Why we shouldn’t guarantee all bank deposits

By Felix Salmon
January 4, 2012
Amar Bhidé is a smart man with a very stupid idea:

" data-share-img="" data-share="twitter,facebook,linkedin,reddit,google" data-share-count="true">

Amar Bhidé is a smart man with a very stupid idea:

We need to take away the reason for any depositor to fear losing money through an explicit, comprehensive government guarantee. The government stands behind all paper currency regardless of whose wallet, till or safe it sits in. Why not also make all short-term deposits, which function much like currency, the explicit liability of the government?

Why not? I can answer that question in one word: Ireland. That country’s blanket government guarantee of all bank deposits was the single dumbest decision of the global financial crisis, and I can’t quite believe that anybody thinks it would be a good idea here. Yes, I understand that the US can print money while Ireland can’t. But that doesn’t mean it makes sense for the US government to take on untold trillions of dollars in extra contingent liabilities.

But let’s rewind to the beginning of Bhidé’s op-ed, and try to work out how on earth he arrived at this rather crazy notion. He begins by saying that “central bankers barely averted a financial panic before Christmas by replacing hundreds of billions of dollars of deposits fleeing European banks” — a statement which comes with no footnote or hyperlink, which makes it hard for me to know exactly what he’s referring to. I suspect it might be the coordinated liquidity operation which was announced on November 30, but I don’t recall anybody at the time talking about “hundreds of billions of dollars of deposits fleeing European banks”.

There was certainly a liquidity crisis in the European banking sector at the time, but there’s a world of difference between a liquidity crisis and a bank run. A liquidity crisis is when banks don’t lend to each other; a bank run is when depositors withdraw the money they have on deposit and move it elsewhere. And while deposits have certainly been flowing out of Greek banks in particular and the European periphery in general, I haven’t seen reports that European banks in toto are seeing massive deposit flight, or that deposit flight was in any way the reason for the November 30 move.

But Bhidé is convinced that there was a bank-run panic in Europe and that there might be one in the US as well:

The Federal Deposit Insurance Corporation now covers balances up to a $250,000 limit, but this does nothing to reassure large depositors, whose withdrawals could cause the system to collapse.

Again, I’d need a lot of argument to be persuaded that a bank run by large depositors in the US is a real danger. According to the FDIC’s Statistics on Depository Institutions, total deposits in the US, as of September 30, were pretty much exactly $10 trillion. Of that, $8.5 trillion was held domestically, and of that, $5.4 trillion is insured. Which means that there’s about $3.1 trillion of uninsured deposits in the US, and $4.6 trillion of uninsured deposits at US financial institutions. (Although some of those international deposits will be insured by the countries where they’re held.)

Certainly a $3.1 trillion bank run would cause the US banking system to collapse — there’s no doubt about that. But where does Bhidé think the money would go? And what makes him think that such a bank run is a real possibility? I can certainly see a run on some individual bank, if it looks like it might be in trouble — we saw that in 2008, at WaMu, although in the end there all depositors ended up with 100 cents on the dollar. But what I can’t envisage is a run on the whole system, where depositors move their money somewhere else entirely — partly because I have no idea where they might move it.

It’s worth noting here that the US differs from Europe in two crucial ways. The first is that companies can’t deposit their money directly with the central bank, in the way that Siemens for instance does. (The only exceptions are the handful of companies which own banks, like GE and Target.)

More importantly, deposits in the US are senior to banks’ bonds: depositors get their money back before bondholders get anything. In Europe, by contrast, depositors are often pari passu with other unsecured creditors. Which means that deposits are riskier in Europe than they are in the US.

All of which helps explain why the total amount of uninsured deposits in the US has continued to rise since the crisis hit: when I ran the numbers in September 2008, using July 2008 data, total domestic uninsured deposits were $2.1 trillion. Which seemed like a lot of money at the time, but it’s gone up by a full trillion dollars since then.

All evidence, then, points to the fact that US bank depositors aren’t worried about the safety of their deposits at all, and that they believe — correctly — that US banks, in general, are a perfectly safe place to park their funds.

But Bhidé’s not happy with that: he wants short-term deposits to be guaranteed just in the way that paper currency is guaranteed. But here’s the thing: the guarantee of paper currency is meaningless, because paper currency isn’t a government liability in the way that a deposit at a bank is a bank liability.

You can walk up to a bank and ask for the money you have on deposit to be converted into paper currency, and the bank has to give it to you in cash. But if you have cash and you walk up to Treasury, there’s nothing the government is obliged to give you in return. That’s the whole point of fiat currency: it is what it is. You can buy stuff with it — you can even buy a Treasury bill, and turn your cash into a US government obligation. But when that Treasury bill matures, it just becomes cash again.

