Let’s get one thing straight: the U.S. Federal Government will not let any major banking and/or lending institution go bankrupt. There may be an intermediary deal where another bank purchases the failing bank for pennies on the dollar (see JP Morgan Chase’s bail-out of Bear Stearns), but there will not be a full bankruptcy. I say this with such confidence for one reason, and the reason is something you have all seen every time you walk into a bank. Federal Deposit Insurance Corporation. The brain child of Republican Senator Arthur Vandenberg and Democratic Representative Henry Steagall, FDIC helped to bring back the people’s confidence in the U.S. Banking industry after the Great Depression.
Why does the FDIC ensure that no major bank will ever go bankrupt? The government does not want to lay out the necessary cash to depositors should the bank not be able to give their members’ money back in the event of closure. It’s true, the government charges every bank an insurance premium based on their relative risk, but that money (similarly to Social Security) gets invested into various financial securities. This would mean the withdrawal and disbursement of those funds.
The money set aside has only one purpose: in the event of a bank closure to make sure that everyone gets their deposits back according to the guidelines set down by the Glass-Steagall Act of 1933 and its subsequent reformations. Why should this be a deal-breaker for the government? Administratively, it is a nightmare from both a cost and organizational perspective. Also, the less money in the FDIC fund, the less return being made in financial markets, the less there is to go around “just in case”. Oh, and there is the whole “have you ever seen the government give back money?” (except for Dubbya, whose economic stimulus is an ill-conceived plan as government spending is not decreasing but the pool of taxes to fund that spending is…enough said).
Let’s assume that a bank does indeed go bankrupt and no deal can be brokered with a stronger bank to purchase the deposits and assets of the failed bank. The FDIC now steps in to provide relief for the failed bank’s customers. Depending on the size of the bank the amount of deposits can be enormous. According to JP Morgan Chase’s 2007 Annual Report the bank had $11.466 billion in deposits. Not all of these deposits are FDIC insured. For the sake of putting some numbers to theory, let’s assume 75% of those deposits are FDIC insured. This equals a total of $8.6 billion of FDIC insured deposits that would have to be funded from the pool of FDIC money.
Guess what happens when someone sells off $8.6 billion in financial markets? Markets crash. Should the FDIC have to withdrawal a sum of money even a fraction of JPMorgan Chase’s deposits the stock market, bond market, and just about every other kind of market would fall to its knees. Since the whole point of being insured is so that people are confident in financial institutions, it is counterproductive to bring about the collapse of financial markets just to save a bank’s depositors. The depositors got their money back and will be confident, but the millions of people who lost countless dollars in the markets that day will have another viewpoint.
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8 Comments
Thanks for laying out the lesser known latent effects that manifest from certain actions.
Quick question, has the amount of money the FDIC insures for increased over time since its inception in 1933?
I never thought of the FDIC as being counterproductive to what it is intended to do, but it seems it has. It is almost worth letting the depositors lose their money when their is a bankruptcy then disturbing the entire stock market.
Rineberg, yet again you simply restated what the author has already said. Well done.
As was my intention, why must you be a jerk?
I did not realize the negative effects that the FDIC could wreak, so this was eye opening for me at least.
Awe, somebody call the Wambulance.
Umm…right…
Anyway, I remember watching Bear Sterns employees walk out of their building with their desks packed up. Unhappy employees for sure. I also remember a few employees saying the whole thing could have been prevented had something been done a few days prior to the bail out.
Also, Jay… Most banks that I see offer a “$100,000 FDIC insured” gaurantee. Can you explain what exactly this means? If someone has more than $100,000 in a single bank and the bank were to go under…does that mean the U.S. Federal Government will only reimburse that amount? Most banks have valued customers with well over $100,000 in their accounts. Do these valued customers only get the same FDIC insurance that someone with a few hundred dollars in their account gets? Jay, you are the man with this stuff, how does it work?
When the FDIC says that they will insure up to $100,000 they mean per account per bank. Also, last year many banks increased their limit to $200,000. So say I personally have $800,000 but it is spread over 8 different accounts each with less then $200,000/$100,000 (depending on the bank) then I will be covered fully.
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