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The $100,000 limit is terribly outdated, and $100,000 28 years ago is significantly different than $100,000 in today’s dollars.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.