And the fact is that we really don’t want a blanket guarantee of bank deposits in any event. Bank deposits are dangerous things — they’re informationally-insenstive assets which do a really good job of housing tail risk in an invisible and impossible-to-measure manner. If there were a blanket deposit guarantee, you can be quite sure that total domestic deposits would rise substantially from their current $8.5 trillion, and I’m not at all sure that I want to give trillions more dollars to the US banking sector, which has proved itself time and time again a very bad custodian of such funds. Bhidé seems to think that you could regulate away any risk: that’s naive in the extreme. If banks don’t take risk, they’re not banks any more.

Sometimes, banks will fail. That’s a feature, not a bug: it’s necessary to impose discipline on them. In Bhidé’s utopia, banks are so stringently regulated that they never fail. That places an impossible burden on regulators, and infantilizes the important capital-allocation function that banks provide in the economy.

“The next time a panic starts,” writes Bhidé, “markets may just not believe that the Treasury and Fed have the resources to stop it.” He’s right about that. So what makes him think that markets will believe a blanket deposit guarantee? If you guarantee everything, you guarantee nothing. Let’s keep private banks private. Because as Peter Thal Larsen says, the logical conclusion of what Bhidé wants is the nationalization of every bank in America. And even François Mitterrand never went that far.

Update: This page says there’s a total of $6.8 trillion in insured deposits, although it doesn’t say how many uninsured deposits there are. And it’s worth answering the point that Ireland guaranteed all bank debt, not just deposits. Which is true. But if there’s an unlimited government guarantee on bank deposits, then banks will simply fund themselves through deposits and not through bank debt at all.

More From Felix Salmon
Post Felix
The Piketty pessimist
The most expensive lottery ticket in the world
The problems of HFT, Joe Stiglitz edition
Private equity math, Nuveen edition
Five explanations for Greece’s bond yield
Comments
20 comments so far

“But if you have cash and you walk up to Treasury, there’s nothing the government is obliged to give you in return. ”

true – they are not obliged to give you anything, but investors do buy Treasury debt obligations – out 3 months for ZERO yield and out 6 months for less than a handful of bps of yield – that kinda contradicts your claim that

“US bank depositors aren’t worried about the safety of their deposits at all, and that they believe — correctly — that US banks, in general, are a perfectly safe place to park their funds”

If your claim were true, I don’t think we’d have near 0% 6 month treasury bill yields – all of that money buying T-bills for zero yield would instead be in a big fat (sarcasm) 75 basis point deposit account. It’s not, though, and there’s a reason – fear of bank insolvency.

Posted by KidDynamite | Report as abusive

Thanks for clearing up the gap between insured and uninsured deposits – Bhide did not give the reader an idea of what this was, and it’s key to his point, which is that the gap is systemically important.

I need to pick two nits with you, though. My understanding of Ireland’s problem was that it covered ALL obligations of the banks (bonds, etc), and not just deposits. This, again, might have been equally systemically important, but is presumably a much greater obligation than Bhide is suggesting.

And I think you’d need to provide a better example of non-bank companies in Europe accessing the ECB than Siemens. Siemens owns two lenders – Siemens Bank and Siemens Financial Services. Are there any other companies without lending operations doing so?

Posted by gringcorp | Report as abusive

If I am not mistaken, all deposits in non-interest bearing accounts have unlimited FDIC insurance through 12/31/2012. This is where businesses keep their money, foregoing the scant interest paid on other savings vehicles. This may explain why there has been no talk about a bank run so far, but what happens when this ends on 12/31 will be interesting. I have little doubt that they will extend the coverage.

“On November 9, 2010, the FDIC issued a Final Rule implementing section 343 of the Dodd-Frank Wall Street Reform and Consumer Protection Act that provides for unlimited insurance coverage of noninterest-bearing transaction accounts. Beginning December 31, 2010, through December 31, 2012, all noninterest-bearing transaction accounts are fully insured, regardless of the balance of the account, at all FDIC-insured institutions. The unlimited insurance coverage is available to all depositors, including consumers, businesses, and government entities. This unlimited insurance coverage is separate from, and in addition to, the insurance coverage provided to a depositor’s other deposit accounts held at an FDIC-insured institution. ” (From FDIC Website)

Posted by maynardGkeynes | Report as abusive

Let’s distill it down – if you have money, the MOST important thing that government can do, is protect your money, no matter how foolish, corrupt, or venal you are. If you are rich, and you buy something….o, what is that called? A pat? A pet? A pot? ….. Well, it doesn’t matter what it is called – what matters is this: if you are rich, our modern society depends on you staying rich, and the Fed will pay any price, bear any burden, etcetera, etcetera…
Poor people??? Do they have bank accounts or bonds????
Maybe we could use their kidneys as assets…

