"FDIC" by Alpha Photo is licensed under CC BY-NC 2.0
Bad ideas never seem to die. Instead, they keep being resurrected and act as if they take on a life of their own. So it should be to no one’s surprise then, that raising deposit insurance is back on the table once more in the House. The Main Street Depositor Protection Act is calling for noninterest bearing accounts to be covered up to $5 million—improving from its absurdly high initial proposal amount of $10 million last fall— yet still poorly merited when the facts surrounding the deposit insurance system are taken into consideration.
Another proposed bill related to the current deposit insurance issue would have the Federal Deposit Insurance Corporation conduct a study and determine an adequate level of deposit insurance protection. GOP lawmakers should be aware of the poison pill embedded in the bill, which states that while the FDIC is granted the power to determine the deposit insurance limit, the new limit cannot be undone by the FDIC, and can only be altered by legislation from congress. This type of lawmaking is arbitrary and serves to enrich the beneficiaries of deposit insurance raises at everyone else’s expense. The bill’s proponents accept agency rulemaking’s discretion to enact rules that will markedly increase the government’s footprint in the financial sector, but do not endorse the same method for repeal or downward adjustment, and reserve that power instead to the federal government who will likely never touch the issue once brought to life.
Consider that 99% of accounts in the United States are already covered under the existing deposit insurance limit. Or the fact that the United States already has the highest deposit insurance limit in the world. Most other developed countries only cover up to the equivalent of $100,000 worth in their currency. Not to mention, the FDIC admits in its own report that most uninsured depositors never incur any losses, and only six percent of depositors who have balances above the deposit insurance limit actually end up being fully compensated. This is because a failed bank’s assets are used to pay for remaining excess balances not covered under the existing limit. In any case, the current bank resolution framework allows for a bank’s assets to be auctioned off and compensate former depositors almost always in entirety, and with certainty for those holding less than $250,000.
Deposit insurance has already been raised multiple times in the past. In 1980, it was raised to $100,000. That decade created unprecedented moral hazard that led to savings and loan institutions to fail in large numbers due to the excess risk-taking encouraged by the heightened insurance limit. Criticism of excess deposit insurance is also accepted by mainstream economists. Researchers at the International Monetary Fund and World Bank conclude that deposit insurance greater than 2x the GDP per capita of a country creates moral hazard. By that standard, the deposit insurance limit should be closer to $160,000 and our current coverage is already excessive.
When it comes to financial stability, there is a misconception held by policymakers that raising deposit insurance will help prevent bank runs before they begin. But this is not true at all. Deposit insurance is an ex post facto tool used to shield consumers in the event of bank insolvency. It is not a remedy for structural weaknesses that banks face in the moments leading up to their demise.
Regardless of whether deposit insurance would be raised to $5 million or is determined by the FDIC, both policies would create more of the very risk that precipitated the global financial crisis and the savings and loans crisis of the 1980s. Lawmakers should be mindful of history and attuned to the incentives they create when they expand government guarantees, which are sure to be a recipe for eventual disaster that get passed on to the taxpayer. Americans for Tax Reform opposes measures to further raise existing deposit insurance limits.
