On Tuesday, both presidential candidates and the Federal Deposit Insurance Corp. Chairman Shelia Bair had made statements encouraging congress to allow the FDIC to increase the limit of protection. The $100,000 limit per account has been in place since 1980, and suggestions have been to increase the limit to $250,000. It’s interesting to note that the $100,000 limit has been in place and remained unchanged for 28 years. While there is a provision to begin increasing this limit for inflation, that wouldn’t take effect until 2011. So, would increasing the limit be good or bad? Like most problems, there isn’t a simple answer. Let’s look at the pros and cons.
The $100,000 limit is terribly outdated, and $100,000 28 years ago is significantly different than $100,000 in today’s dollars. To get a better idea of what the current insurance limit would be if it was indexed to inflation each year, let’s look at an inflation calculator. According to this calculator, which goes to 2007, $100,000 in 1980 would be $248,583 in 2007. As you can see, it wasn’t like they pulled the $250,000 number out of thin air, and that level of insurance would be comparable to what was insured when the program started.
There is also a belief that increasing the limit would provide added confidence. People feel safe when their money is insured, so the more insurance available, the safer people will generally feel, whether they have that much money or not. This new confidence could lead to increased deposits, which helps the bank’s books and leads to a more financially stable company.
There is also a valid case to be made for businesses. There are many businesses that have to maintain large cash balances, whether it’s for payroll, purchasing, or what have you. But in many cases, the traditional $100,000 just isn’t suitable, and the idea of spreading money out across different institutions to stay insured isn’t exactly feasible.
But, even with some added benefits, there are concerns. FDIC insurance costs money, and premiums are paid by the financial institutions that want to offer this coverage. So, there are two problems here. If the amount of coverage is increased without raising the premiums, we have a problem where there won’t be enough money to cover all the potential losses (there already isn’t enough, so it would get significantly worse). This puts taxpayers on the hook. If the FDIC insurance fund, which is under $45 billion, is exhausted from a few bank failures, the government would have to step in and bail out yet another agency.
On the other hand, they may decide to increase coverage and also increase coinciding premiums. This means the banks that offer FDIC coverage will have to pay even more. As you know, banks aren’t exactly thriving right now, and putting added stress on the books will undoubtably be passed on to depositors. Whether it is in the form of higher fees or lower interest rates, the banks will have to find ways to come up with the money. In a worst-case scenario, you might even find smaller banks simply unable to cope with the higher premiums and opt to not even provide FDIC insurance any more. Not likely, but a possibility.
What Do You Think?
As always, there’s no such thing as a free lunch, and there are two sides to every coin. What do you think? Is this a step in the right direction, or are we setting ourselves up for even bigger problems down the road?
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
You make a good point about FDIC insurance costing money, however, governments and banks should really be thinking beyond that. Right now the system is failing, governments should step in, as Ireland and Germany have done, and insure all savers money or at least make it $1mn which would take in the vast majority of people.
The UK, so far has said it will cover £50,000. What does that say about the UK governments confidence in the banking system?... Not much.
Desperate times call for desperate measures. The insured amount can always be reduced when the system calms down.
I just wrote a post why I don't understand why this matters? With a savings rate of 3% (according to the newest info from the BEA). How many Americans really have $100K in liquid dollars?
In my humble opinion this is nothing more than good, attack the government, tv time. Just like the "death tax" which only affects less than 5% of the country.
I voted yes. One, to keep up with inflation. But more importantly, given today's climate, I'd make the limit "limitless." Think what that would do for liquidity!
If everybody pulled out of stocks and bonds, to "wait it out," they'd most definitely put most of their money in one of the few remaining mega banks. They'd then have scads of cash with which to make loans.
Liquidity crisis? Not any more.
You're lucky. Here in the UK we're currently protected upto £35,000, and they're now talking about raising it to £50,000, which is still only the same level as your old limit, ie $100,000.
Keep in mind the FDIC's trust fund of $45B is just like any other government trust fund -- it is only an accounting entry. The premiums banks pay to the FDIC go into the general treasury budget, not some bank account somewhere with $45B sitting in it waiting for a crisis. As such, there is about zero chance FDIC will ever "run out" of money. Treasury will pay to meet its obligations and over time the premiums will balance out the outlays.
