bank in trouble.
(Details on how that is accomplished are in chapter eight.) But there are practical limits to just how far that process can work. Even the Fed will not support a bank that has gotten itself so deeply in the hole it has no realistic chance of digging out. When a bank's bookkeeping assets finally become less than its liabilities, the rules of the game call for transferring the losses to the depositors themselves. This means they pay
THE FDIC PLAY
The FDIC guarantees that every insured deposit will be paid back regardless of the financial condition of the bank. The money to do this comes out of a special fund which is derived from assessments against participating banks. The banks, of course, do not pay this assessment. As with all other expenses, the bulk of the cost ultimately is passed on to their customers in the form of higher service fees and lower interest rates on deposits.
The FDIC is usually described as an insurance fund, but that is deceptive advertising at its worst. One of the primary conditions of insurance is that it must avoid what underwriters call 'moral hazard.' That is a situation in which the policyholder has little incentive to avoid or prevent that which is being insured against.
When moral hazard is present, it is normal for people to become careless, and the likelihood increases that what is being insured against will actually happen. An example would be a government Program forcing everyone to pay an equal amount into a fund to protect them from the expense of parking fines. One hesitates even 36 THE CREATURE FROM JEKYLL ISLAND
to mention this absurd proposition lest some enterprising politician should decide to put it on the ballot. Therefore, let us hasten to point out that, if such a numb-skull plan were adopted, two things would happen: (1) just about everyone soon would be getting parking tickets and (2), since there now would be so many of them, the taxes to pay for those tickets would greatly exceed the previous cost of paying them
The FDIC operates exactly in this fashion. Depositors are told their insured accounts are protected in the event their bank should become insolvent. To pay for this protection, each bank is assessed a specified percentage of its total deposits. That percentage is the same for all banks regardless of their previous record or how risky their loans. Under such conditions, it does not pay to be cautious.
The banks making reckless loans earn a higher rate of interest than those making conservative loans. They also are far more likely to collect from the fund, yet they pay not one cent more. Conservative banks arc penalized and gradually become motivated to make more risky loans to keep up with their competitors and to get their
'fair share' of the fund's protection. Moral hazard, therefore, is built right into the system. As with protection against parking tickets, the FDIC increases the likelihood that what is being insured against will actually happen. It is not a solution to the problem, it is
REAL INSURANCE WOULD BE A BLESSING
A true deposit-insurance program which was totally voluntary and which geared its rates to the actual risks would be a blessing.
Banks with solid loans on their books would be able to obtain protection for their depositors at reasonable rates, because the chances of the insurance company having to pay would be small.
Banks with unsound loans, however, would have to pay much higher rates or possibly would not be able to obtain coverage at any price. Depositors, therefore, would know instantly, without need to investigate further, that a bank without insurance is not a place where they want to put their money. In order to attract deposits, banks would have to have insurance. In order to have insurance at rates they could afford, they would have to demonstrate to the insurance company that their financial affairs are in good order.
Consequently, banks which failed to meet the minimum standards of sound business practice would soon have no customers and THE NAME OF THE GAME IS BAILOUT
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would be forced out of business. A voluntary, private insurance program would act as a powerful regulator of the entire banking industry far more effectively and honestly than any political scheme ever could. Unfortunately, such is not the banking world of today.
The FDIC 'protection' is not insurance in any sense of the word. It is merely part of a political scheme to bail out the most influential members of the banking cartel when they get into financial difficulty. As we have already seen, the first line of defense in this scheme is to have large, defaulted loans restored to life by a Congressional pledge of tax dollars. If that should fail and the bank can no longer conceal its insolvency through creative bookkeeping, it is almost certain that anxious depositors will soon line up to withdraw their money—which the bank does not have.
The second line of defense, therefore, is to have the FDIC step in and make those payments for them.
Bankers, of course, do not want this to happen. It is a last resort.
If the bank is rescued in this fashion, management is fired and what is left of the business usually is absorbed by another bank.
Furthermore, the value of the stock will plummet, but this will affect the small stockholders only. Those with controlling interest and those in management know long in advance of the pending catastrophe and are able to sell the bulk of their shares while the price is still high. The people who create the problem seldom suffer the economic consequences of their actions.
THE FDIC WILL NEVER BE ADEQUATELY FUNDED
The FDIC never will have enough money to cover its potential liability for the entire banking system. If that amount were in existence, it could be held by the banks themselves, and an insurance fund would not even be necessary. Instead, the FDIC
operates on the same assumption as the banks: that only a small percentage will ever need money at the same time. So the amount held in reserve is never more than a few percentage points of the total liability. Typically, the FDIC holds about $1.20 for every $100
or covered deposits. At the time of this writing, however, that figure had slipped to only 70 cents and was still dropping. That Weans that the financial exposure is about 99.3% larger than the safety net which is supposed to catch it. The failure of just one or 38 THE CREATURE FROM JEKYLL ISLAND
