Federal deposit insurance was introduced 90 years ago during the heart of the Great Depression. Ever since then, small depositors within the F.D.I.C. limit of coverage have slept soundly. Now, in light of the bank failures of the last few days and the F.D.I.C.’s extension of coverage, why will any depositor worry about risk?
Having bailed out depositors of two banks in full, how will the government refuse others?
Established as part of the landmark Glass-Steagall Act of 1933, written by two Democrats, Senator Carter Glass of Virginia and Representative Henry Steagall of Alabama
During the 1920s, low farm prices led to waves of bank failures. Various states adopted insurance, but the statewide systems failed. Scores of bills for federal insurance were also introduced.
The president of the American Bankers Association protested that insuring deposits was “unsound, unscientific and dangerous.” It was opposed by President Franklin D. Roosevelt and by his Treasury secretary, William H. Woodin.
Roosevelt opposed insurance because he thought it would be costly and also encourage bad behavior. If there was no need to mollify depositors, then banks would be free to take all sorts of risks.
Today we call this “moral hazard.”
In 1933, an estimated 4,000 banks failed. Roosevelt took office in March, and declared a national bank holiday to prevent more failures. After a pointed debate, in June Roosevelt signed the Glass-Steagall Act.
In the 1970s and ’80 a combination of financial deregulation, revived animal spirits on Wall Street, and rising inflation led to financial instability and swings in interest rates. Voilà — bank failures returned.
n the 1980s, lenders known as savings and loans had invested their funds in long-term mortgages paying a fixed rate of interest. When the Federal Reserve, under pressure of rising inflation, began to jack up rates, S.&L.s had to pay higher rates to attract deposits.
The mismatch between the cost of their money and the (lower) rate that their mortgages earned sank the industry.
In the 2008 crisis, the limit was raised to $250,000. And after the failure of IndyMac in 2008, the F.D.I.C., when possible, quietly protected uninsured depositors.
Strictly speaking, President Biden’s assurance that taxpayers are not on the line was accurate. However, in the sense that banking customers are a pretty big group, the “public” will be affected.
Moreover, the hazardous effect on behavior will be the same.
The regulators clearly failed to monitor S.V.B.’s unhealthy mismatch of assets and liabilities.
Once you take risk out of a part of a bank’s operations, it is hard to let market principles govern the rest.
Allowing uninsured depositors of banks that fail to suffer a haircut might have been healthier for the system in the long run.
And the bailout does nothing to address the condition that fostered financial instability: inflation. It may even exacerbate it.
This is not what Henry Steagall had in mind.
Roger Lowenstein NYT 15 March 2023
Mr. Lowenstein is a financial journalist and author of “When Genius Failed: The Rise and Fall of Long-Term Capital Management.”
The Glass-Steagall regulations separating investment and commercial banks were introduced by Franklin Roosevelt in 1933, repealed by Bill Clinton in 1999, partially reintroduced in the 2010 Dodd-Frank Act that followed the 2008 Lehman Brothers meltdown.
SVB Backstop Revives the Specter of Moral Hazard - Dodd-Frank Act
When bad things happen in banking, limits on deposit insurance turn out to be meaningless.
During the late 1980s, nearly a third of the nation’s savings and loan associations failed, ending with a taxpayer bailout — in 2021 terms — of about $265 billion.
The Savings and Loans Bailout