Posted by fresnodan | Report as abusive

It seems like your ignoring Gary Gorton’s work on the role of the repo markets in the crisis, along with subsequent work by Sing and Aitken at the IMF on repo and shadow banking. What these authors argue is that the cap on insured deposits, combined with corporate risk controls limiting uninsured exposure to individual banks, led to the creation of the very large shadow banking system relying on repo transactions (which, because they are backed by supposedly informationally-insensitive assets, pass risk-control muster). The danger in this system is that the assets backing the repo transactions cease to be informationally insensitive, resulting in a run on the repo market (haircuts rising to 100%). One way to avoid kind of crisis we’re still digging out of would be to provide a much larger supply of genuinely informationally insensitive assets (treasury bonds) but there does not appear to be a viable political path to doing so on an adequately large scale. Uncapping deposit insurance is the alternative, which may be more feasible politically (though who knows). But neither addressing the shortage of informationally insensitive assets, nor replacing the shadow system with insured, in-the-light banks seems like a recipe for continually getting “slapped by the invisible hand.”

Also, Sweden guaranteed all bank liabilities in 1994, and that is typically cited as the best-in-class response to a banking crisis. Ireland’s problems are all about not having its own currency, not its response to the bank crisis as such.

Posted by richclayton | Report as abusive

I believe Ireland guaranteed all Bank Debt not Deposits. That is a big difference.

Posted by JayTrader | Report as abusive

If there were a blanket deposit guarantee, you can be quite sure that total domestic deposits would rise substantially from their current $8.5 trillion.

Are you sure?

Posted by DanKervick | Report as abusive

I agree with most of what you say but some changes to your facts:

1) there currently is unlimited FDIC Insurance on non-interest bearing demand deposit accounts. http://www.fdic.gov/deposit/deposits/unl imited/implementation.html

2) Insured deposits have increased to $6.78 trillion a/o 9/30/2011 http://www.fdic.gov/bank/statistical/sta ts/2011sep/fdic.html

Posted by jarjam | Report as abusive

richclayton:

Why, at this late date in the credit crisis, should it remain the responsibility of governments (i.e., taxpayers) “to provide a much larger supply of genuinely informationally insensitive assets [IIA] (treasury bonds)” when the entities needing such IIA could — nay, should — instead delever, reduce their borrowing needs, sell their assets?

How can one know if the problem is indeed a worldwide shortage of IIA rather than a mere unwillingness of overlevered borrowers to take losses on overvalued collateral?

In Nov 09 Bernanke told FCIC investigators:

“the collapse of Bear Sterns might bring down the entire repo market, the entire tri-party repo market, which is a two-and-a-half trillion-dollar market, which was the source of financing for all the investment banks and many other institutions as well. Because if it collapsed, what would happen would be that the short-term overnight lenders would find themselves in possession of the collateral, which they would then try to dump on the market. You would have a big crunch in asset prices. And probably what would have happened would—our fear, at least—was that the tri-party repo market would have frozen up. That would have led to huge financing problems for other investment banks and other firms; and we might have had a broader financial crisis.”

http://fcic-static.law.stanford.edu/cdn_ media/fcic-docs/FCIC%20Interview%20with% 20Ben%20Bernanke,%20Federal%20Reserve.pd f

pages 21-22.

Now, almost 4 years since Bear collapsed, policymakers are still intent on avoiding “a big crunch in asset prices.” (Bernanke actually spells-out Gordon’s name to his FCIC questioners, sigh.)

But for how long will we be told that there is a shortage of IIA requiring emergency lending — until the nominal value of debts has been inflated away?

Posted by dedalus | Report as abusive

The curious thing about the almost universal and lofty scorn pored upon the Irish bank guarantee decision is that no ever ponders what would have happened had it not been done. Maybe we all prefer to indulge the fallacy / bias based on outcome / omission

Posted by nordtrader | Report as abusive

“If there were a blanket deposit guarantee, you can be quite sure that total domestic deposits would rise substantially from their current $8.5 trillion”

What would this do to investment? Isn’t one of the problems that is continually railed on about money hoarding? Wouldn’t this exacerbate that problem?

Posted by spectre855 | Report as abusive

On Your Update…You state:
“But if there’s an unlimited government guarantee on bank deposits, then banks will simply fund themselves through deposits and not through bank debt at all.”

This is potentially catastrophic to the Economy as we have seen.

AMAR BHIDÉ notes that banks should only be..

“Banks must therefore be restricted to those activities, like making traditional loans and simple hedging operations, that a regulator of average education and intelligence can monitor. If the average examiner can’t understand it, it shouldn’t be allowed.”

Bhide is on the right track here. Felix is just looking at one side of the equation here which is the blanket guarantee but not the whole side which is the severe limiting of bank spec activity.

