Non-Fiction Friday: FDIC Fraud

FDIC Fraud

It's so crazy you'd think it is fiction. However, the FDIC is full of fraud and backed by facts. Note: this is not a book review.

What is FDIC?

The FDIC is the Federal Deposit Insurance Corporation. They are the ones that are supposedly keeping your savings account safe in the event that the bank goes bust.

Moral Hazard

Moral Hazard is when something makes the event against which it insures more likely. The FDIC insures our deposit accounts (checking, savings, etc) against bank failure. The banks pay a premium for this insurance (from our deposits) and transfers risk of failure from the bank and it's depositors to the FDIC.

Banks must take advantage of this "free" risk in order to maintain competitive edge. If they don't others will and they will fail. This means that because the banks transfer the risk of failure to the FDIC, they can and will be more risky in their investment and lending decisions, therefore increasing the likelihood of bank failure.

Under Funded

The FDIC is required by law to maintain cash reserves equal to or greater than 1.15% of it's liabilities (insured deposits). Durring the financial crisis this ratio fell to a low of .27%. That means for every $1 million of deposits insured by the FDIC, they had $2,700.

The biggest problem here is the fact that our financial systems is by design forcing us to put more and more deposits in the same place. That is, banks are getting bigger and bigger. As of 2009 Bank of America held more than 12% of national deposits. However, at the low, if a bank holding .27% of the nation's deposits failed, the FDIC would have gone bankrupt.

But wait! Would the Fed ever let the FDIC go bankrupt? No. Most premiums, paid by banks from deposits, are immediately invested in treasury bonds and spent by congress. The majority of the FDIC's assets are government debt. So, in the event that the FDIC ran out of money, the fed would just print more for them. Essentially, your deposits are protected by inflation. If they need to, they will just inflate your deposits back to you. It's all a perception play. They need you to think your money is safe.

Private Insurance Alternative

The answer to most big government problems is privatization. A private deposit insurance company could asses each individual bank's risk of default and charge an appropriate premium. Then depositors would know immediately how risky it is to deposit their money with that bank. If they decided to deposit money at that bank, they would also have the option to opt out of the deposit insurance.

This would allow prudently managed banks to thrive. They would also be able to pay higher interest rates, because of lower deposit insurance premiums. This system would reward wise management decisions. It would reduce the likelihood of a financial crisis or bank failure. It would actually do what the FDIC is suppose to do.

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