While this might have averted a run on other U.S. banks, it also reveals that the deposit insurance system is broken. At this point, the $250,000 cap is illusory. Worse, it is window dressing, part of a tale bankers and others tell about their institutions — that they are more like private businesses than public utilities — which obscures the reality of what banks do and the essential role the government plays in their operation.
In 1933, Congress created the FDIC to protect bank deposits and prevent bank runs. But Congress placed a limit on this insurance, now set at $250,000. The limit is premised on the idea that deposit insurance should protect the ordinary consumer, while leaving large, sophisticated users unprotected. Such depositors can fend for themselves, the thinking goes. Moreover, with these depositors exposed, bankers will be more careful about how they operate.
Silicon Valley Bank’s rapid collapse reveals the flaw in this theory: Large depositors are both bad at monitoring banks and perfectly capable of engaging in destabilizing runs. Meanwhile, runs on banks and bank-like entities can become contagious, posing a threat to the financial system as well as ordinary households and businesses.The “consumer protection” theory of deposit insurance, then, is incomplete. Yes, deposit insurance provides vital protection for consumers.
There are still other benefits. Removing the cap would lessen large depositors’ incentives to flock to the largest, “too big to fail” banks, where they can count on a government bailout. It would also lessen demand for non-bank “money substitutes,” such as money market mutual funds and “repo” balances with Wall Street firms, which have proved even more unstable than bank deposits.
Banks will take larger risks and inevitably the idea of loss will fall on the shoulders who don’t. What happens when the FDIC is insolvent?
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No.
On the other hand, EatTheRich.
They missed their Economics 101 class.
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