Unlimited Deposit Insurance: A radical idea gaining momentum in Congress

Organized at historic speed, the government bailout of Silicon Valley bank depositors may have saved the US economy from a devastating wave of bank failures, but it also underscores the potential need for a dramatic overhaul of the US deposit insurance system and banking regulations more broadly.

At a hearing before the Senate Finance Committee on Thursday, asked the legislature Treasury Secretary Janet Yellen has a question on the minds of many Americans: Should regional bank depositors expect the federal government to help them if their bank fails?

Yellen responded as the law requires: Uninsured deposits are only guaranteed if your bank’s failure poses “systemic risk” to the US economy.

Continue reading: Yellen says banking system is ‘healthy’ as analysts see little chance of new legislation for the troubled sector

Of course, up until last week, no one thought that the collapse of a mid-sized regional bank posed a risk to the entire US economy, and it would be reasonable to expect that regulators could again rely on the systemic exception in the law in the future to justify protecting the hard earned savings from individuals and businesses in the US.

Additionally, it was Silicon Valley Bank’s reliance on uninsured deposits — those in excess of what the Federal Deposit Insurance Corp. set insurance cap of $250,000 — which made them vulnerable to a bank run in the first place.

For this reason, some lawmakers, including Republican Senator Mitt Romney of Utah and Senator Elizabeth Warren of Massachusetts, are warming to introducing universal deposit insurance. according to a report in Semafor.

A major concern for other powerful lawmakers is how to pay for it, since the vast majority of Americans find it hard to imagine having $250,000 in a bank account. A spokesman for Ohio Sen. Sherrod Brown, the Democratic chair of the Senate Finance Committee, told MarketWatch that Brown believes that “any changes to deposit insurance must protect small businesses and workers, not large investors.”

Robert Hockett, who teaches monetary law and economics at Cornell Law School, argues that since lawmakers have reformed the FDIC system to fund it with risk-based pricing, it would be relatively easy to remove the cap entirely.

“We already base insurance rates on the risk profiles of the banks themselves,” Hockett told MarketWatch. “Higher-risk banks pay higher premiums, just like smokers pay higher premiums for health insurance.”

Hockett advocates removing the cap entirely, allowing banks to charge the fees for larger accounts to cover the cost of the additional insurance and preventing banks from charging those fees for smaller accounts.

An added benefit of this approach is that it would shrink the so-called shadow banking system, or the network of unbanked intermediaries like money market funds that companies rely on as cash management tools, argues Hockett.

“There would be a lot less money going into the shadow banking sector, and that’s a good thing,” he said, noting that the opacity of the shadow banking system makes it difficult for regulators and counterparties to assess its financial health.

The banking industry would likely fight a move to remove the deposit insurance cap as higher fees could eat away at profits. The status quo gives the industry an implicit guarantee that deposits will be insured, while the cost of that insurance is borne by the more responsible banks and other US taxpayers.

In addition, a move toward unlimited deposit insurance could open the door to even more radical banking sector reform, such as the introduction of retail accounts with the Federal Reserve.

Dean Baker, senior economist at the left-leaning Center for Economic Policy Research, advocated the move in a recent blog post, writing that modern technology allows the government to run a single payment network at a much lower cost than the patchwork private systems in use today. Why allow private banks to finance themselves with cheap consumer deposits when the state guarantees these deposits anyway?

“We would have the Fed-run system to conduct the vast majority of normal financial transactions, replacing the banks we use now,” Baker wrote.

“However, we would still have investment banks like Goldman Sachs and Morgan Stanley lending money in the financial markets and lending money to companies and underwriting stock and bond issues,” he added. “While investment banks still need regulation to prevent abuse, we need not worry that their failure will cripple the financial system.”

The complementary nature of unlimited deposit insurance and state-sponsored retail banking could discourage some in Congress from supporting them, given the vocal opposition to Federal Reserve retail accounts that Republicans have expressed in recent years.

Republican Congressman Tom Emmer from Minnesota, for example said last year that the Fed’s retail accounts would put the US “on an insidious path akin to China’s digital authoritarianism.”

However, the current system of public subsidies for private bankers with implicit deposit insurance is unlikely to be sustainable either.

Source : www.marketwatch.com

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