Lifting The FDIC Cap Makes Bad Policy Worse

In the aftermath of the Silicon Valley Bank debacle, it is tempting to view removing the FDIC deposit insurance limit as an improvement over the current system. As the argument goes, explicitly backing all bank deposits and assessing fees for that extra coverage before it is needed is better than the implicit coverage that exists now, where all deposits over the cap are covered without assessments.

It’s tempting, but it’s a trap. On the surface, it’s a perfectly logical argument, but it depends on a lazy analysis that focuses too narrowly on one improvement while ignoring all the tough questions about the proper role for government. Don’t fall for it.

For starters, the federal government did not have to back uninsured deposits. The existing group of government officials chose to do so.

Perhaps they genuinely feared that failing to insure $230 billion of uninsured deposits would crater a $26 trillion economy, even though, according to the same officials, the banking system is sound. FDIC Chairman Martin Gruenberg, for example, insists that banks have “strong capital and liquidity positions that allow them to absorb unexpected setbacks while continuing to meet the credit needs of the U.S. economy.”

Or, possibly, they believed the only way to stick to their statutorily required duty to minimize future taxpayer losses was to cover those uninsured deposits.

Either way, the U.S. regulatory system does not have to be structured on such evaluations. In fact, the system shouldn’t be structured this way because it depends too heavily on subjective and ill-defined concepts. As it stands, though, the system allows elected officials to avoid accountability while giving unelected officials every incentive to initiate bailouts.

The argument for lifting the FDIC cap and charging higher fees also assumes the federal government should insure bank deposits. But that’s a less settled question than one might think.

Yes, federal backing helped quell a panic during the Great Depression, and there have been fewer bank runs in the FDIC era. But even if one ignores the federal policies that caused the U.S. banking sector to be such a mess prior to the Depression (and beyond), it does not automatically follow that the federal government should insure bank deposits.

Nor does it follow that the FDIC should oversee winding down failed banks. There’s no economic reason, for example, a federal bankruptcy court could not be in charge of bankruptcy for all financial institutions. It’s even conceivable that FDIC coverage could still be provided to most people under such an arrangement, and that large uninsured deposit flights would be pointless because a bankruptcy judge could force those depositors to return anything deemed a preferential transfer.

In fact, one can make an excellent argument that the steady erosion of normal bankruptcy safe harbors in financial markets, implemented in the name of maintaining stability, contributed to the 2008 financial crisis. Reinstating these safe harbors and extending something like them to the banking sector could be a vast improvement over the current system, particularly with respect to uninsured deposits.

It is also possible that FDIC insurance, which historically has had caps much higher than needed to protect the typical American, has prevented private insurance solutions from arising. Why would anyone under the current FDIC dominated system try to start an insurance company to protect middle class Americans’ deposits?

More broadly, the question of federal deposit insurance must be viewed within the overall public-private nature of the U.S. economic system.

Policies that require federally insuring all bank deposits, for instance, effectively suppose private financial markets cannot safely exist. And if the U.S. government is going to insure all bank deposits in the name of maintaining stability, there’s no objective reason to refrain from covering all money markets or, for that matter, all financial losses.

I suspect most people would still balk at federally insuring profits for Walmart, Apple, and Amazon, but it’s the same principle. Just as with large banks, the failure of one of these companies would endanger millions of people who depend on them for a living and for obtaining necessities.

If stability is the key principle, and the government can guarantee it, there’s no reason to bother with the private side of the public-private nature of the economy.

Most members of Congress are likely more comfortable limiting this stability principle to financial market regulation, but that’s no better. Under this regime, virtually no weight is given to people’s ability to manage their own safety outside of government. Yet an inordinate weight is given to a handful of other people who, supposedly, know precisely how everyone else can manage their finances for safety.

But no group of regulators can possibly have such knowledge. Ignoring this painful fact has ended in spectacular failure multiple times in the U.S. (including the Savings & Loan crisis and the 2008 meltdown). And taxpayers always clean up the mess, no matter how many times politicians swear it will never happen again.

We can pretend that special assessments, whether for being a systemically important financial institution or for accepting federal deposit insurance, are more than a tax that goes into the government’s general fund and gets spent on something else. And we can pretend that “the banks” pay for such assessments. But the truth is those assessments get passed on in the form of lower wages, higher fees, and fewer economic opportunities.

Nor does it help that the 2010 Dodd-Frank Act codified financial stability mandates.

A regulatory mandate to maintain financial stability is, itself, a flawed concept. Aside from requiring regulators to set rules based on which financial risks they believe are acceptable, it enshrines the basic principle that stability is both achievable and paramount. There’s virtually no way such a system doesn’t ultimately rely on taxpayers to cover losses.

The core issue is now much bigger than what the appropriate FDIC caps and assessments should be.

For roughly 100 years, Congress has consistently expanded regulation, regulators’ discretion, and federal backing. The Fed, supposedly a lender of last resort, now holds $2 trillion of the public’s cash in its reverse repo facility. Its new operating framework has decimated the inter-bank lending market, pays large financial institutions billions, and makes it very easy to accommodate excessive fiscal expenditures.

It appears the solution to every problem–for most Republicans and Democrats–is to borrow, spend, and regulate. But the whole apparatus provides a false sense of security, one that always ends badly and always brings more of the same. And this hostility to private markets never works out for the masses, only for the best connected.

The U.S. government has been playing a very dangerous game since 2008, and the current debate over unlimited deposit insurance is just the latest piece to pop up. But governments can’t just borrow and spend to fix everything without consequence. Not even the U.S. government.