Thursday, October 02, 2008

One step back 

I had thought the House bill that failed on Monday was a fair bill. It did not address enough the question of capitalization, but it would deal with the liquidity issue. The bill passed by the Senate last night is two large steps back with the FDIC insurance extension.

First, in the process of making this a Main Street bill rather than a Wall Street bill, the Senate raised limits on FDIC insurance to $250,000 from $100,000 per accountholder. In the WSJ's Political Diary, Stephen Moore reminds us that this was just the thing that got the savings and loans in trouble back in the 1980s. After the passage of the Garn-St. Germain Act in 1982, which raised FDIC limits from $40,000 to their current level, deposit brokers started to seek out high returns and send "hot money" from bank to bank. To keep deposits, banks started to increase interest rates they paid on deposits. This of course hurt profitability. Moore notes that the Senate bill "will also be an invitation for troubled banks to started taking high-risk gambles in real estate and other ventures with taxpayer insured accounts." The last thing we need is to encourage banks to take on more risk.

Second, FDIC insurance isn't free; banks are already concerned about an increase in deposit insurance premia for failure of IndyMac. (As the article I linked points out, the sale of WaMu was fast enough and at a sufficient price to not expose FDIC to any losses.) This new insurance is not free -- and the costs will be born by the banks, as CBO director Peter Orszag notes:
Most depository institutions (commercial banks, savings associations, and credit unions) are required by law to have federal deposit insurance. CBO, therefore, considers changes in the federal deposit insurance system that increase requirements on those institutions to be private-sector mandates under UMRA. The cost of the mandate would be the additional premiums assessed during each of the first five years the mandate is in effect. While CBO expects that any additional losses from the temporary expansion in coverage would gradually be offset by higher future premiums, we cannot estimate the cost of the mandate because of uncertainty about the timing of the losses and whether or by how much premiums would increase during those first five years.
The uncertainty he feels is felt by the banks as well. Now is not the time for that. If the banks would want to buy the additional insurance, it is only right to ask them to pay for it. But to mandate it? Not a good idea at all.

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