Banking Insanity

One of the follies this crisis has brought out is the idea of unlimited backing of bank deposits. The old limit was $100, 000 per person at each bank. The emergency bailout bill increased the limit for 1 year to $250,000 per person. Subsequently, the FDIC announced that it was guaranteeing all bank deposits.

The original rationale for the limit on deposit guarantees was that it allowed big (supposedly sophisticated) depositor to enforce a market discipline on banks. Any bank that was careless in lending would lose large depositors. Banks have gamed this rule by using "brokered deposits", that is getting deposits from brokers who break up big chunks of money into FDIC backed amounts. The bad banks attract the brokered deposits by offering above market rates, which puts pressures on the good banks to compete with higher rates. Regulators should step in and stop the zombie from cannibalizing his fellow banks.

But now that is all gone away. Nothing bad is allowed to happen to anyone any more. The government will make all ouchies go away. The non-socialist of you will realize that government doesn't create wealth it just moves it around. The depositors are protected but the taxpayers are on the hook for bad bank behaviour, with no incentive to lend prudently. We've seen this movie before and it's a bad horror film. In theory, the banks pay for the deposit guarantees with the fees to the FDIC. But when a lot of banks get into trouble, the FDIC goes running to the U.S. Treasury and borrows as much money as it needs. Now, how much money does it take to back an unlimited guarantee?