Common sense is better than U.S. at insuring bank accounts

May 12, 2002|By JAY HANCOCK

ONE GOOD thing about last winter's Allfirst Financial mess was that, despite the combustion of $691 million in bad currency bets, the bank's deposits were safe, backed up by Allfirst reserves and government insurance.

Another good thing is that depositors worried anyway.

When the Baltimore bank's adventures hit the papers in February, the first thing many customers asked was whether Allfirst would implode and whether they should hurry to claim their cash.

Many people did hurry. This newspaper reported that tens of millions of dollars in refugee Allfirst greenbacks flowed into branches of Allfirst's competitors in February.

The day the scandal broke, Allfirst President Susan C. Keating announced that "nothing is wrong with the core activities at Allfirst." My wife reminded me that Enron boss Kenneth L. Lay had made similarly soothing reassurances about his company right before it vaporized.

Of course, Allfirst did not collapse. The bank and its parent, Allied Irish Banks PLC, had enough capital to absorb a $691 million loss. Even if Allfirst had suffered liquidity problems, the Federal Deposit Insurance Corporation stood ready to reimburse customers with deposits of $100,000 or less.

But the initial doubt among customers - and the deposits that Allfirst did lose - served a crucial economic purpose.

Allfirst paid a price for its mismanagement. Savers were reminded that bankers guarding their money sometimes do stupid things with it. And banks that had decided not to set up poorly supervised, multibillion-dollar currency desks were rewarded for their wisdom.

This is the balance we need in banking policy: the discipline of market consequences for inept operators, combined with a government safety belt to keep the consequences in check.

The banking industry wants to upset the balance. Bank lobbyists, leaning hard on Maryland Democrat Paul S. Sarbanes, chairman of the Senate banking committee, are pushing to raise the cap on government deposit insurance from $100,000 per saver, where it's been for more than two decades.

Some argue the guarantee should be doubled to $200,000. Others would push the limit to $130,000 and then follow a Federal Deposit Insurance Corp. recommendation to raise it annually in line with inflation.

Both are bad ideas. To see how bad, harken back to the last time the government raised the savings-insurance limit, from $40,000 per depositor to $100,000 in 1980.

Government-guaranteed money immediately flooded into banks and thrifts. The savings-and-loan industry, in particular, became aggressive about paying very high interest rates for deposits and then lending the funds to dubious borrowers.

Without federal insurance, savers would never have entrusted so much money to shady S&L operators. With no federal insurance, 12-percent rates on certificates of deposit would have signaled "HIGH RISK - AVOID ME." But generous government protection rendered the sirens and blinkers irrelevant to depositors.

The result: Boatloads of capital got invested in dud projects, and U.S. taxpayers had to fork over more than $100 billion to pay back deposits that had been flushed away by incompetent and felonious lenders.

It is true that the S&L industry was shaky even before 1980 and that poor regulatory oversight contributed to the disaster. But economists and banking experts generally agree that increasing the deposit-insurance ceiling vastly inflated the bill.

Deposit insurance was introduced in 1934 after numerous bank failures wiped out millions of savers and destroyed the country's capital base. Even President Franklin D. Roosevelt, excoriated by many as an alleged socialist, was initially opposed to deposit insurance and essentially predicted the 1980s S&L blowup.

"We do not wish to make the United States government liable for the mistakes and errors of individual banks and put a premium on unsound banking in the future," Roosevelt said in 1933.

FDR eventually accepted deposit guarantees, mollified by arguments that they would protect only small, unsophisticated savers and would leave much of the banking sector subject to the rigors of the market. The original, 1934 deposit-insurance cap was $2,500, and it was quickly raised to $5,000.

Because only $67,000 in today's money would buy what $5,000 commanded in 1934, it is reasonable to conclude that even the prevailing $100,000 limit on deposit insurance is too high, not to mention $130,000 or $200,000. Anybody with more than $100,000 in cash either has wits enough to keep their balances under the guarantee limit or the means to buy pretty good advice.

Let's not remove too much risk and market discipline from the financial system. Entrusting one's cash to a depository institution ought to be as safe and sure as money in the bank - most of the time.

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