by Calculated Risk on 8/20/2008 05:12:00 PM

When IndyMac failed, a frequent question was: Why is the FDIC paying 50% to uninsured depositors when the taxpayers are going to lose billions?

From the FDIC on IndyMac:

Based on preliminary analysis, the estimated cost of the resolution to the Deposit Insurance Fund is between $4 and $8 billion.

and yet (from the same release):

The FDIC will pay uninsured depositors an advance dividend equal to 50 percent of the uninsured amount.

The answer (hat tip Rick) is that the FDIC and the uninsured depositors are sort of partners after the bank fails.

From the FDIC:

When an insured institution fails, creditors of the institution have a set priority of claims, similar to priority in bankruptcies. There are two classes of claimants, secured and unsecured. Secured claims are paid in full up to the value of the pledged collateral (principal and interest to date of closure) but no post-closing investment losses are paid. Unsecured claimants are paid in the following order: administrative claims, deposit liabilities, general creditors, subordinated obligations and finally, shareholders. In a typical failure the FDIC is appointed receiver of the bank and provides coverage for insured depositors. After paying or covering insured depositors, the FDIC as insurer is subrogated for the depositors' claims and receives dividends from the proceeds of the sale of assets along with uninsured depositors. Over the closing weekend the FDIC either sells the whole bank, parts of the bank or decides to pay off the insured depositors and liquidate the assets of the bank.
emphasis added

Although there are complications, especially if money is owed the Federal Home Loan Bank (FHLB), are is a simple example of how I think it works:

Say a bank has $18 billion in insured deposits and $2 billion in uninsured deposits. When the bank fails, the FDIC pays off the insured depositors and starts to liquidate the assets of the bank. At this point, I'd think of the FDIC and the uninsured depositors as partners in the liquidation. The FDIC put up 90%, the depositors 10%.

For every billion collected from the liquidation of assets, the FDIC would receive $900 million in dividends, and the uninsured depositors $100 million. If the FDIC was confident that the assets would bring in at least $10 billion, they could pay an advance dividend to the uninsured depositors of 50%.

There are many complications, but I think this is generally how this process works.