Posted by JayTrader | Report as abusive

On Your Update…You state:
“But if there’s an unlimited government guarantee on bank deposits, then banks will simply fund themselves through deposits and not through bank debt at all.”

This is potentially catastrophic to the Economy as we have seen.

AMAR BHIDÉ notes that banks should only be..

“Banks must therefore be restricted to those activities, like making traditional loans and simple hedging operations, that a regulator of average education and intelligence can monitor. If the average examiner can’t understand it, it shouldn’t be allowed.”

Bhide is on the right track here. Felix is just looking at one side of the equation here which is the blanket guarantee but not the whole side which is the severe limiting of bank spec activity.

Posted by JayTrader | Report as abusive

spectre855: Increasing (or lifting) the limit on insured deposits would not likely have any very direct impact on investment or the cash-hoarding behavior of corporations. They’ll hoard as much cash as they do now, just in insured deposits rather than via repo transactions. But lifting the limit on insured deposits would (presumably) sharply reduce the flow of funds into the repo market, and hence shrink the shadow banking system relative to the official banking system. Since the former is easier to supervise and regulate, I think this would have a positive impact on financial stability. That seems to have been Bhide’s point. Obviously, there are many problems that this would not solve, but Bhide’s proposal would go a long way toward solving the shadow banking problem.

dedalus: Not quite sure I understand your question but
First, its not that there’s a taxpayer responsibility to provide IIA, its that only public sector debt (of countries that print their own currency) that functions as IIA. In so far as we have a financial system heavily dependent on a limited (and shrinking!) supply of IIA, we run the risk of a recurrence of the “market freeze” of Sept/Oct 2008. Now, I would point out that at the moment the US federal govt can borrow at a negative real interest rate up to 10 years (at least) and that we have huge unmet public investment needs, and a whole lot of unemployed people, so this would be an ideal time to increase public investment and “pay” for it by borrowing at a negative real interest rate. Into the bargain we help stabilize the financial system by increasing the supply of IIA.

But if that’s not your cup of tea, then Bhide’s proposal would be an alternative mechanism to stabilize the financial system.

Second, the reason there is a shortage of IIA is that a lot of what had been treated as IIA (MBS, etc) prior to 2007 is now subject to such high haircuts that it does not facilitate lending. Maybe more honesty in the valuations would lead to a restoration of confidence in the formerly-II-now-IS assets, but I’m skeptical. And in any event, selling the assets doesn’t really do anything to address the question here. There’s all these big corporations and asset managers, and they’ve got cash, and they want both assurance that their cash will be available when they need it and a return on the cash while its sitting around. Repo backed by IIA gives them the assurance and the return, as would unlimited deposit insurance. Banks admitting that their assets are worth less than they say would be a good thing in many ways, but not really relevant to this discussion as far as I can see.

Posted by richclayton | Report as abusive

Again, as I and jarjam point out, an unlimited FDIC deposit guarantee has been in effect for more than a year, with an additional 12 months to go. It seems we have a real world experiment here, and the result is that nothing untoward has happened. The mistake Ireland made was to guarantee bondholders, which was insane. The bondholders made money twice — they got a higher interest rate than depositors, and then got bailed out 100 cents on the dollar anyway. The definition of moral hazard.

Posted by maynardGkeynes | Report as abusive

I would go further and bring back double liability, while at the same time raising pay for bank directors and holding them more accountable. The system stinks and we need to remove asymmetric risks and rewards, empower the right people in the corporate structure and use market based methods where possible, doing the above makes that happen.

Posted by Sechel | Report as abusive

@maynardGkeynes…sorry I missed your early post re unlimited insurance. It has actually been in effect since 2008 but was reformulated and extended in Dodd-Frank. Not sure I would agree that nothing untoward has happened though. Insured deposits have skyrocketed putting the taxpayer at greater risk yet this provision really benefits mega-depositors like Apple and Microsoft, not the average taxpayer. See http://seekingalpha.com/article/301849-i s-the-u-s-encouraging-blue-chip-corporat ions-to-hoard-cash-at-taxpayer-risk.

Posted by jarjam | Report as abusive

Who cares if the Banks back the phony private Federal Reserve IOUs? Fire them and order the U.S. Treasury to start printing and coining U.S. Currency instead of fiat currency American taxpayers have to pay interest on.

Posted by SavageNation | Report as abusive

I hate to feed an off-topic question, but if the US Treasury is printing money, how is that different from Fiat currency?

Posted by Ragweed | Report as abusive

Don’t you think that since banks are used by every person in society except nomads, there should be a bank (a very strict one which offers very low interest rates) but that would guarantee unlimited amounts?

Posted by gooneraki | Report as abusive
Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/