Responsible banks on the other hand (loaning smaller amounts of money and loaning more cautiously) are basically pouring their FDIC payments down the drain. Not only do they earn less because of their responsible practices, they’re least likely to ever collect a penny from the fund they’re paying into. In this way, conservative banking practices are penalized and reckless practices are encouraged. In the insurance business, this is what is known as a “moral hazard” and it’s an example of how a seemingly good idea (FDIC) actually increases the likelihood of bank failure.
We can only imagine how different things might be if a real deposit insurance program existed; a voluntary private insurance program acting on free-market principles. Customers would still be likely to choose banks offering deposit insurance, as they do now, but the banks themselves would be dealing with a much different situation. If they were reckless in their lending, the rates they paid for insurance would be much higher. In some cases the rates would be so high they couldn’t afford insurance at all. This would help limit reckless lending. It would signal to customers whether a bank was a good place to put their money. (A bank’s inability to afford insurance would be a telltale sign that better options existed.) But for now, non-FDIC deposit insurance is just wishful thinking, so let’s dig a little deeper into this problem.
Just as the banks never keep anywhere near the amount of money in their vaults that they owe their customers, the FDIC has nowhere near the amount of money it claims to insure on hand in the event of a banking collapse. How thin are the “reserves” standing by to rescue the people from irresponsible banking? Just about as thin as one could imagine. Not 50%, not 30%, not 15% or even 5%...more like 1%. As if that isn’t bad enough, that paltry 1% doesn’t even exist in the form of cash. By law, the bank fees paid into the “FDIC fund” must be invested in Treasury bonds. In other words, it is “loaned” to Congress which of course promptly spends every penny. (If the FDIC truly “insures” anything, it’s a steady supply of money flowing into Treasury bonds for our politicians to spend.)
One major bank failure could easily wipe out the so-called FDIC fund in an instant. Not to worry though, the fund is “backed by the full faith and credit of the federal government.” Well, doesn’t that make you feel warm and fuzzy inside? The same federal government that doesn’t have any money; the same government that is currently borrowing more than a billion dollars a day to try and support its spending programs…
So what happens when the FDIC needs money to cover depositor’s losses? The government must borrow it. So it sells more I.O.U.’s (treasury securities) and whatever the public doesn’t buy, the Federal Reserve agrees to purchase. But the Fed has no money either…no problem. Whatever the Fed needs to buy the bonds will simply be “created out of thin air” and presto: the FDIC is now funded. The newly created money floods into the economy, the purchasing power of our currency goes down, and through the hidden tax of inflation we all pay the price. Isn’t this fun?
-Enough with explaining how the game works; now we’ll have a look at the scorecard.
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