There’s a small but growing movement of concerned citizens that are hoping to turn the financial world on it head and eliminate the Federal Reserve. We recently looked at what the United States might look like without the Federal Reserve, but a major movement was birthed to privatize the banking industry and the Federal Reserve was legislated out of existence. What if consumers demanded more control over their currency and demanded that other federal banking institutions as well? What would the United States look like if the Federal Deposit Insurance Corporation (FDIC) was eliminated?
A Brief History of the Federal Reserve, the FDIC and Bank Failures:
First, let’s take a look back at history. When the Federal Reserve System was brought into force in 1913, it was primarily on the basis that it would be a lender of “last resort” to banks and financial institutions that were struggling. This would allow the Federal Reserve to extend credit in hopes of preventing short-term economic downturns and to prevent the failure of banks. Instead, it was used to create currency out of thin air, leading to great periods of inflation.
There’s also the problem of fractional reserve lending. Under the way that banks are allowed to operate, they only keep a small fraction of their deposits in reserve and lend out the remainder to borrowers, while maintaining the obligation to redeem all of the deposits on demand. While fractional reserve banking in itself is not a major economic problem, the ratios of capital that banks need to keep can be a problem. Currently, banks have almost no requirement to keep any of their depositors’ funds on demand for withdrawal. If banks were required to have more capital on hand, they would not be able to over-extend themselves as much as they do and the vast majority of the bank failures could be prevented.
After the currency panic of 1907, economists began calling for a “lender of last resort” to provide banks capital if they had found themselves overstretched on their commitments. In other words, economics were looking for a way to “bailout” banks that had lent too much money. Who knew that we’ve been in “bailout” mode over 100 years? Unfortunately, the Fed’s lending powers didn’t meet the expectations of politicians and banks continued to fail. Between 1921 and 1929, there were 600 bank failures each year!
During the 1930’s, people grew weary of the banking system. Consumers lost trust in the system and began to withdraw money. Banks restricted credit and liquidated their assets, leading to over 9,000 bank failures between 1930 and 1934 alone. Politicians reacted by proposing a system of deposit insurance that was backed by a Federal Agency, despite failures from similar state-level organizations, which had all gone broke by 1930.
When President Roosevelt signed the Banking Act of 1933, the Federal Deposit Insurance Corporation (FDIC) was established as a temporary agency to insure banking customers’ funds. When the FDIC began on January 1st, 1934 it had $292 million in its balance. When President Roosevelt signed the Banking Act of 1935, the FDIC was established as a permanent government agency. The primary purpose of the FDIC was to insure deposits through its Deposit Insurance Fund (DIF) and examine and supervise banks for their “safety, soundness and consumer protection.” The FDIC’s mission hasn’t changed much in its 75 year existence, but it’s now become a staple in the United States’ modern economic policy.
Many modern economists and politicians consider the FDIC as an effective and necessary banking program, but banks that have misbehaved are taking a serious toll on those that are left. Some estimates state that the FDIC will need to take 25% of banking profits in 2010 to make sure that customers are fully paid for the expected 100+ bank failures that will happen in the next 12 months.
Life After the FDIC:
What if the FDIC were simply eliminated as part of the banking system? Economists, banks, and bank customers would then need to look at the root of the cause of bank failures instead of simply insuring the risk away. Consumers would demand that banks keep more capital to ensure their liquidity and banks would likely over-extend themselves much less. Banks would strive to show their customers their stability and longevity.
There would also be a wave of private insurance options for banks to pop-up. Insurers could write policies for banks or branches of banks to ensure customers have access to their money in the event that the bank fails. Banks would be able to shop among insurers and find a policy that works well for them and their customers or they could choose to not offer insurance at all and offer better interest rates because of their lack of insurance.
Individuals would likely also be able to buy their own policies in the event that any of their banks failed. Instead of having one, Soviet-style option to make sure that your money at the bank is insured, you would have hundreds of options to choose in the market place. You would be able to choose the amount that you want to cover, the types of accounts you want to cover and pay an insurance premium for the privilege instead of having the FDIC dictate to you what they will and will not cover.
Consumers would also likely diversify their funds amongst a lot more banks than they do currently. Funds would likely move out of major banks and smaller banks would see waves of new customers hoping to diversify their savings across a few different banks.
Banks would be competing with one another to offer the best insurance policies to win over customers. Insurers would be competing with one another to provide the best policies to banks. The free market would be in play and the best options in the marketplace would rise to the top. Ending the FDIC would bring consumers and banks a new level of choice about the insurance that they want on their money at the bank.