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$250K FDIC Caps: Nice, but Irrelevant

posted by Adam Levitin

I haven't seen the rerevised bailout bill yet, but if its major improvement is raising the FDIC insurance cap, to $250,000 that's a huge yawn. Such a move is helpful, but largely irrelevant to the current crisis.

Sure, it's ridiculous that FDIC caps haven't been inflation indexed, but this crisis is not about lack of FDIC insurance. The current cap is $100,000/depositor/institution. But there just aren't that many Americans with more than $100K sitting in their bank accounts. The Federal Reserve's 2004 Survey of Consumer Finances indicates (on p. 14) that of the top 10% of Americans in terms of wealth, the median amount held in accounts that could be FDIC insured was $58,000. Most Americans have nowhere close to $100K sitting around in the bank, much less $250K. And if you're super rich, you don't just park hundreds of thousands of dollars in your savings account--you either spread it out over several institutions or, more likely put it into higher-yielding investments.

So what is the $250K about?

Three things, I think.

First, it helps small (but not very small) businesses. A small business might have payroll of over $100K or might receive payments of over $100K. The small business could spread its deposits out over several institutions, but that's a (small) pain and the small business might get caught with a lot of cash in the bank at the time of a bank failure.

Second, it helps a consumer confidence generally, by showing that the Federal government will offer even greater theoretical backing of banks (even if it has real little impact). There was, apparently, a point this past week when the T-bill rate dipped negative. This makes no sense, because a T-Bill and an FDIC insured deposit are both backed by the full faith and credit of the United States government. Why pay interest to the government to have a T-bill instead of putting your money in an interest-free FDIC-insured checking account or interest-bearing FDIC-insured savings account? The answer could reflect a lack of confidence in FDIC insurance (and the belief that the FDIC's obligation is limited to the funds in the Deposit Insurance Fund).

And third, it helps a handful of consumers--the super-rich who have lots of cash sitting in a single account and can't be bothered to spread it between a bunch of institutions, even though there are services that do this, and folks who are sitting on a lot of liquidity from a house sale or preparing to purchase a house.

Bottom line: small, but really unimportant improvement in banking law. That this is the improvement that is being trumpeted by the two presidential candidates is really sad. It misses the forest for a weed.


I guess they don't want a run on banks which I think would make matters much worst. But, ya I agree. What does that do for us? I know I don't have a $100k in the bank much less $250k. I thought I heard them kick around insuring 401Ks as well. ??? That might be something. ??

THANK YOU for pointing this out. I cannot believe that people are not seeing this all important point. Why else would people be defaulting on their mortgages, which is one of the major contributors (defaulting mtgs) to the crisis. Certainly not because they have $250K in their bank accounts. It is sad and pathetic that our two candidates cannot come up with something real, other than jumping on a sort of mindless mantra. Maybe they should teach economics in kindergarten.

It appears they are trying to find a way to prevent a run on banks and to appear to be doing something when they are really not. Guess the FDIC doesn't want to be accused of doing absolutely nothing.

As I understand, the proposal for FDIC protection is $250,000 per SSN not per account.

There are people who have saved responsibly and hold those savings in a 'secure' CDs.

Their protection would be much less.

The cap is per depositor per institution, as it always has been. It is not pegged to SSN.

The concern about bank runs is the rational behind deposit insurance, but if most people are insured far beyond their deposits, then the risk of a run is smaller. That said, there are large institutional/corporate depositors, who have millions in their accounts. Raising the cap from $100K to $250K doesn't really change their situation materially.

Another angle to consider about deposit insurance: moral hazard. Patricia McCoy at U Connecticut School of Law has a forthcoming book chapter about deposit insurance in which she makes a convincing case that it actually creates a moral hazard for banks--knowing that they won't face a run, banks engage in riskier behavior--and higher caps exacerbate this problem.

Perhaps it is more debt for the FDIC to assume when it sells a troubled bank to JP Morgan or Bank America??

The raised limit will also benefit the grannies of the world who have a few hundred K in CDs. They are not common as a percentage of the population, but might be about 10-15% of retirees. (Remember, retirees tend to have more wealth than the rest of us, although not more income.)

I share Adam's ambivalence on high deposit caps. But there are "real people" who will benefit from them.

I view this as a small part of the overall picture, but one that, as I understand it, made a difference in getting some legislators on board with the bailout generally. This is a messy process, but I think one has to view the effort as a whole, rather than critiquing one aspect or another. No one is suggesting that the increase in insured deposits is THE answer to all of this.

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