Deposit Insurance Undermines Bank Stability
Provisions in both Senate and House bills extending the temporary
coverage cap of $250,000 for deposit insurance until 2015 could be as
damaging as the now defeated "cram-down" provision in the proposed
changes in the bankruptcy code. Extending deposit insurance coverage
helps few families, and those helped are among the wealthiest, while
reducing market discipline on our banking system. As the temporary cap
is in place until December 31st, Congress appears to have plenty of time
to examine and debate the issue.
Tucked away in the TARP bill was in increase in the then $100,000 cap
for deposit insurance to $250,000. That "temporary" cap was set to
decline back to $100,000 on January 1, 2010. With no hearings on the
need for this increase, or any report language on the provision, one is
left to assume Congress believed that depositors would panic and
withdraw their deposits above $100,000 from our banking system in the
absence of this protection.
Who are these supposed panic-prone depositors? Of the 117 million
households in America, only about 10 million have total bank deposits
above $100,000, or less than 9 percent of all American households.
These same families also have incomes of over twice the median, putting
these households in the top 20 percent of earners. Nor are these
households without significant wealth, with total median holdings of
financial assets alone of almost $600,000. Most households with
deposits above $100,000, given their considerable financial wealth,
demonstrate sufficient sophistication to provide monitoring of a bank's
financial condition. Even if families with bank deposits above $100,000
were to suffer a loss in deposits resulting from a bank failure, the
typical family in this group has both considerable income and wealth to
buffer such a hit. In contrast, the typical, or median, American
household, has only about $6,400 in bank deposits, well below the
previous ceiling of $100,000.
Outside of providing public benefits to a small slice of our wealthiest
families, what else comes with extending deposit insurance? Arguably a
more stable banking system; yet a substantial share of other countries
continue to have functioning banking systems in the absence of any
deposit insurance. A recent academic study across over 150 countries
found that, all else equal, those countries with more generous deposit
insurance schemes also suffered more frequent banking crises.
Similar results hold for the US, as various academic studies have found
that U.S. uninsured deposits provide substantial monitoring of bank
health. The related decline in market discipline that results from
deposit insurance has been documented across time and differing
regulatory structures. Few relationships in economics have been found
in so many different settings as the link between expanded deposit
insurance and bank instability.
FDR and the New Deal have been invoked regularly as a model for solving
our current financial crisis. But FDR vocally opposed the creation of
deposit insurance and threatened to veto the Glass-Steagall banking bill
over its inclusion, saying it "would lead to laxity in bank management
and carelessness on the part of both banker and depositor." Ultimately
he signed Glass-Steagall into law, believing its other provisions
out-weighed the potential harm that might follow from the creation of
the FDIC. History continues to confirm FDR's initial fears toward
The performance of the Canadian banking system compared to that of the
United States during the Great Depression illustrates the problems of
deposit insurance. The Canadian banking system, which lacked any
deposit insurance during the 1920s and 1930s suffered only one bank
failure in the 1920s, and none in the 1930s. The U.S., with its
state-based deposit insurance system, suffered over 6,000 bank
suspensions and almost 4,000 mergers and acquisitions in the 1920s
alone. The worst of those failures were found in states with the most
generous deposit insurance systems.
There is no reason to believe that extending deposit insurance will not
again undermine market discipline, as it consistently has in the past.
Congress is poised to now undermine the future stability of our banking
system, largely for the benefit of the country's wealthiest families.