US deposit insurance

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The US banking system’s emergency surgery is proving complicated. Why not add an extra sticking plaster? The Senate has given the nod to a revised $700bn rescue bill, which includes a provision to raise for one year the main threshold on deposit insurance to $250,000. The move is designed to aid ebbing confidence in the banking system and sweeten the bail-out in the eyes of the taxpaying public.

The existing $100,000 cap has, admittedly, seen its real value eroded since it was last increased in 1980. The proportion of insured deposits in the US system has fallen from an 82 per cent peak in 1991 to 62 per cent at the end of 2007, leaving $2,600bn of uninsured deposits. The well-informed, though, could always spread their funds between institutions to make the most of federal protection. A change just lessens the legwork. But promoting the notion that deposits at all banks (no matter how poor their risk management) are a sure thing sets a poor precedent. The limit, theoretically temporary, will surely prove hard to reverse.

Moreover, the extent to which the measure will reassure savers is unclear. Some paranoid types will always opt to remove their nest egg, however secure, from a troubled institution. No one wants to trawl through the wreckage of a bank collapse clutching a government guarantee. In a nation of net spenders, the $250,000 threshold is well above the savings held by the average inhabitant of Main Street. Still, the commercial balances that constitute most uninsured deposits will have reason to look elsewhere.

The Federal Deposit Insurance Corporation tentatively estimates that the new limit would bring an extra $670bn under its protection, but future demands on the fund and therefore potential costs remain uncertain. The bill in front of Congress, though, removes the need for extra increases to the risk-weighted premiums on banks and instead extends the fund’s Treasury backing. Main Street, in this confidence trick, has to pay up to make itself feel better. The real patient needs more drastic treatment.

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