Should FDIC Limits Go Up?

If so, should they stay higher?

Lawmakers are debating an increase in FDIC coverage limits. Instead of insuring up to $100,000 per individual depositor per institution, they may insure up to $250,000. The proposed increase is temporary, and would last until Dec. 31, 2009.

• How FDIC Insurance Works

Is a Higher FDIC Insurance Limit a Good Idea?

Right now the economy is gripped by fear. Many people never knew that banks could go under, unless they heard about it from grandma. Rumors about weak banks spark bank runs, and bank failures are caused or accelerated by bad news.

You might think that $100,000 per individual is more than enough. A married couple can easily have up to $400,000 of FDIC insured deposits at one bank. That’s a lot of money.

However, some people want a safe place for their money, and the bank is it for them. FDIC limits have not increased with inflation, so they are now lower in real terms than lawmakers intended them to be.

In addition, think about businesses that keep their payroll dollars at a bank. Employees count on getting paid for the work they do, and a bank failure could leave them high and dry. Higher FDIC limits would help.

Why are Increased FDIC Limits Bad?

On the other hand, an increase in FDIC limits would only shift more risk to taxpayers. The FDIC is backed by the full faith and credit (or taxing power) of the US government. If the FDIC takes on a bigger burden, then so do we. Especially now, increased limits would result in immediately increased taxpayer risks - but FDIC funds would not be immediately strengthened.

Presumably, anybody (especially businesses) with enough money to be above FDIC insurance limits is sophisticated enough to understand and manage their risks. If not, they have the resources to hire somebody to do so.

Wealthy people have alternatives. They can open bank accounts at various institutions to spread their risk, and they can use alternatives to traditional banks. It’s not like they have nowhere to go. Think about it: what does the guy with $300,000 of uninsured deposits do - take it out in cash and put it in a duffel bag? No, he wires it to another institution that he has more confidence in.

The wealthy can also use institutions that offer supplemental insurance above and beyond FDIC limits, or institutions that spread their money among various banks, such as CDARS.

FDIC limits could certainly be higher, but somebody has to pay for it. Either the public pays higher taxes to cover shortfalls, or the banks pay higher premiums.

Note that banks generally lend out a portion of their assets, so raising premiums would reduce the amount of lending they can do ($1 million in additional premium costs would reduce potential lending by $10 million, assuming a 10% reserve requirement and all other things staying equal). We’re currently in a liquidity crunch, so reduced lending would only worsen the problem.

What Should We Do About FDIC Limits?

I don’t know if the limits should permanently go up. A temporary increase is reasonable – it would help reduce fear at a time when fear is part of the problem. Once the dust settles, lawmakers can discuss the issue with cooler heads. I don’t like the idea of them making a permanent decision in an environment of fear. The permanency of increased FDIC limits is not going to substantially help end the crisis.

What do you think? Tell us in the comments.