Does the Expiration of the TAG Program Represent a Threat to the Banking System?

The Transaction Account Guarantee Program (TAG) is scheduled to expire at the end of the year. TAG, which was originally part of The Temporary Liquidity Guarantee Program (TLGP) of 2008, adds unlimited insurance coverage to noninterest bearing accounts, such as checking accounts, regardless of balance. It is entirely unrelated to the FDIC regular deposit insurance coverage whose maximum cap of $250,000 has been made permanent through recent legislation. Only those accounts that total over that cap will be left exposed. Accounts of this type exist at 90% of our financial system’s banks and hold a staggering amount of money, with a total of 750,000 accounts containing over $1.5 trillion in deposits. The dollar figure associated with accounts of this type has increased by 85% since the TAG program’s initiation.

Many associated with the financial system have expressed concern that such an abrupt end to the program as the one currently scheduled could lead to a major disruption. Among those fearful that a cessation of the program might erect yet another roadblock for the economy include Sheila Blair, the former FDIC chairperson, who has suggested that the program should be slowly phased out thus avoiding the potential for a mass withdrawal of money from the accounts that would be affected by TAG’s termination. While the nation’s largest banks, those who fall into the category of “too big to fail” are unlikely to be significantly affected, the end of TAG poses a greater threat to medium and small banks whose capacity to handle large outflows of capital might be strained beyond their ability to remain solvent. Although only approximately 10% of the $1.5 trillion expected to be impacted is held at such institutions of lesser size, the financial system is ill positioned to sustain another round of bank failures as the negative impact on an already sluggish economy would not be insignificant.

Several banks have issued research reports which focused upon the potential impact of an abrupt end to the TAG program. Per a Goldman Sachs study there exists the possibility of a mass exodus from the banks housing the affected accounts. A similar Bank of America assessment concludes that due to risk aversion amongst many depositors, a portion of the $1.5 trillion in the currently fully insured accounts that would lose their coverage upon the cessation of TAG would leave the banks and seek safe havens elsewhere, such as in money market funds or Treasury and agency securities. Such an influx of money into the Treasury market could push some bonds into having negative yields, as well as having an adverse affect on the smaller and medium banks less well equipped to handle such a scenario. The money is less likely to leave the system entirely than it is to cause some dislocation for individual banks, however, so the overall damage may be mitigated.

There are four general outcomes that could result if TAG indeed expires at the end of the year:

• It is possible that much of the money will simply stay put as a significant percentage of the overall funds is employed in transactional accounts used by businesses as a necessary tool for their daily operations. A mass shift of money used in this manner would be difficult.
• The cash will migrate to larger, more credit worthy institutions, i.e. the “too big to fail” group of banks that are unlikely to be allowed to go under by the government in the event that there occurs a negative financial or economic development of significance. This would alleviate the concern of investors with the long term viability of smaller banks.
• The cash will be shifted into money market funds. While there is little money to be made there given the current interest rate environment, it does represent the path of least resistance.
• Finally, the cash could be invested into short term Treasuries, a move that comes closest to replicating the FDIC coverage given the extreme unlikelihood of government issued bonds not being paid back to investors in full.

If the first scenario proves true, then the expiration of TAG is rendered to near irrelevance, as the money will, for the most part, stay put. If any of the other three scenarios prove true, either individually or in combination, the fear that small and medium size financial institutions may experience crippling banks runs, might prove to be well founded. Given the recent credit crisis and the instability and uncertainty associated with the global marketplace due to ongoing economic troubles, most notably in Europe and China, the wisest move would seem to be to follow Sheila Blair’s suggestion to engage in a slow phase-out as opposed to an abrupt termination. Prudence and caution are rarely unwise approaches, particularly when dealing with things as complicated as our domestic banking system and the global economy.