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Should FDIC insurance be unlimited?

By Claes Bell, CFA · Bankrate.com
Friday, January 6, 2012
Posted: 11 am ET

Should the U.S. remove the $250,000 limit on FDIC insurance, in order to give corporations and wealthy investors access? That's one of the ideas advanced by Amar Bhide in the New York Times this week in an op-ed on how to prevent freeze-ups in global capital markets.

Bhide wants to prevent runs on the so-called "shadow banking system," where large financial institutions lend money to one another on a short-term basis. He would do that by having the FDIC insure companies' "deposits" with one another the same way it insures your checking account:

An overwhelming proportion of the "quick cash" in the global financial system is uninsured and prone to manic-depressive behavior, swinging unpredictably from thoughtless yield-chasing to extreme risk aversion. Much of this flighty cash finds its way into banks through lightly regulated vehicles like certificates of deposits or repurchase agreements. Money market funds, like banks, are a repository for cash, but are uninsured and largely unexamined.

Relying on the Fed and other central banks to counter panics is dangerous brinkmanship. A lender of last resort ought not to be a first line of defense. Rather, we need to take away the reason for any depositor to fear losing money through an explicit, comprehensive government guarantee. The government stands behind all paper currency regardless of whose wallet, till or safe it sits in. Why not also make all short-term deposits, which function much like currency, the explicit liability of the government?

That touched off a debate with Reuters blogger Felix Salmon, who thinks doing so would have a few big downsides, including creating a huge liability for the U.S. government in the event of a mass bank failure, encouraging institutions to take bigger risks in search of better yields on their funds, and crowding out Treasuries as the standard safe investment for many companies.

I'm going to have to agree with Salmon on this one. As it is, upping the FDIC limit to $250,000 and bearing the losses from the 2008-2009 banking crisis has resulted in a big uptick in FDIC premiums, which all bank customers bear in the form of lower interest rates and higher fees from banks looking to recoup that extra money. What would be the premium associated with insuring these types of huge interbank, intercompany deposits? Who would pay them?

Then there's the problem that the FDIC ultimately relies on the federal government to be an insurer of last resort. I think the risk that the FDIC fund will be depleted by a major crisis, as it was this last go-around, is a risk worth taking to protect the vast majority of Americans whose deposits fall under $250,000. But is it really worth taking that risk in perpetuity to protect companies that can, and should, be savvy enough to keep tabs on where they're stashing their money?

The bottom line is, as Salmon points out, we don't want huge piles of corporate money chasing yield, regardless of the risk, simply because they're backstopped by the federal government.

What do you think? Should the FDIC insure all deposits, regardless of size?

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3 Comments
bob
January 07, 2012 at 7:16 am

Why have a fixed limit? Let the banks buy as much insurance as they want. They can use that as a sales pitch.

Thurston
January 06, 2012 at 7:09 pm

They shouldn't have raised the FDIC limit in the first place. All it did was drive up the cost for smaller banks that had nothing to do with the mortgage mess. Also, the best way to prevent too big to fail is simply to tell banks that if their leverage ratio ever gets above X, their FDIC insurance will be revoked, and they'll be required to post signs in the bank letting customers know that their deposits are no longer insured. If I saw that sign, I'd run for the hills. Of course, FDIC is the most expensive insurance a consumer can own already. The only guarantee you have with CD's and other FDIC-insured accounts is that you'll lose money and won't keep up with inflation.

bytejockey
January 06, 2012 at 1:21 pm

Go to full reserve banking, and eliminate the FDIC.

Allow banks to choose whether or not to provide deposit insurance to attract customers, forming coalitions to do so if necessary.