Do Banks Have a Fiscal Cliff of Their Own to Worry About?

The financial sector has a fiscal cliff of its own to worry about; when the Federal Deposit Insurance Corporation’s Transaction Account Guarantee program expires on December 31, big banks like JPMorgan Chase (NYSE:JPM), Citigroup (NYSE:C), Bank of America (NYSE:BAC), and Wells Fargo (NYSE:WFC) expect that between $100 billion and $300 billion will be withdrawn from their accounts.

TAG was introduced at the height of the financial crisis in 2008 to give companies and consumers confidence that their money would not be lost if banks failed. Previously, the FDIC only guaranteed the first $250,000 worth of bank deposits. In comparison, TAG protected an unlimited amount of money if the funds were deposited in a non-interest-bearing account.

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In more economically stable times, the concept of placing large sums of money in an account that paid no interest would have few interested parties. Yet in recent years, with bond yields decreasing, TAG has become more appealing. In the past two years, TAG accounts have doubled in size; in the third quarter of 2012, the $1,500 billion held in non-interest-bearing accounts represented 13 percent of total bank assets.

FDIC chairman Martin Gruenberg has said that banks should have no trouble transitioning back to the old regime when TAG expires. After all, banks are significantly healthier than they were in 2008; in the third quarter, financial institutions posted their best results in six years. But some banking analysts disagree. Analysts at JPMorgan expect to lose between $100 billion and $300 billion, while analysts at the Royal Bank of Scotland predict twice as much.

According to the Financial Times, whether TAG creates a second fiscal cliff depends on the speed at which the funds are withdrawn from banks. “If corporate treasurers feel sufficiently confident about the health of American banks, and equally disenchanted with other investment options, that they leave most of their deposits in place after December 31, or withdraw them slowly, then there is reason to think this ‘cliff’ should not cause a jolt,” stated the publication. “But if there is a stampede out of TAG funds, the money in motion may not only destabilise the banks but the wider bond markets, too.”

Ahead of the expiration date, the American Bankers Association is lobbying to have TAG extended, and Senate majority leader Harry Reid has introduced a bill that would push back the December date. However, congressional Republicans think that prolonging TAG will created even more market distortion.

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