In my last column I discussed FDIC insurance and what some of the psychology involved does to the behavior of depositors as well as the banks. In this column, I want to spend some time talking about alternatives to the FDIC coverage and an alternative to individual bank solvency.
On Feb. 19, I had the privilege of having Hester Peirce from the Mercatus Center at George Mason University on my radio program, “Eye on Your Money.” We were able to spend some time talking about her research and commentary on the Dodd-Frank legislation and the devastating effect it is going to have on the economy. (You can listen to the podcast at privatewealthconsultants.com)
We mainly talked about two points in our conversation: First, instituting a deductible on the FDIC coverage and second, something called double liability for bank reserves.
Most of the insurance that you and I have in our lives has some sort of deductible or co-insurance, which is similar. What would happen if the FDIC insurance on your bank accounts had a deductible of, say, 5 or 10 percent? Would you be more interested in the overall finances of the bank? Would the bank be more diligent if it knew that potential depositors were going to scrutinize their balance sheet before putting any money in the account?
As it stands today, the investor really doesn’t need to be concerned about the financial condition of the bank they are depositing in as long as the account is under the $250,000 limit. After that, no one even looks at the financials, the lending practices or the people involved. Furthermore, the bank — knowing that no one cares about the financials — doesn’t need to concern itself with the amount of risk it takes because the government will provide the safety net if anything doesn’t work out as planned.
Having a deductible would go a long way toward fixing some of these issues. We have a deductible everywhere else, why not on our bank accounts?
Double liability is a concept that has been around for a long time and was in place before FDIC came along. Double liability simply means that the shareholders of a bank could be called upon to contribute additional capital to the reserves if needed. The amount required was generally a small percentage of the original share amount but additional nonetheless.
Prior to the Glass-Steagall Act, double liability was very effective in protecting bank creditors, including bank depositors. In fact, during the first four years of the Depression, very little depositor money was lost while double liability was in place.
Reintroducing double liability for financial firms would cause investors to increase the risk-monitoring by bank shareholders and managers. Shareholders — not federal deposit insurance — would be the primary bearers of losses resulting from poor risk management. This would greatly change the way depositors and investors in banks would approach their decisions.
Additionally, “too big to fail” would no longer be part of our vernacular with regards to financial institutions. The taxpayer would no longer be the safety net for banks and other financial institutions that wish to take on inappropriate risk with depositors and investors money.
Will either of these things happen? Doubtful. No one wants to take responsibility for their own decisions, be it banks, investors or depositors. As long as the attitude of a risk-free financial life prevails there will be no long-term solution to the financial institutions’ problems.
Gary L. Rathbun is the president and CEO of Private Wealth Consultants, LTD. He can be heard every day on 1370 WSPD at 4:06 p.m. on “After the Bell,” everyday on the Afternoon Drive, and every Tuesday, Wednesday and Thursday evening at 6 p.m. throughout Northern Ohio on “Eye on Your Money.” He can be reached at (419) 842-0334 or email him at garyrathbun@private wealthconsultants.com.
