No Upside In Raising Bank Deposit Insurance Limits

Monday, August 5, 2002
by Marc J. Lane

Reprint permission from the August 5, 2002 issue of Crain's Chicago Business.

A wildly popular national banking reform bill, once thought unstoppable, may become a casualty of an obscure U.S. Senate race in South Dakota. And, if it does, taxpayers will have been spared a fiscal mega-blunder.

The bill, which passed the U.S. House on May 22 in a 408-18 vote, would increase the coverage limit from $100,000 to $130,000 for most insured bank deposits and to $260,000 for retirement accounts, index the new limits for inflation and adjust them every five years.

Community banks, hungry for a competitive edge, are behind the reform effort. They argue that if insurance limits aren't increased, larger institutions - those deemed too big to fail - will build on their unfair advantage.

The community banks' argument is baseless. In fact, Congress generally outlawed the too-big-to-fail doctrine in 1991. Under federal law, regulators can only bail out a bank after the secretary of the Treasury, two-thirds of the Federal Deposit Insurance Corp.'s (FDIC) directors and two-thirds of the Fed's governors agree that its failure could significantly impair the rest of the industry and the overall economy. And, since 1991, not a single bank has been saved because it was deemed too big to fail.

But the new legislation is a crowd-pleaser. Lobbyists joined forces with public relations specialists and easily sold the bill to individual savers and investors; after all, they can't be expected to monitor the condition of banks. And the American Bankers Assn. (ABA) told them inflation has cut the real value of deposit insurance by more than half in the last two decades.

The truth is that individuals are having no problem keeping their assets safe, whether they invest in multiple accounts or in multiple institutions.

And inflation is a phony issue, too. The ABA fudges the math when it contends that, on an inflation-adjusted basis, today's coverage is worth no more than the $40,000 protection built into the law before the limit was increased to $100,000 in 1980.

The ABA conveniently ignores the earlier history of deposit insurance. From 1934, when coverage first took effect, to the early 1970s, the level of insurance more or less tracked inflation. When the limit rose to $40,000 from $20,000 in 1974, that increase was more than enough to compensate for any loss in the dollar's purchasing power. And when the limit increased again to $100,000, the coverage actually outpaced inflation by $70,000. Even now, assuming a 3% annual inflation rate, the current limit will maintain its value until 2020.

Fed Chairman Alan Greenspan and Treasury Undersecretary Peter Fisher believe that increasing deposit insurance limits will hurt the taxpayer, and they are absolutely right. Higher limits would undermine market discipline by making depositors indifferent to the risks their banks take without adding to the stability of the banking system.

Hiking insurance limits would be tied to a grant of discretion to the FDIC to decide exactly how premiums on banks are to be charged. And taxpayers would be on the hook for any unfunded losses, just as we were in the 1980s when we paid $150 billion to bail out reckless savings and loan associations.

The Senate's version of the deposit insurance reform bill, which is similar to the House's, was introduced Feb. 14 by Sen. Tim Johnson, a South Dakota Democrat. Sen. Johnson is in a fight for his political life with Rep. John Thune, a Republican and the state's only U.S. congressman. Senate Republicans are likely to block any attempt by the Democratic leadership to call Sen. Johnson's bill up for a vote between now and November, lest he be handed a pre-election legislative victory that could help him keep his seat.

And, if Sen. Johnson's bill goes nowhere, the U.S. banking system will be better off, and so will the taxpayer.


Marc J. Lane is a Chicago lawyer and financial planner and an adjunct professor of law at Northwestern University School of Law. He can be reached at

Copyright 2002 by Crain Communications Inc.

Send this page to a friend

Announcing Marc J. Lane's 35th Book:

The Mission-Driven Venture: Business Solutions to the World's Most Vexing Social Problems

More About The Book
Our monthly newsletter