Time to Get Rid of Deposit Insurance

Want to fix safety and soundness concerns at credit unions? Want to make member ownership and the democratic process mean more at credit unions? Eliminate the NCUSIF.

Seriously, get rid of it. Get rid of the FDIC Deposit Insurance Fund (DIF) as well.

I realize this cannot (will not) happen, but it needs to. Here's why:

1) We need an environment of healthy risk. Our regulators are charged with maintaining the health of deposit/share insurance fund pools. Their goal is to minimize risk. But while too much risk is clearly not healthy, zero risk is a problem as well. A financial system that allows for zero risk doesn't help entrepreneurs get ideas off of the ground, doesn't help borrowers that need help the most, and doesn't allow the flexibility necessary to adapt quickly enough to changes in consumer need.

"Dude... Haven't you read about that thing they call the Great Depression?" you're likely wondering. "How about all of the bank and credit union failures in the past couple of years? Consumers need protection."

You're right. There were many lessons to be learned from the Great Depression. The most important one, of course, was that we have an obligation to make sure consumers and investors are provided with reliable information about the financial institutions they do business with. Deposit insurance doesn't improve the reliability or transparency of information, it makes information irrelevant. That brings me to the second reason we need to abolish deposit insurance.

2. Deposit insurance doesn't protect consumers, it harms them. Deposit insurance puts consumers at risk, even if indirectly. It's expensive. Although credit union members have never lost a dime of their insured funds in the history of the NCUSIF, and no taxpayer dollars have ever been used into the fund, its administration and the opportunity cost of maintaining a $20 billion organization (and keeping $10 billion in liquidity from consumers) is significant.

The story is worse for the FDIC's fund. Underwater by $21 billion, and losing on average nearly $2.8 billion/month due to bank closings since July 2008, the FDIC DIF has seen better days. Unfortunately, these aren't simply paper losses.

Where does this money come from? (After all, it is a zero sum game.) Recapitalization of these funds requires some combination of increased money supply (Treasury prints more money), taxpayer funded bailouts, and special assessments charged to financial institutions. The result is a vicious circle of some combination of higher taxes, more expensive financial services, more bank/CU closures, more consolidation (less consumer choice), and inflation.

"Great. So what you're saying is if a depositor's financial institution goes under, it's OK that they lose their life savings?"

Well...yes. That sounds awful, but let me explain with my third reason we should abolish deposit/share insurance.

3. The deposit/share insurance safety net discourages consumer due diligence. You know why people deposit funds at risky financial institutions? It doesn't matter if the bank/credit union fails. Their deposits/shares are covered. What if they weren't? Consumers would be forced to scrutinize the institutions they choose to do business with, be more skeptical of "too good to be true" offers, and take more ownership of their financial decisions (who they bank with, which products they choose, etc.).

The financial literacy crisis in America has been exacerbated by an almost ever-present consumer safety net. Want businesses, consumers, and government to be more cautious with risk? Let them fail. The reality of a poor decision's painful consequences is a great teacher.

"But how do you prevent a potential 'run on the bank'? Sounds like you are begging for the entire system to fail."

Actually, I'm begging for a much less intertwined system. That brings me to my last point.

4. Cooperation and insurance coverage should be opt-in and fair. Unlike in the banking world, where riskier institutions pay a higher premium to the DIF than more conservative banks, the NCUA makes no distinction between the funding requirements for risky credit unions versus more conservative credit unions. What does that mean? It means that conservative credit unions get punished for being responsible stewards of their members' assets, while credit unions that pose a much larger threat to the NCUSIF are not required to compensate for that risk. Risky credit unions do all the drinking and dancing, then ask the designated drivers to split the bill with them. Not cool.

Banks and credit unions should be given the choice to offer insurance or not. Further, they should be allowed to collaborate with any other financial institution or third party to form their own insurance funds with like-minded organizations. Some consumers will refuse to do business with a financial institution that doesn't offer deposit insurance. That's cool. The market will adjust. Some consumers will decide that higher returns, convenience, and innovation are worth a little bit of risk on their end. That's cool, too.

Government should demand financial institution transparency, send financial institution employees to jail for any deposit losses, and let consumers dictate what system develops. The system that crashed in 2008 rewarded ignorance, encouraged unnecessary risk, and placed zero responsibility on consumers or financial institutions to manage the balance of risk and reward. The system I'm proposing is different.

Now that you all think I'm crazy. Let me suggest an alternative fix: reduce the cap on insured shares.

The move to permanently increase deposit insurance from $100,000 to $250,000 flies in the face of reason. If anything, we should reduce that number to $25,000-$50,000. That amount covers most of America. The wealthier segment of the population, then, would be left with three choices: 1) Deposit funds in multiple, diversified financial institutions; 2) Do business with only the most safe and sound financial institution(s); and/or 3) Find an alternative use for those funds.

The sooner we can move away from the ghosts of misunderstood Great Depression lessons, the sooner we can develop a system of personal responsibility, managed risk, and sustainable operations.