is running deep in the red. Banks lost $32 billion in the fourth quarter of 2008, the FDIC said last month.

Yet observers say that the continued problems plaguing big banks like Citigroup (C, Fortune 500) and Bank of America (BAC, Fortune 500), not to mention the serial bailout pratfalls at AIG (AIG, Fortune 500), have left policymakers with few other options. The issue of bad assets stuck on financial firms' balance sheets had to be addressed.

"The FDIC is really stretching the fund a long way," said John Douglas, a partner at law firm Paul Hastings who was the FDIC's general counsel from 1987 to 1989. "It's going to be expensive no matter what they do, and we don't know the full size of the problem."

Perhaps the silver lining is that by putting the FDIC in the middle of the worst banking mess in decades, the administration has chosen an agency that has gotten good marks for competence -- and has a vested interest in seeing the problems resolved as quickly as possible.

"The FDIC's fingerprints are all over this plan," said Hal Reichwald, co-chair of the banking and specialty finance group at law firm Manatt Phelps & Phillips in Los Angeles. "They are going to have a lot of influence over how well this works."