Another bad bailout idea — raising deposit insurance cap is regressive and counterproductive

As the Wall Street crisis has expanded, politicians are falling all over themselves arguing on behalf of the “little guy” against “fat cats.” But in reality, the main elements of “rescue” plans receiving a bipartisan push would represent a massive transfer of wealth from little guys and gals to fat cats’ pockets.

First, there was Treasury Secretary Hank Paulson’s $700 billion bailout the House defeated on Monday, but to be revived in the Senate as early as Wednesday night. Then there is the upper-income wealth transfer that will now be added as the cherry on top of this bailout: raising deposit insurance to bank accounts of $250,000 or more.

According to the Associated Press, both Barack Obama and John McCain on Tuesday backed lifting the deposit insurance cap to $250,000 from the current $100,000 maximum. And Federal Deposit Insurance Corporation Chairwoman Sheila Bair wants Congress to give the FDIC “emergency” authority to raise the cap to any level she deems necessary to “restore confidence” in the banking system.

But wasn’t too much confidence in the banking system in large part what got us into this mess? Deposit insurance, even at current levels, encourages “moral hazard” as consumers assume their banks are totally safe and don’t look for quality as they do with investments and so many other products.

And I’m sorry, but if you were fortunate enough to inherit or sophisticated enough to accumulate more than $100,000, you don’t need the extra protection from other taxpayers. How hard is it, under the current system, for folks with $250,000 burning holes in their pockets to find three different banks to put it in?!

This could result in billions more liabilities now on the shoulder of the average taxpayer. And even if banks had to pay increased fees to cover this instead, that would be that much less they had to lend out during the credit crunch, defeating the whole purpose.

It also would be counterproductive in the sense that there would be that much less assurance a bank’s shareholders would get anything in a goverment takeover, because laws since the savings-and-loan crisis give insured depositors first priority of any money the banks have left. With shareholders being wiped out at the failure of Washington Mutual and Wachovia, giving depositors an even larger claim to assets would further scare off potential bank investors, just at the time that banks are issuing new stock to get further cash to lend.

In fact, some of the important credit crisis fixes being discussed, such as the mechanism used in Europe of “covered bonds” to finance mortgages, recognize the need to give at least some investors an equal claim with depositors to a bank’s assets. Raising deposit insurance without these measures would be a step backward and leave things even more precarious for the nation’s banks.