Newspaper article THE JOURNAL RECORD

Nation Must Address Deposit Insurance Problem

Newspaper article THE JOURNAL RECORD

Nation Must Address Deposit Insurance Problem

Article excerpt

Incredibly, more than five years after trouble first showed up in the savings and loan industry, most of the fundamental causes of this costliest scandal in history are still unfixed.

With a bailout bill of perhaps $300 billion or more facing taxpayers, we have no assurance that such a catastrophe will not happen again, perhaps on an even larger scale.

Deposit insurance, one of the major causes of the thrift scandal, remains a ticking time bomb.

Federally insured accounts helped encourage savings institutions to take on risky investments. If the investments sunk, the thrift executives knew the government would bail them out thanks to the $100,000 insurance limit on each account.

This is far removed from the original intent of deposit insurance, which began in 1934 to protect small depositors and restore confidence to a banking system ravaged by the Great Depression. Oiginally accounts were insured up to $2,500.

For years the system worked well. The banking and thrift industries were sleepy bastions of conservatism working on the 3/6/3 formula: borrow at 3 percent, lend at 6 percent and be on the golf course by 3 p.m.

But by the '70s all that was changing. Inflation destroyed the comfortable interest rate certainty of the past, and opened the way for competition from other financial services firms. Suddenly banks and thrifts faced something new: competition.

The deregulation begun in 1980 was intended to let these institutions better compete and offer more choices to consumers. It succeeded in both these areas, but also opened up taxpayer to a dangerous liability. As banks and thrifts were allowed into new businesses, deposit insurance was not only left in place, it was increased from $40,000 to $100,000 per account.

This helped move deposit insurance from something intended to protect small depositors to a subsidy for large investors and a crutch for desperate executives.

Finally, the fundamental conundrum about deposit insurance - foreseen back in the '30s - surfaced.

On the one hand, deposit insurance maintains stability in the banking system. But on the other, it erodes the market discipline that comes when business people know they are risking their own money, and leaves taxpayers exposed to huge losses. …

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