$200,000 of FDIC Insurance? The Battle Has Just Begun.

The battle is onu00e2u20ac”in one corner there`s the proverbial David in the person of FDIC Chairman Donna Tanoue, and in the other corner, three giant Goliathsu00e2u20ac”Senate Banking Committee Chairman Phil Gramm, Treasury Secretary Lawrence Summers, and Federal Reserve Board Chairman Alan Greenspan. Technically the conflict is over the FDIC`s Deposit Insurance Option Paper (published in August), which suggested (some said foolishly) that deposit insurance coverage should be increased from $100,000 to $200,000 per depositor. As the paper pointed out, such an increase would compensate for the last 20 years or so of inflation since the insurance level was set at $100,000. The new ceiling might also help to meet an increasingly difficult problem for community banksu00e2u20ac”obtaining sufficient deposits to meet growing loan demand. Core deposits as a source of funding for community banks have steadily declined and largely are being replaced by loans from the Federal Home Loan Banking System. Once this idea was floated, Senator Gramm, an ever-pure free marketer, reacted with a resounding “No wayu00e2u20ac”not on my watch!” At a recent Senate committee hearing (on an unrelated subject) Gramm gained support for his position from the secretary of the Treasury and the Fed chairman. Treasury said it doesn`t agree with the proposal because it increases risk taking and possible government liability; Greenspan said “no” because he feels it`s a subsidy for the rich. (I guess he`s been in government so long that anyone who has over $100,000 is really rich.)Do these opinions nix the possibility for a change in the deposit insurance ceiling? I don`t believe so. This is a complex issue that will require congressional hearings and much research, because it relates to “too big to fail” policies and overall financial reform. Here are some of the important points to be weighed in this debate: Increasing deposit insurance brings more financial risk to governmentu00e2u20ac”Possible, but unlikely, since the bank insurance fund has never cost the Treasury a penny (the thrift insurance fund is the one that went broke). Even Chairman Tanoue and Fed Governor Meyer have pointed out that the greatest risk to the fund is likely to be the failure of a large complex bank. Moreover, the risk is much greater to the federal government when it supports a huge home loan bank financing institution (another quasi-governmental agency such as Fannie Mae or Freddie Mac)u00e2u20ac”where any trouble means big trouble. It distorts the operations of the free marketu00e2u20ac”This is also referred to as creating a “morale hazard,” the idea being that FDIC depositors won`t have to worry about the condition of the bank. Of course, the so-called free market is out of kilter anyway, what with the Federal Reserve`s discount window and the Treasury`s bailout of Mexico and half of Asia through the IMF. In fact, the government seldom does anything that doesn`t impact the free market (think environmental protection, antitrust, regulation of good drugs, bad drugs, and so on). The issue of whether to increase the deposit insurance ceiling has less to do with the distortion of the free market than it does with whether this particular action in total is “good for the country.” (In the case of Mexico, for instance, the free marketers decided that a U.S. bailout of rich U.S. business leaders was good for the country and the world; bingo, the funds were granted.) It`s a subsidy for the richu00e2u20ac”It`s debatable whether FDIC insurance is a subsidy at all. Most economists (though not Greenspan) doubt that there is much of a subsidy because the banks have paid for all of the insurance and the insurance fund has covered any losses. Now that I`ve laid out the opposing views, here are several good reasons for approving the FDIC deposit guarantee increase: It will level the competitive playing fieldu00e2u20ac”Historically, governments have protected all bank depositors when very large banks are in trouble, thus providing an implicit guarantee of unlimited insurance for those institutions (e.g., Japan, Saudi, Korea, Thailand, and the U.S.). Therefore, at the very least, the increase to $200,000 tends to give community banks a better chance to maintain their deposit base against a too-big-to-fail competitor. The increase will reduce the risk that smaller banks and the communities they serve will stagnate due to the banks` inability to obtain funding at a reasonable costu00e2u20ac”It could also reduce future FDIC insurance payments if these weak banks fail in the next recession. (Incidentally, an FDIC study shows that if the insurance level had been at $200,000 during the problems of the `80s and `90s, it would not have materially increased FDIC insurance costs.) The increase will help to maintain a banking system that is decentralized and diverseu00e2u20ac”This type of system helps the economy, boosts productivity, and promotes entrepreneurshipu00e2u20ac”important factors in our present prosperity. It provides a savings incentiveu00e2u20ac”As more baby boomers retire with savings in excess of $100,000, the increased FDIC insurance coverage will provide a convenient and conservative savings option and will encourage savings, which all economists agree would be good for the U.S. economy. You may have guessed by now that I`m rooting for the corner with little David (Chairman Tanoue) in this important policy showdownu00e2u20ac”and the battle is far from over. Why? I`ll simply use the litmus test that applies to all other proposed reforms: It`s good for the country.

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