Major banks, including Citigroup, Wells Fargo, JPMorgan Chase, and Bank of America, recently told the government that the FDIC program to back their bonds is not a strong enough guarantee. They want unconditional support; but the FDIC wants a more regulated and controlled bailout.

Nine major banks fault the FDIC debt guarantee plan because it's not based on the model of the rescue plan offered by the central bank in the UK. There, the bank guarantee offers unconditional support to pay principal and interest if the bank should default on its bond obligations. They claim that without an unconditional bank guarantee policy, investors will avoid buying their debt products, opting instead to do business with other banks, like those in the UK, where their investments will enjoy stronger backing to protect them from losses.

Credit markets at a standstill

For the time being, the credit markets remain virtually paralyzed. A month after the government offered to guarantee new bank bonds, not a single American company has so far taken them up on the offer. In fact, no major bank in the U.S. has sold debt since early September. But last year, banks issued more than 70 percent of our nation's corporate debt through more than a trillion dollars worth of investment products. By contrast, since the UK program of unconditional support was instituted, banks have issued more than $20 billion of government-guaranteed bonds.

Bair protecting consumers

At the center of the disagreement between banks and the FDIC is Sheila Bair, the FDIC chairperson. She has a career background as a bank regulator, and thinks like one. But others in the government's financial offices, including Treasury Secretary Paulson, come from big investment banks or Wall Street. They tend to side with the banking and investment community on issues regarding payment of debt and bank guarantee commitments. Bair has a less cozy relationship with bank executives and Wall Street institutions, however, and is more inclined to support policies that protect homeowners and taxpayers. She wants to lend support to banks without giving them a no-strings-attached blank check, and she's already frustrated with their lack of action on her loan modification proposals to stop home foreclosures.

Politics making a messy muck

One of the biggest and most important unknowns in the larger scheme of things is what will happen between now and the inauguration of our next president. Congress is in a lame duck session, the current White House seems unbelievably aloof from the historically catastrophic financial crisis, and nobody knows for sure what the team transitioning into power will look like. We can guess, but nobody is sure how the political transfer of responsibility and authority might impact policies like the ones that the FDIC is putting forward.

For now, at least, banks and the FDIC are in a stalemate regarding debt guarantees and other important tools to help restore confidence and strength. The country's economic future remains in a precarious state of imbalance.

Published on December 13, 2008