The FDIC and the Follies of Modern Banking
The FDIC attempts to universalize risk in banking. Regardless of whether or not you even deposit money in a financial institution, whether or not you discriminate between different banks and the practices thereof, we are forced into subsidizing risk through government deposit insurance. The FDIC normally guarantees deposit insurance up to $100,000, while the insurance temporarily covers $250,000 of deposits until 2013. It does not take much to realize that bank management will make different decisions, pursue riskier ventures, and accept financially-qualified clients if they know the FDIC has their back. The moral hazard that comes with the FDIC is undeniable.
The main flaw with the FDIC and the current banking system is that the control does not lie with the individual. Government’s history in banking has amounted to protecting banks, offering special and unnatural privileges to financial institutions (what other industry has a “lender of last resort” and a government program to help pay for risk?), and diminishing the regulatory power of the individual. A free market encourages and generally requires individual initiative, research, and understanding of the product, all of which the FDIC has assumed as its proper role.
What other industry needs a government agency to fall back on if they make unsustainable and irrational decisions? The truth is that the FDIC’s role is nothing more than to bail out bad management decisions and an inefficiently run business. Can you imagine what such a system would have done to an industry like technology? Tech companies would have much less incentive to improve their products if they knew they had the federal government guaranteeing major consumer losses.
By attempting to cover different risks in banking, the FDIC removes the incentives of banks to avoid those risks. It removes the incentive for individuals to scrutinize their potential banking options more carefully. If you know that all or the majority of your deposit is insured by the government, why bother with the details of bank management, financial health, etc.? Like economist Peter Schiff said, people spend more time researching a toaster than they do opening a bank account.
The FDIC’s softening or total removal of incentives to avoid and search for risk also slows the development of other options to banking. The amount of banks and the style with which they operate has not significantly changed since the FDIC came into existence in the 1930s. Nearly any other industry you can think of has undergone some major changes in operation over the past seventy years, while banking is essentially the same.
The FDIC locks people and businesses into a certain style of banking. (What banks and individuals wouldn’t want government guarantees of deposit insurance?) This may be fine and dandy for a time, but it stalls the development of what could be much more sustainable and sensible financial options for individuals, such as credit unions. With government regulators and bureaucrats calling the shots, rather than the free individuals of the country, new developments that would better serve the individual have been heavily limited and discouraged.
The slightly hilarious part is that in the event of a true banking meltdown, the FDIC wouldn’t have near the amount of necessary funds to ensure depositors got their money back. According to the FDIC’s own website, they manage an “insurance fund” of more than “$52.8 billion,” yet the agency “insures more than $4.3 trillion of deposits in 8,494 U.S. banks and thrifts.” Let’s see… $52.8 billion of funds to cover $4.3 trillion of deposits. Yes, the FDIC carries enough cash to cover a whopping 1.23% of the total deposits that it claims to insure.
The FDIC does not expand the power of the individual to make his own choices in the marketplace; it builds corporate loyalty to government standards, not individual standards. The problem with the banking system to begin with was the neglect of the individual’s regulatory abilities, the FDIC is simply an expansion of that unfortunate trend. The folly of the modern banking system is that it does not encourage individual initiative, research, and involvement in banking as a free market system would.
Rather than encourage free and alternative choices like individual deposit insurance plans, community credit unions (where individuals have a stake in where their deposits are spent), or discretion as to where one saves or invests their hard-earned money, we have consistently moved toward a centralized, bureaucratized, planned banking system. Such a system makes it extremely difficult for individuals to effect real change with their own local regulatory power, and prevents a truly sustainable and involved financial industry from coming about. Only the free market can guarantee a system swayed not by the government, but by free men and women exercising their ultimate regulatory authority as individuals.
Click here for Part 1.