Right about now we should all be very thankful for the protections that the FDIC offers on banking deposits. Whether it's the prior $100,000 guarantee or the new $250,000 ceiling, banking consumers can sleep easily at night knowing that their deposits are safe, even if their deposit holder might not be.
But as nice as this arrangement is, perhaps we should be asking whether a guarantee on banking deposits has really been a good thing for our financial system.
For the love of deposits
Deposits are the lifeblood of banks. They provide low-to-no-cost financing for the banks to make loans and buy investment securities. Bank of America
And what would happen if depositors started yanking their money out of the clenched fists of one of these banks? It'd be shut down faster than you could say "Troubled Asset Relief Program."
Only 700 billion easy payments ...
Normally, failed banking institutions don't touch taxpayers' pocketbooks. The FDIC funds itself through premiums that it charges member banks and interest earnings on its insurance fund. However, recent experience has been a little more costly for taxpayers, as banks ranging from Goldman Sachs
And if the FDIC ended up being overwhelmed by the banking system fallout, I would bet the farm on Uncle Sam showing up with the taxpayer checkbook ready to shore it up.
A scary new world
A world without FDIC guarantees would be a much more frightening world, where consumers might actually start stashing cash under mattresses or in holes in the backyard in times like these. Of course it'd also be a world where most depositors would go out of their way to seek out banks like US Bancorp
After all, if you're getting a measly 1% or 2% on your deposits, any extra risks that the banks take would represent nothing but increased worry for you.
But don't worry, even though the FDIC's Deposit Insurance Fund has taken a hit during the financial crisis, I figure there's a near 0% chance that FDIC deposit guarantees are going anywhere. And it's not as if I'd root for that outcome anyway. Although guaranteed deposits reduce the functioning of the deposit market, most banking customers are not equipped to adequately judge the financial soundness of banks competing for their deposits. Heck, most supposed professional analysts proved ill-equipped to judge banking soundness over the past few years.
But as long as depositors are going to be protected at any and all banks by deposit guarantees -- not to mention that open-checkbook policy at the Treasury -- maybe it's time to start seriously reconsidering the scope of these coddled institutions.
Further financial Foolishness:
