Deposit insurance reform: Act now to boost FDIC coverage

Northwestern Financial Review, Sep 1-Sep 14, 2002 by Goetz, Jim

A well-functioning federal deposit insurance system is the foundation on which consumer confidence in our banking and financial system rests. It has worked well for more than 60 years but a much-needed increase in the amount of coverage provided is long overdue to maintain its real value. Eroded by inflation during the past 20 years, deposit insurance protection would be more than $200,000 today if properly adjusted for inflation. Increasing deposit insurance coverage to $130,000 from $100,000 - as the U.S. House of Representatives recently voted to do - is an important victory in preserving stability and taxpayer confidence in our financial system. The U.S. Senate is poised to act on this important legislation as early as September.

Unfortunately, there are powerful forces opposing this sensible increase in the deposit insurance level including the big-bank lobby and Federal Reserve Chairman Alan Greenspan, who has little use for a federal deposit insurance system. Ironically, it was the Federal Reserve that recommended in early 1980 that coverage per depositor be raised to $100,000 from $40,000.

Increasing deposit insurance coverage is not some novel, wild and morally risky endeavor that some opponents would lead you to believe. To maintain the protection of Americans' savings, deposit insurance has always required periodic increases as witnessed in 1935, 1950, 1965, 1969, 1974 and 1980. Now frozen for 22 years, we have gone the longest period in history without updating the coverage amount - completely ignoring inflation, and the growth in income and wealth during that time.

The argument that raising deposit insurance coverage to $130,000 greatly increases risk and "moral hazard" is specious. In reality, an increase to an explicit set amount of deposit insurance coverage poses less risk and "moral hazard" than today's growing too-big-to-fail implicit protection of large financial conglomerates, provided at political and regulatory discretion. Allowing deposit insurance coverage to simply keep par with inflation and income growth with a set level makes known to all parties involved the exact amount of protection provided and a quantifiable risk. The government is explicitly capping risk exposure to the amount of the guarantee.

Conversely, there is tremendous hazard and risk associated with allowing a large and growing amount of deposits to be implicitly insured under the real too-big-to-fail scenario presented by asset concentration in a few large complex banking organizations (LCBOs). Such systemic risk that could trigger a bailout is a much greater public policy hazard (the cost of which could ultimately be borne by unwary taxpayers) than increasing deposit insurance coverage to an explicitly set coverage level and ground rules.

On a more fundamental level, the need to increase deposit coverage is straightforward. Simply stated, to meet today's financial needs such as retirement, long-term health care, college expenses, and small business pay-rolls, the $100,000 insurance limit (worth $45,000 in inflation adjusted terms) is insufficient to protect the financial needs of typical American savers. A retiree will certainly need a safe nest egg well in excess of $100,000 for retirement. Inflation erosion of deposit coverage alone over time makes depositors face increased risk they currently don't face.

In the midst of the "bank holidays" and panicked withdrawals that had crippled the nation's financial system, in his first "fireside chat" to Americans on March 12, 1933, President Franklin D. Roosevelt stated, "After all, there is an element in the readjustment of our financial system more important than currency, more important than gold, and that is the confidence of the people." The FDIC was created three months later and federal deposit insurance took hold on January 1, 1934. In its seventh decade, the federal deposit insurance system remains a proven ingredient in the confidence consumers have in our financial system.

Adequately increasing deposit insurance coverage, as well as indexing it for inflation going forward, would go a long way in preserving the desired stability and confidence in our financial system. Solid legislation pending in Congress to accomplish this goal is ripe for passage. Let's triumph over the nay-sayers and get it done.

Jim Goetz is chairman, president and CEO of Security First Bank of North Dakota, in Center, N.D.