Great analysis, Jeremy. I side with the "raise the limit" crowd, knowing full well it is but one of many steps to be taken. While people holding $400K in cash could (and should) not have any uninsured deposits, by either choosing multiple banks or by meeting the different account titling requirements in order to be fully covered, I'd say that's a waste of society's time. If the money is covered through clever and legal administration, why make it so that you need to be "clever?" Just insure it.
The fact is that we've seen the periodic run on the bank during this crisis and a higher limit would have helped that from happening. Yes, the costs should be passed along to the banks, who will, in turn, pass it along to us in the form of lower interest rates paid on savings and higher debt costs. But I am happy to accept this minor cost increase even though I don't have $100K in cash lying in a bank somewhere.
Finally, we must be careful when not indexing amounts for inflation. The AMT is one example of something that became grossly distorted over time.
I voted yes, since in the long-term, I think it's a good idea. As for the short-term costs, what if they phased in the premium increase?
Also, as someone else suggested, you could have different limits for personal accounts versus business accounts. I know small businesses have to distribute their cash across more than one account/bank. While this may seem like a simple thing to do, from an operational point of view, it's cumbersome and inefficent.
marlincarter, you're exactly right, and it's obviously proving to be a poor strategy. There is only $45 billion in reserves to pay for failures as it stands.
But in 1995, which times were obviously much better than they are now, they reduced and even eliminated some of the premiums.
Taken from an article in a 1995 New York Times:
"Ricki Helfer, the chairman of the F.D.I.C., said premiums needed to be reduced because of the banking industry's current health, the economy's strength and the expectation of F.D.I.C. examiners that few banks would fail soon. Premiums will still be collected for some banks with risky business practices and less solid finances. Still, the income from premiums as a share of insured deposits will fall to the lowest level in the 62 years of Federal deposit insurance."
This isn't much different than the whole lending issue that got us here. Times were good, so let's take advantage of it and take on more risk. Who cares about the future, things are good now!
Of course, the FDIC has also proposed a premium increase, but this was determined a while back even before there was any mention of increasing the limit to $250,000.
Funny how that works. When times were good and banks were making a ton of money, they reduce the premiums, and when times get tough and banks are losing money, they make things worse by increasing the premium.
Anyway, I'm all for increasing the limit because A) it should be higher factoring in inflation and helping business, and B) adding to consumer confidence. But I don't like all of the pull money out of thin air just to make it look good tactics. If you're going to put the taxpayer's money at risk by adding more coverage, it should be backed by the appropriate funding to minimize the risk.
It's all still just a small issue of a much larger problem, but I wish lawmakers would look ahead instead of just doing what seems good at the time. This goes for what went on 10-15 years ago and today.
I've heared it said that during good times preiums are either reduced or not paid at all by banks due to chances of failure are slim and when in times like now when trouble looms preiums are forgiven to some extent due to lack of an ability to pay...
This is a good idea, but it's just window dressing on the real problem.
Also, if you have $400,000 sitting around in one bank, and were dumb enough not to open four $100k accounts at four different banks, I don't feel sorry for you. We shouldn't keep trying to correct mistakes made by stupid people...this includes Wall Street.
I think the only thing that this would bring is more confidence back to the consumers. It would allow them to have more confidence that there money is going to be safe. I agree with Hank that there is a much larger problem that needs to be addressed besides this smaller issue.
Isn't this just window dressing that isn't addressing the real issue of why banks are failing? The investors & savers who actually understand how the FDIC works and protects us are not the ones pulling out their money and adding to banks' troubles.
Premiums are based on the dollar value insured - each $1 of insured funds costs $.xxxxx in insurance premiums.
I spoke with my father, who is president of a community bank, and he was all for it. Said it wouldn't cost him anything more - and he'd have more funds from some customers with which to issue more loans.
The limit for individuals should absolutely stay the same. If you've got a hundred grand sitting around in the bank, it's time to put it into a proper investment.
But there is definitely an issue for businesses. Perhaps there could be an alternate limit just for businesses over a certain size?