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The FDIC and the Follies of Modern Banking



September 05, 2009 – Comments (9)

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.

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9 Comments – Post Your Own

#1) On September 05, 2009 at 7:02 PM, whereaminow (< 20) wrote:

Bravo, David. Well done!

Over the years, when I approached people on the subject of the FDIC, more so than any other government regulation I object to, I have received the most scorn.  It is just assumed that without the FDIC, the banking industry would fail and everyone would lose their money.  They can not, or will not, see the undeniable truth that institutions like the FDIC make failure an absolute certainty.

Yes, they have removed the uncertainty prevalant in the wild wheel of capitalism and human freedom. In its place, they have substituted the absolute certainty of stagnation, destruction, and bondage in the slow moving wheel of tyranny.

Fantastic blog.  Keep up the great work!

David in Qatar

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#2) On September 05, 2009 at 7:18 PM, largesse (< 20) wrote:

Great!  So now you want ordinary people of modest means to spend their increasingly scarce free time trying to figure out from complex financial statements what the state of each potential banking service is or will be or paying exorbitant fees to financial advisers for similar information of dubious accuracy.  That worked very well indeed in 1933!

Do you expect somehow that the trend toward nationwide and international banks is going to be reversed by local deposit insurance plans and community credit unions?  That's laughable.

It's time for libertarians to develop some empathy for people who will never be rich.  The alleged moral hazards from FDIC deposit insurance have not been borne out in practice.



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#3) On September 05, 2009 at 7:42 PM, whereaminow (< 20) wrote:


The alleged moral hazards from FDIC deposit insurance have not been borne out in practice.

Are you not aware that the banking industry required a multi trillion dollar bailout in order to avoid complete collapse earlier this year, and that despite this, banks are still failing left and right?

FDIC Failed Bank List

If Libertarians only care about the rich, why is it that the government is always bailing out the rich, and we are always opposed to it?  Shouldn't we be cheering on the enrichment of Goldman Sachs, AIG, and the cadre of bankers?  That doesn't make sense.  Perhaps it doesn't make sense because you do not understand us.

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David in Qatar

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#4) On September 05, 2009 at 9:48 PM, jatt22 (59.51) wrote:

i  agreed  wth  u  but  keeping  in  mind   human  nature  any  institution  wthott  da  baking  of  some  biggger  insurance  will  probably  make  pplz  very  nervous   and  that  buisness  will  not  prosper  . one  idea  why  not  creat  a  private  FDIC   run  by   free  market  pplz   .  free  from  govt  baking  an  pplz  can  run  dat  corp  or  industry  just  like  any  other  public  company  .  just  a  fools  idea

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#5) On September 05, 2009 at 10:04 PM, devoish (66.87) wrote:

David and David,

The investment banking industry received a multi trillion dollar bailout. The FDIC insured savings banks did not.

David K,

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 FDIC normally guarantees savings bank deposits in exchange for 10% capital requirements, and low risk investments including a maximum of 2% in real estate and nothing in equities. Savings bank managers are legally restricted from pursuing riskier ventures, not encouraged to, by the guarantee.

Temporarily until 2013 the FDIC guarantee extends to money market accounts, and allows the remaining investment banks that have rechartered as savings banks to transfer savings account deposits to their investment banking business's and still be FDIC insured. That is a special privilege delivered to the same investment banks that received the special privileges of 40:1 capital requirements and unregulated CDO's from the last small gov't Republicans/Conservatives rebranding themselves as ?

The main flaw with the FDIC and the current banking system is that the control does not lie with the individual. This main flaw you imagine does not actually exist. I have a choice of investment vehicles including FDIC insured savings accounts and CD's, higher risk and return money market accounts and, until the Paulson Panic, not FDIC insured. I have investment bank vehicles, hedge funds, my mattress, fire proof safe, gold, my own business, Cousin Vinnies latest venture and so many others I am not sure what new developments that would better serve the individual you are talking about.

Your paragraph about the FDIC funding insuring 4.3 tril is thought provoking. An enjoyable thought. Most of those banks are savings & loans and their risk is restricted. In many cases when those banks are closed there is no loss at all to the FDIC, and other banks with enough capital to meet requirements pick up the savings accounts and investments from the FDIC closed banks. BUT, in the case of the investment banks who have transfered funds from their savings bank alter egos, $250k/ depositor might be worth it to see the FDIC walk the GS executives out of their offices and onto the Wall Street curb. In fact maybe if it happens we could have an applause party outside their offices celebrating the closing of GS or JPM if it happens.

Seperately there was no "run on the banks" because depositors had more confidence in the Federal Gov't than panic stricken commentators, right or wrong.

The last two paragraphs are incorrect. FDIC guarantees create an additional choice for inviduals, that otherwise would not exist. Higher risk, not guaranteed investments are still readily available. Ask anyone who has lost their money, or made lots.


(what other industry has a “lender of last resort” and a government program to help pay for risk?)

Your health insurance and life insurance policies are backed through the States and ultimately the Federal gov't. I personally would love to see the end of that guarantee and  the value of UNH stock afterward, and the ascension of Medicare for All that would follow. The Nuclear power industry requires federal loan guarantees to get borrowing, the risk of default and overruns is ridiculously high.

I could come up with quite a few more if you change "and" to "or".

Regards, and thanks for the thought provoking post.


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#6) On September 06, 2009 at 1:32 AM, fransgeraedts (99.57) wrote:

I agree with Devoish. Just wanted to add two points.

