Stop Yelling About FDIC Limits - In Fact, Just Stop Yelling

The newest discovery of TV “screaming heads” is that FDIC insurance limits are causing a quiet run on certain weak banks by large depositors. The screamers tell us that suddenly corporate depositors have discovered that keeping large deposits at weak banks is risky. They shout that BofA (BAC), Wells Fargo (WFC), US Bancorp (USB) and JP Morgan (JPM)  are going to vacuum up all of the corporate deposits and all other banks are uncompetitive. And they warn that without raising the FDIC insurance limits, the banking industry will be ruined and national calamity will result.

Given the events of the recent months I understand why everyone is upset, but cooler heads and analytical thought needs to prevail, especially among those who have a national platform on which to speak.

I understand what happens when the U.S. is upset. The 1976 movie Network was fictional but reflected a national consensus that the little guy was getting “screwed” by big corporations and big government. Now, unfortunately, fiction is really close to reality. But just because we are “mad as hell” doesn’t mean that we should shout out bad ideas.

So, let’s look at FDIC insurance dispassionately and rationally.

The public policy behind FDIC insurance is to provide a safety net to small depositors who don’t have the ability to do bank credit analysis.

FDIC insurance works well for small depositors. No small depositor has lost money in a bank account since the FDIC was established and small depositors don’t’ have to be bank credit analysts. The $100,000 insurance limit covers the deposits of most citizens and businesses in America. And, for most depositors that have more than $100,000, it is easy to split up deposits between institutions so that each insured deposit is under $100,000.

FDIC insurance is supposed to protect depositors, not undercapitalized banks.

The rationale for expanding FDIC insurance is to protect undercapitalized and non-competitive banks from the harsh reality of their actions and financial position. That isn’t the purpose of FDIC insurance and the public mission of the FDIC shouldn’t be expanded to protect bad banks. Large depositors are supposed to evaluate the credit of their banks and not do business with banks that are crummy credits. The essence of market discipline is that bad credits can’t borrow money and it shouldn’t be any different for banks. If commercial banks want to deal with large businesses, then they need to make sure that they have the appropriate capital base and are a good credit risk. This isn’t the first time in American history that large commercial depositors have had to decide which banks are acceptable and which are not. Such is the meaning of market discipline.

The problem of $100,000 insurance limits isn’t even a real problem. There are good private and public alternatives that extend FDIC limits.

Banks that belong to Promontory Interfinancial Network can offer banking deposits up to $50 million that qualify for FDIC insurance. There are approximately 2,500 institutions that belong to Promontory and are able to provide FDIC insurance on very large deposits. Using a $1 million deposit as an example, through the Promontory system, the deposit is split up among 10 institutions and therefore gets the full benefit of FDIC insurance. By the way, Promontory’s most well known founders are Eugene Ludwig (former Comptroller of the Currency) and Alan Blinder (former Vice Chairman of the Federal Reserve). This is a very legitimate and well known system for extending FDIC insurance. In fact, in today’s local paper where I live, the Sun Sentinel, there are ads from banks that are in the Promontory system touting the fact that they can offer deposit services for up to $50 million. Banks that don’t offer this coverage are doing it by choice and the Federal government doesn’t need to change the FDIC insurance limits to compensate for this decision.

There are public alternatives as well. As an example, savings banks in Massachusetts belong to the DIF insurance pool which insures all deposits (regardless of size) and acts as a supplement to FDIC insurance. DIF is state sponsored and has existed since 1934.

And, there are a wide range of additional solutions that large depositors can utilize if they want to keep their deposits at banks that they are concerned about. There is private credit protection that can be purchased and effectively supplements FDIC insurance. So, for a fee this issue of FDIC limits goes away. And, by the way, the banks that are weak and accepting deposits can arrange for private insurance and credit protection for their customers. They don’t need the Federal government to compensate for their decision not to purchase private insurance.

The New York Times ran an article a few days ago about why journalists’ words matter. I don’t think that the NYT meant only print journalists’ words; I think it meant all journalists’ words, and that includes the numerous TV journalists whose primary selling point is that they are “mad”.

Let’s try to raise the quality of the economic discussion and debate. I know we are all mad and we want to do something about it, but manufacturing problems that aren’t problems isn’t the answer. We have enough real problems to deal with first.

Comments

[Steven Hansen:]

interesting info. who are the 2500 members?

2008 Sep 30 05:41 AM

[PastTense:]

"There is private credit protection that can be purchased and effectively supplements FDIC insurance"

The companies offering various types of credit insurance have been failing.

2008 Sep 30 09:29 AM

[.*.:]

This author's point sound like it is being made by a prissy dorque, though I am sure the author is sensible in all other respects. The point is not there are administrative alternatives. The point is to stop the panic. Panic is often partly irrational. Th solution is not to send depositors through administrative hoops to try to protect their money--set up 10 bank accounts...? Come on! Yes we know we can do that. In fact I have done it. It is a royal pain in the *ss, not to mention putting my name, social security number and address on another 50 computerized, never-to-be-erased, hackable junk mailing lists. The 100K cap has been increased....never?...... is not even indexed to inflation. Small businesses that want to make payroll out of a simple account cannot do it. Promontory might be a solution but I don't know much about it, and anyway, it is a response to a pig headed delay by Congress to address the real problem, which is a paltry sized limit. It should immediately be made at least $10 million, and indexed to inflation.

2008 Sep 30 10:06 AM

[hwood007:]

I would agree with the above, too many small companies are not insured enough. Several smaller banks are having a run on deposits,( some what like the old Jimmy movie), and the fact that the bank is really in OK shape, if all the deposits are removed in several days, that bank will not have enough cash to cover deposits and the FDIC will step in and close them down.

I also would suspend the mark-to-market rule for a month and see how that worked out. Both of these ideas are not as harsh as the defeated bill and may help, give it several weeks and see. Just because some assest sold for $1,000 less this month than last month is not a reason to revalue all your assests.

2008 Sep 30 11:26 AM

[Forward Obs...:]

I would like to see what the limit would be if it was adjusted from inception to today. I don't know what that would be, but it has to be quite a bit higher than $100,000. At least that would be a start.

2008 Sep 30 12:00 PM

[couldashoulda:]

If Promontory is a good thing, doesn't that ifso facto mean that the base law should be raised from 100,000. Why force folks into a dance amoung banks.

2008 Sep 30 02:59 PM

[Leave FDIC ...:]

FDIC limits have been raised. A couple can now be insured for $400,000 ($100k each in single account, $200k joint) in each bank. Raising the limits invite reckless investment in banks that should be avoided. Doubling the limits makes the entire FDIC twice as risky for everyone and puts the entire banking system at risk.

2008 Sep 30 03:23 PM

[davethewave:]

I am in agreement that raising deposit limits is a BAD idea. Deposit brokers and the dollars they provide "Brokered Deposits" have had a bad name since before the S+L crisis. This increase would just excaberate problem banks. It's funny how none of his deposits have any negative connotations!

Bill Issac has an alternative to the TARP plan, which would insure loans to a 100K. Perhaps a better idea then buying back mortgages.

2008 Sep 30 06:15 PM