Cap The Financial Black Holes
A consensus is emerging that the rate of U.S. thrift and bank failures stems in large part from the perverse incentives of Federal Deposit Insurance. But change will not be easy, given the prevalence of the No Disasters on My Watch” philosophy of Congress and the Reagan administration.
In his first 100 days, the new president should offer a four-point program to resolve the growing financial-services crisis. It would acknowledge the need for a onetime Taxpayer Bailout, develop a Big-Bank Closure Plan, set a Taxpayer Liabilty Cap starting next year and thereby create incentives for Market Based Deposit Insurance.
The president would note that American taxpayers have already and largely unwillingly assumed a massive future obligation in this area. He would admit that a further sizable hit on the Treasury was unavoidable, but that, in return. the industry must assume greater responsibility for Its own risks. The current system of profit side capitalism, he might add, mixes poorly with loss-side socialism. At the same time, he must not forget that politically based regulation and insurance coverage of financial services are part of the problem, not the solution.
Consider how the limited deposit insurance system of the. 1930s evolved into the universal security blanket of trday. After all, the original plan was intended only to reassure and protect “small depositors” while discouraging “bank runs.”
Crisis Demanded Action
Those involved were well aware of the problems of government insurance. Bankinig Industry spokesmen and key legislators at the time noted the “moral-hazard” risk of allowing depositors to escape all responsibility for their investment decisions. They viewed any decision to lump all financial institutions into a single risk category as foolish and inequitable. President Roosevelt made his concerns explicit, noting that there was no intent to encourage “unsound banking in the future.”
Nonetheless, the banking crisis demanded action. The 1933 law Insured all deposits up to $2,500 and imposed a fee on all domestic deposits of 1/12 of 1% to finance this “Insurance” system. Similar guarantees were provided the S&Ls.
For decades, the federal deposit Insur ante system seemed successful. Indeed, lied the original modest system been retained, things might not have gone awry. The initial $2,500 figure was soon raised to $5,000, but it stayed at that level for many years. Moreover banking in the late 1930s first stabilized and then in the postwar era prospered along with the general economy: That led some to believe that disconnecting the pressure gauges had no adverse consequences,
The insurance limit was raised until in 1980 It reached the present $100,000, a jump far in excess of that justified by inflation. The S&L deposit coverage woo expanded in a parallel but slightly slower fashion. Jake Garn, then chairman of the Senate Banking Committee, now collected the last thrift increase-reported prompted by comings that depositors. wield flee troubled institutions-was a serious mistake.
Yet, this tendency toward broad coverage to protect everyone from everything; was present at the beginning. The deposit The deposit limit, for example. was never applied to the depositor but rather to the deposit, and the Federal Deposit Insurance Corp. and Federal Savings and Loan Insurance Corp elected early to insure interest as well as principal liabilities. Deposits have become risk -free, encouraging the rush of funds to whatever institution offers the best interest rate today.