1. The financials are not an industry like all others. Within the economy their position is a strategic one. As we once again (almost) witnessed a failure of the financial system would lead to a collapse of all economic activities. Financial institutions have not just a private economic function (to make a profit) but also a public one. That is why there has to be "a public option", a "lender of last resort", "a regulator", etc. etc. Of course it would also help if bankers acted upon their public responsibility out of .. ahum...integrity. 

2. The FDIC guarantees deposits. That does not create a moral hazard, contrary to the suggestions above. Why? because it only protects the depositors, it does not protect the bankers, managers, shareholders and bondholders of the bank. Excessive risk leads therfore to a destruction of the capital and the jobs of those that took the risks  -as it should be.



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#7) On September 06, 2009 at 9:31 AM, dbjella (< 20) wrote:

"As we once again (almost) witnessed a failure of the financial system would lead to a collapse of all economic activities." 

Who says we didn't have and are experiencing a failure? 

All economic activities?  

I would imagine I could still buy food and clothing and if I couldn't use money we could trade.  

I have less and less faith in gov't.  I have seen both parties put our country in peril.  I don't think individuals are themselves evil, but when they group together in politics it becomes dangerous to all of us.

It seems to me that the Federal Reserve is the FDIC for the "choosen" banks and the FDIC is there to protect depositors of the non-choosen banks that are allowed to go under.  Since, the "choosen" banks are protect they are allowed to take more risks.  Since the non-choosen backs have to compete, they take on more risks.  If the "choosen" banks fell within the realm of the the FDIC, then in my opinion the FDIC would be in bankruptcy now.

It seems to me that the entire system of gov't backing has led to more risk taking not less.  Do you really think we need more gov't?  At what point, is gov't big enough?  30% of GDP, 50%, 75% or a 100%? 

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#8) On September 06, 2009 at 11:30 AM, whereaminow (< 20) wrote:

fransgeraedts and devoish,

Why fransy, are you going to actually humor me with a debate today or are you going to hide behind perjoratives like "market fundamentalist."  You still haven't answered my questions on the Federal Reserve and Social Justice.  Don't worry, I'm sure there is a team of technocrats somewhere furiously calculating the a soon-to-be copyrighted algorithm which shows beyond a doubt that the Fed helps people on fixed incomes.  They will rescue you from intellectual honesty in no time.

The financials are an industry like all others because so few industries have the tremendous amount of power that the finanacial industry possesses. Now, for a person that waxes haughty educated musings to the masses, your knowledge of history is disappointing, particularly in the banking sector. 

Fractional reserve banking arose from embezzlement (sp?).  The historical record is clear.  Here is a copy of Money, Bank Credit and Economic Cycles by Jesus Huerta De Soto.  If you can find dispute with anything in this book (outside of his somewhat hazy construction of prisoner's dilemma), I would be delighted to hear it. Since ancient times, banks were looked to as a safeguard of people's money.  There should be no reason to manage the risky behavior of banks with a regulatory kleptocracy.  The fraudelent embezzlement of safeguarded funds should be punished, at the very least with bankruptcy and at the most with jail time.

You may gasp, but oh it is true.  The history of banking works like this:

1. Banks were established as money warehouses, offering 100% reserve safeguarding for a fee.

2.  Bankers embezzled the funds, every time since ancient history (fractional reserve banking dates back at least 2400 years! Some modern financial instrument that is! Ha!)

3. The robbed customers seek government assistance.

4. The bankers and government decide it would be much more beneficial for both of them to rewrite the rules, rob the customers, and continue on with the status quo.

5. The intellectuals and the courts are enlisted to provide an ex post facto justification for the obvious duplicity.

6. The ignorant public believes "that's just the way things are done."

Fortunately, we have the Internet, and I can easily hop around and read various accounts of history, and learn how much was left out of my two-bit worthless State education. 

We do, on the other hand, have a record of a bank that maintained 100% reserves for 170 years.  That modern bank was the dynamic foundation for the economy of Amsterdam from 1610-1780.  As suckers from European countries were forced to flee you're beloved fractional reserve banks, the Bank of Amsterdam became the most respected and successful bank in history.

Now, there is one joker on CAPS that is always asking if I want to turn back the clock to the 17th century.  Instead he prefers the 3rd century BC relic of fractional reserve banking, I guess.  So don't even bother with that silly argument.

Finally, you're argument against the FDIC's moral hazard is merely it's not a moral hazard because I say so. Sorry enlightened one, but that's not going to cut it.

Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk.

That is the definition of moral hazard.  You can't wish it away with Orwellian newspeak.  Nice try though.


There was a run on the banks.  It was an electronic run.  That's how they will occur from now on.  They are silent and happen in the middle of the night.

You are correct to point out my mix up of investment and FDIC banks.  Sorry about that.

Are you still trying to blame Republicans for supposed deregulation?  Are you an operative of the Democratic Party or something?  You're blind loyalty to them is beyond bizarre. 

The Republicans are a bunch of pork barreling, subsidizing, warmongering jackarses.  On that much we agree.  But what's your point?  That the Democrats are not?  That's so laughable I have to imagine that you are either slightly retarded, a pre-pubescent that is masquerading as an adult on our message boards, or a dreamer desperately hoping that an Obama staffer is trolling the CAPS boards looking for a new recruit into the Workers Paradise Party.

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David in Qatar


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#9) On September 07, 2009 at 12:05 AM, devoish (66.87) wrote:


in Qatar this time.

Your insult riddled reply speaks for itself, and very poorly of you.


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