That call scared me. The financial deposits we think we possess don’t really exist, except as a promise to pay when asked. If we mistrust that promise, the system fails. John was chucking his bank without even judging his relative risks. How will the government win his confidence back?
The first step came earlier this month, when the Federal Deposit Insurance Corporation presented a plan to beef up the anorexic Bank Insurance Fund (BIF). Not that you’d lose any savings if the BIF went broke; the U.S. Treasury underwrites every dime of your insured deposits. Still, confidence sags when people read that the fund is low.
On paper, the rescue plan is fully funded by the banking industry, not the taxpayer. Banks will kick in higher deposit-insurance premiums (their second increase since December). Congress has been asked for a $20 billion line of credit on the U.S. Treasury, up from the $5 billion authorized now. If any money has to be borrowed to protect insured deposits, the banks say that they will repay.
Once the BIF is shored up, the next question is: how many accounts should be insured? The administration wants to limit the BIF’s liabilities by allowing you no more than $200,000 in protected deposits in a single institution - up to $100,000 in a retirement account and $100,000 for everything else. No more separate coverage for Individual Retirement Accounts, Keoghs, joint accounts and trust accounts. But this apparent cutback is pure sleight of hand. Savers over the $100,000 limits would simply move money to another bank. I rate this “reform” possible but pointless.
A more radical proposal would insure you for no more than $100,000 in all banking institutions combined. The Treasury wants it studied; the bankers want it killed. In order to enforce such a rule, the Feds would have to monitor the whereabouts of all your deposits - an unacceptable invasion of privacy. What’s more, accounts in excess of the $100,000 cap could simply be switched into Treasury securities. Result: no loss to savers, who would keep their federal guarantees, but a significant loss of deposits to banks. I rate this “reform” as too dumb to live.
A more reasonable proposal would end deposit insurance for certificates of deposit sold through stockbrokers. Today, brokers can scoop up money from hundreds of investors and put it into individually insured CDs. That money goes to banks that pay 0.4 to 0.7 percentage points above average, says Norberto Mehl of Banxquote Money Markets. A law passed in 1989 stops brokered CDs from being used to prop up failing banks. But they’re still available to fast-growing banks whose reach may easily exceed their grasp.
It’s no skin off your nose if brokered CDs are de-insured; you’re perfectly free to buy those same investments directly from a high-paying bank. All you’d lose is the convenience of having your broker find them for you.
Of all the Treasury’s ideas, only one might put your future at risk: the proposal to quit protecting all deposits made by corporate pension funds. For pension-fund managers, banks have always been safe havens. Every person in the plan is separately insured for up to $100,000, even when all the plan’s money is put into a single account. The Treasury wants to end all that by guaranteeing no more than $100,000 for the plan as a whole. Everything else would be uninsured. If your manager happened to choose a feckless bank, your profit-sharing could go down the drain. Separate coverage would be kept only for money you invest yourself, in Keoghs and Individual Retirement Accounts.
The pension-fund proposal reflects the Treasury’s central purpose: to impose market discipline on the banking system by encouraging professional investors to shift their money to the safer banks. To compete in such a world, all bumbling banks would have to pull up their socks or close. But there’s risk to this approach. Uninsured investors might switch to the money-center banks, be they sound or not, in the faith that the government won’t let them fail. That might prop up the worst rather than the best.
The policy known as TBTF (too big to fail) arouses passions on all sides. Its supporters hew to the domino theory: the fall of a big bank might hurl the system into chaos. “Rumors of other banks being in trouble would lead to a run,” says Paul Horvitz, finance professor at the University of Houston. “People might be reluctant to accept checks drawn on certain institutions.” Adds Robert Litan of the Brookings Institution, “If uninsured investors were not protected in the Bank of New England case, a lot of foreign depositors would have withdrawn from money-center banks. Depositor discipline is right in theory but ridiculous in practice.”
Opponents consign these arguments to the Chicken Little school of economics. “Neither theory nor history provides strong support for them,” says George Kaufman, professor of finance at Loyola University. To his mind, TBTF weakens the banking system by removing the incentive for depositors to avoid jerry-built institutions. Result: big losses and costlier bailouts. Absent TBTF, the banking industry would operate on a sounder basis, he says.
How would I handicap this debate? Certain success for TBTF. The Federal Reserve will stoutly defend the dispensation accorded the biggest banks. But perhaps not the second-tier institutions. There, uninsured depositors may lose the coverage commonly granted to them now.
Don’t conclude from this that everyone should pile into a TBTF bank. Roughly 83 percent of the nation’s 13,000 banks are rated as sound by Veribanc in Wakefield, Mass. - which gives you plenty to choose from. For a safety rating on your bank, call Veribanc at 800-442-2657. It costs $10 (charged to a Visa or MasterCard), plus $3 for each additional bank or S&L you ask about in the same phone call. Check on your bank once every quarter, when the latest financial data come out. If it slips in the ratings, switch.
