Limit Access to Deposit Insurance Fund

The recent losses at JP Morgan have renewed calls to break up the banks and/or increase regulation of the banks.  I’ve written elsewhere why I believe these losses do not justify more regulation, particularly of the Volcker rule variety.  While I have some sympathy with the break them up view, and a number of people for whom I have great respect have argued for that position, I think that position is ultimately flawed beyond repair.

First any size limit would be arbitrary.  I don’t know anyone who thought that Bear Stearns was too big to fail ex ante.  I still don’t believe Bear was too big to fail.  More importantly, when it comes to banking, small is not always safer.  The most obvious example is the savings and loan crisis, which cost, on net, more than the TARP.  That was all small institutions.  And don’t forget over 300 small banks have failed this time around.  There is also some research suggesting that the more concentrated your banking system is, the more stable it is.  Just look at Canada for one example.  There are several others, and again this finding holds up to empirical testing.

If the ultimate concern is risk to the taxpayer, due to the backing of the Federal Deposit Insurance Fund, then it would seem to be that the obvious answer, and easy to implement, is to limit the amount of insured deposits that can be held by any one bank.  The previous limit was 10 percent of the insurance fund, although that could be breached by organic growth (rather than via merger).  We should reduce the limit to 5 percent and make such a hard cap.  If banks want to take uninsured deposits that’s fine, as long as we limit the risk to the FDIC.  And we should also roll back the extensions of deposit insurance coverage in Dodd-Frank.  Few households have $250,000 in deposits (and that is just per person, per account).  Ultimately we should go back to the pre-1980’s level of about $40,000 and limit that to total coverage per person.  If we want to reduce the taxpayers’ exposure, then the more effective way, in my view, is to limit the bank safety net or at least limit the extent that the safety backs any one bank.