Failure-wracked FDIC reaches for yield

March 25, 2011, 2:40 PM UTC

Think you’re getting killed by low interest rates? Just imagine how Sheila Bair feels.

The Federal Deposit Insurance Corp. is spicing up its investment strategy after the $40 billion portfolio backing its deposit insurance fund returned just 0.2% last year. Intensifying that dull ache, the portfolio shrank by a third as the agency tapped the account to clean up after 157 bank failures.

Many unhappy returns

For the past two years, the FDIC has kept its money in Treasury bills that mature within a year, giving it ample access to cash for an unending string of bank takeovers. But with the bank failure wave cresting, interest rates rising and fund assets shrinking, the agency has been creeping back into longer-dated government debt, with maturities as long as three years.

This shift doesn’t exactly scream “risk” like a plunge into pay-in-kind toggle bonds or defaulted mortgages. But it does show that like savers, the FDIC is tired of getting pennies on the dollar at a time when the price of everything but houses and, well, labor is rising.

“This strategy attempts to balance the need to maintain sufficient portfolio liquidity for the funding of potential near-term resolutions against the yield pick-up that can be obtained by investing in short-maturity Treasury securities,” the FDIC’s chief financial officer, Steven App, said in his annual report to the FDIC board, released Thursday.

The FDIC could use some pick-up. The fund’s 0.2% gain last year trailed by 5 percentage points the return of the benchmark the FDIC tracks, the Merrill Lynch 1-to-10-year Treasury index. It marks the third time in five years the deposit insurance fund, or DIF, has underperformed the index (see chart, right). The value of the fund shrank by $20 billion last year and “is expected to continue to decline over the next few quarters,” App said.

Of course, no one is putting their life savings in the DIF and hoping it will make them rich, so fund performance is not probably Sheila Bair’s biggest worry. But restricting yourself to investments that yielded at best 0.24% at last count, thanks to the Federal Reserve’s policy of holding the fed funds overnight bank lending rate near zero to restore solvency to the big banks, most certainly is not a recipe for portfolio growth.

App wrote that under its new strategy, the FDIC is buying the longer maturity bonds “so as to take advantage of the recent increases in Treasury yields.” The two-year Treasury recently yielded 0.70%, which isn’t much but is three times the yield on one-year debt.

The move comes amid signs the rush to short-term debt is overdone. Some investors are betting the two-year yield will rise further as the yield curve flattens, reflecting continuing economic growth, reduced bond buying by the Fed and the ever-present worries about thick-headed U.S. fiscal policies.

The two-year Treasury has spent most of the past three years below 1% but traded as high as 1.38% in the middle of 2009, when worries about the banking system started to clear. If it trades there again and the FDIC gets its timing right, it could have a bit of good news for once.

Also on

Follow me on Twitter