Why Increasing FDIC Insurance Is A Good Thing (Just Not the Way Congress Wants To Do It)

There seems to be some disagreemnt about the change to the bail out bill to increase the FDIC Insurance limit. Bryan Fischer writes regarding the FDIC Insurance increase: proposal:

In fact, if anything, it creates additional exposure for taxpayers by proposing increasing FDIC insurance for bank deposits of $250,000, up from today’s $100,000.

The exposure is minimized here due to the fact that banks pay premiums for this insurance, but if the day comes when that insurance must be collected, and there’s not enough in the kitty, taxpayers will be on the hook.

Clayton Cramer writes:

Some of the “sweeteners” are at least marginally related to financial institutions–such as increasing the FDIC insurance limit from $100,000 to $250,000. Oh yes, lots of ordinary Americans have more than $100,000 in the bank–you can see why this is so important!

It’s rare that I’ll disagree with both Fischer and Cramer, but mark it on your calendars. Increasing the FDIC Insurance is a good thing that could solve a lot of problems. In itself, it’s not enough to make me support the bill. Minority Leader Boehner described the bill as a dung sandwich and if you put sugar on dung, it’s still dung.

However, my disagreement with them is only in part. It is responsible to increase FDIC Insurance. However,  the way the Senate bill does it is absurd and Fischer is right that it’s a hazard to taxpayers. The bill does not charge banks an increased premium, but rather it extends to the FDIC an unlimited line of credit from the U.S. Treasury. Oh and the increase in FDIC Insurance is only temporary, so in theory, the total amount of FDIC insured deposits drops back down to $100,000.

 Only in Congress would such stupidity prevail.

Why FDIC Insurance Exists

Anyone whose seen It’s a Wonderful Life, knows what a bank run looks like. In the Great Depression as George Bailey’s about to go on vacation, in a bank panic everyone shows up at the Bailey Building and Loan and wants their money:

[youtube]http://www.youtube.com/watch?v=_Er69b4HMl8[/youtube]

We all know George Bailey was able to use his own personal wad to keep the Building and Loan afloat, but many bankers weren’t so lucky during the depression. In order to avoid runs on the bank, the FDIC came into being.

It guaranteed the deposits people had in financial institutions up to a certain limit, so that people wouldn’t feel like taking a run on the bank. Their deposits are secure, even if the bank is struggling or fails. The FDIC has never failed to pay a claim.

The Problem With the Limit

The FDIC set the limit at $100,000 per person per institution in 1980 and has not change since. There’s a big problem with that. $100,000 today is worth less half what $100,000 was worth in 1980. In 2008 dollars, the $100,000 insurance offered by the FDIC would be $265,881.07 according to this inflation calculator. Raising the Insurance Limit to $250,000 would mean depositors would have only slightly less protection than they did in 1980.

More than fairness, increasing FDIC Insurance levels could stave off bank failures and also help with liquidity in the credit markets.

First of all, when rumors about bank trouble begin to circulate, depositors begin to pull money and the worse the rumors get, the more rapid withdrawals can get. Washington Mutual was seized on September 25th after they’d lost $16.7 billion in deposits in 10 days-an Astronomical sum.

Now, some of those folks pulling out may have been FDIC Insured and 1) they didn’t understand FDIC Insurance or 2) Didn’t feel like having their money managed by a bank that’s in financial trouble, but you can bet your bottom dollar that a lot of people left because they had more in WaMU than the FDIC insured.

There are many reasons someone might have $100,000 in the bank. For example, small businesses with a large cash reserve or businesses with large payrolls.

Losing deposits is trouble because banks extend loans with money that’s deposited.  As people lose confidence in a bank, it has less to loan money with. If a customer with $250,000 in the bank draws out $150,000 to ensure all their funds are insured, it’s as if you had 30 depositers with $5,000 in deposits walk out the door. Too many of these and you’ve got a problem.

If you increase the limits, you’ll increase confidence in the banking system, particularly for larger depositers, which could help avoid some potential bank failures, as well as increasing liquidity somewhat.