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Written by Ronnie J. Phillips
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Thursday, 09 October 2008 03:00 |
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The Emergency Economic Stabilization Act of 2008 implements a temporary increase in deposit insurance from $100,000 to $250,000 per insured account in banks and credit unions. This increase is scheduled to expire December 31, 2009, but there might be advocates for making it permanent. This temporary increase will not be accompanied by higher premiums for the financial institutions. Nor will it replace the inflation adjustments already enacted by law. Instead, both the Federal Deposit Insurance Corporation and the National Credit Union Administration will be able to borrow without limit from the Treasury should they need funds to cover excessive bank failures.
Federal deposit insurance was introduced in 1933 with a limit of $2,500, which fully covered 96.5% of depositors. The government increased the limit to $5,000 in 1934. Increases were put into place periodically over the next four decades until the limit reached $40,000 in 1974. The increase to $100,000 in 1980, which allowed financial institutions to offer jumbo CDs fully backed by the insurance fund, received some of the blame for the financial debacle of the 1980s.
Deposit insurance may lead financial institutions to improperly increase the riskiness of their assets. The higher the insurance limit, the greater the potential temptation. The introduction of risk-adjusted premiums would help alleviate this problem. One lesson of the financial crisis of 1980s is that any permanent increase in deposit insurance limits should be carefully weighed. Any attempt to make the $250,000 limit permanent should be viewed with alarm and opposed by those who, like Franklin D. Roosevelt, felt that the guarantee of bank deposits would "put a premium on unsound banking in the future."
Ronnie J. Phillips is professor of economics at Colorado State University. A visiting research fellow at AIER in 2008, he also has been a resident scholar at the Jerome Levy Economics Institute of Bard College and a visiting scholar at both the FDIC and the Bank Research Division at the Office of the Comptroller of the Currency.
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