Many pro-market economists have been explaining for years that the FDIC banking system creates an intolerable risk for banks and the economy.
They say the federal government’s guarantee for deposits, low reserve requirements on deposits, and the small FDIC Deposit Insurance Fund have created a moral and financial hazard for the nation’s banks. If the recent credit and banking crisis has shown anything, it is that the moral hazard of government guarantees can provoke financial disasters that jeopardize the economy.
Many free-market economists, including Jeffery Rogers Hummel of the Independent Institute and George Kaufman, professor of banking and finance at Loyola University in Chicago, have warned the FDIC insurance system encourages banks to take risks that have put depositors, investors, and U.S. taxpayers at risk.
This has been a year of reckoning for FDIC-insured banks. Since January, 12 banks have been seized by FDIC, at a cost of $7 billion. Those seizures have taken a significant bite out of the Deposit Insurance Fund, the FDIC’s reserve fund for covering the deposits of millions of Americans. Currently, the DIF is holding only $45 billion in reserves to cover $4.5 trillion in deposits—a reserve ratio of only 1 percent.
FDIC has a watch list of an additional 117 “at risk” banks in danger of collapse. In a recent Bloomburg article, Christofer Whalen, managing director of Institutional Risk Analytics, predicted, “By the end of 2009, about 100 U.S. banks with collective assets of more than $800 billion will fail.”
In the event of a large-scale banking emergency, FDIC will be unable to cover all its insured accounts, which would require tapping additional Treasury funds at taxpayers’ expense.
It is too late to avert the current crisis in the banking industry, but to its credit, FDIC has begun to take steps toward correcting the imbalance of artificially low insurance premiums and reserve ratios by raising the premium rate it charges its member banks to participate in the deposit insurance program.
By raising both premium levels and reserve requirements, the government would encourage a private market for deposit insurance to develop, providing an alternative that would not impose on taxpayers the risk of bank failures. Privatizing deposit insurance would encourage robust regulation by the marketplace itself, resulting in a sounder banking industry.
A free-market banking system would encourage investors, insurers, and savers to reward banks with stronger equity positions and less subprime mortgage debt. Transitioning from FDIC banking insurance to a free-market deposit insurance system will not only make our banks sounder but will also protect taxpayers from billion-dollar bank failures. The focus of reform should be to move deposit insurance gradually away from FDIC and into the private market.
Matthew Glans ([email protected]) is legislative specialist in insurance and finance issues for The Heartland Institute.