May 28, 2002
From the desk of Jane Galt:Now here's something that will
Now here's something that will make the hair of any reputable financial type stand on end: the House has just voted to raise the ceiling on federal deposit insurance from $100,000 to $130,000.
Those of you who, like me, have $14.73 in your savings account may not be aware that that $14.73 is backed, as they say, by the full faith and credit of the United States government. If your bank goes under, the government will hand you your full $14.73, in cash, so that you can seek another, hopefully more stable, institution. This is what's known as deposit insurance. Banks are insured by the Federal Deposit Insurance Corporation, or FDIC, while Savings and Loans have their own insurance agency, cunningly named the Federal Savings and Loan Insurance Corporation, or FSLIC. We'll pause for a moment while you tap your head lightly to rid it of this utterly useless information, and then move on.
All right. Well, there are some good things about deposit insurance. It keeps us from losing the $14.73 we need for a down payment on a Cuisinart. Most importantly, it prevents bank runs. This is what did so much damage to our banking system in the 1930's; it's what's threatening to devastate Argentina's now (or at least the tiny piece of it that hasn't already been devastated by the financial foolishness of the Argentine government). Here's how bank runs work. Banks do not actually keep very much money on hand; your deposits get lent out as quickly as possible so they can make money on it in the form of interest payments from mortgages and such. They only keep enough cash on hand to meet the day-to-day requirements of their depositors. (We'll leave the discussion of reserve banking for another time) However, if people start to fear for the solvency of the bank, they will want to pull their money out before it fails. In this way, the fear of insolvency can produce the actuality; as people try to get their money out before the bank fails, they make the failure inevitable by pushing the bank towards insolvency, since the bank can't call in all it's mortgages and such to hand its deposits back to depositors. When you know that the government's got your $14.73 covered, there's no need to rush to get it out before the whole house of cards collapses; bank runs are thus largely a thing of the past.
However, there's a downside to deposit insurance. For one thing, it reduces competition. Ever wonder why banks all offer pretty much the same interest on your savings account, and that interest rate sucks? Because the federal government regulates the hell out of the bank in order to minimize the risk of a bank failure requiring FDIC to come in and bail out their depositors, that's why. Innovative structures? Take them elsewhere, fiend! We will have none of this here! Willing to assume a little more risk to get a better return? Not with Uncle Sam's money, you don't. Bank accounts are probably less risky than is optimal, because the government doesn't want you or the bank playing with taxpayer money.
Which brings us to the real problem with deposit insurance: moral hazard. Which is a fancy way of saying that we take more risks when someone else is picking up the tab for our mistakes. People build their houses on flood plains when FEMA covers any water damage. People aren't as vigilant about setting the burglar alarm when the insurance company is responsible for replacing stolen items. Kids major in Comparitive Folk Dancing when it's mommy and daddy stumping up the 30K per annum.
And why should you care? Well, remember the Savings and Loan Crisis? The precipitating cause was the raising of the insurance ceiling from $40,000 to $100,000 in the early eighties, coupled with a decrease in regulatory oversight. To be fair, there were reasons for doing this: the S&L's were crippled by the inflation of the 1970's and 1980's. But the moral hazard afforded by the deposit insurance was a critical factor. Depositors didn't bother to check what the S&L's were doing with their money because the deposits, after all, were insured. And with no one watching them, the S&L presidents acted like high-school kids on spring break. Many of them were crooks, using their S&L's to generate slush funds for personal consumption and political advantage; this is why it was, contrary to the Democrats bleating, natural to be suspicious of Whitewater. Many others were just stupid, taking outsized financial risks because the downside had been effectively eliminated. Either way, it cost us a hell of a lot of money.
About 90% of depositors are fully covered by the ceiling. The ones who aren't are those least prone to panic, and least vulnerable to financial devastation from losing their whole bank account: large net-worth investors. In other words, raising the ceiling offers almost no benefit.
So why is the House doing it? Calm down there: it isn't the Republicans offering big payoffs to their rich friends. The interest group behind this one is distinctly plebeian: the American Association of Retired People. They're not shilling for cash; they're shilling for votes. At the expense of us taxpayers.
In other words, business as usual.
Posted by Jane Galt at May 28, 2002 5:43 AM | TrackBack | Technorati inbound links