Art Consoli

Global Coordinated Rate Cut: Nice Try, but the Party Is Over

October 8, 2008


Raising the level of insurance on bank deposits is like pouring gasoline on a fire.

By: Art Consoli

There are many reasons why this financial crisis occurred but every one ultimately comes to rest at the throne of the banking industry. The banks did a poor job of making loans: mortgages, credit cards, and automobiles.

Congress and regulations can’t make the people who run banks smarter or get them to do a better job. The only thing they can do is to examine the role they play in allowing the industry to continue to do a poor job.

What Congress did to encourage poor performance was to provide depositors with insurance on their deposits. This eliminated measuring the banks’ performance as a criterion for obtaining working capital. What other businesses are able to obtain their inventory (in the banking industry, the inventory is money) without regard to how well the business performs? Does any depositor check the financial statements of a bank before he or she gives it money? No!

All depositors look for is the interest rate. The only thing we want to know is how much is the bank going to give us for using our money. And the higher the interest rate, the more we give them. And who wants the most money? The banks that are doing the worst. They want - no, desperately need - the most money. And why do we not care how well run the bank is? Because we know the government will give us our money back if the bank fails. Yes, I know there are limitations but they can be circumvented.

Certainly deposit insurance helped restore confidence in the banks during the depression, but now deposit insurance has outlived its usefulness. By allowing poorly-run banks to obtain deposits the FDIC allows them to stay in business

Take away deposit insurance and depositors will become much more interested in how well a bank is run. Poor performers won't get deposits and well-run banks will get all the money they can use.

AND properly managed banks won't have to match the higher interest rates offered by the poorly run banks. Yes, as a depositor I want high interest rates but what I don’t want is a bank putting my money at risk in poor investments. And isn’t that the only way a bank can pay high interest rates? It has to loan my money to less capable borrowers and more risky projects; those who will pay anything to get their loans.

In addition, good banks won't have to pay the cost of deposit insurance Remove this expense from the bank’s operation and they will be more profitable. Banks will be better investments for those who want to buy their shares.

If the government does provide the bailout then it better quickly begin to get its house in order. The days of free spending are over. Serious cuts will be required for our country to get back on the productivity, prosperity track. AND one of the first places to reduce costs would be to eliminate the FDIC.

With no FDIC we would save the cost of that department and we would cut the tie that binds the government to the financial institutions. Banks would have to compete and perform. The market would deny those that are poorly run the funds they need to continue.

Providing deposit insurance is just another form of subsidies. And when we subsidize anything including poorly-run banks don’t’ we "insure" that we will get more of them.