It is a sign of the bankruptcy of our politics that both Senators McCain and Obama independently called for precisely the wrong change in FDIC insurance coverage. The Washington Post ran a piece entitled Obama and McCain Call for Increase in Deposit Insurance:
In a moment of unintentional unity, Sens. Barack Obama and John McCain today both proposed raising the cap on federally insured bank deposits to $250,000 from $100,000 in an effort to broaden support among Republicans for the financial rescue package that failed on a close vote in the House yesterday.
The insurance increase would particularly benefit small businesses, a core GOP constituency. “While that guarantee is more than adequate for most families, it is insufficient for many small businesses that maintain bank accounts to meet their payroll, buy their supplies, and invest in expanding and creating jobs. The current insurance limit of $100,000 was set 28 years ago and has not been adjusted for inflation,” Obama noted.
McCain also called for the Federal Deposit Insurance Corp. limit to be raised, saying at an economic roundtable in Des Moines, Iowa, that “we cannot allow a crisis in our financial system to become a crisis in confidence.”
This may be good politics — a way to get support from people with over $100,000 in the bank — but it is horrible policy.
On the one hand that is way too much insurance for the government to give to people who are chasing yield. It will result in an instantaneous boom in CD brokering as weak, undercapitalized banks offer high interest rates to woo deposits. Such a policy is setting us up for the next big financial crisis.
On the other hand, it is a wildly insufficient amount when it comes to stopping bank panics. Businesses can often have checking account balances well over the quarter-million proposed limit — and they would still be at risk. A citizen who sells a house on Tuesday and intends to use the money on Wednesday to buy another one — and so has a big bank balance for one night — will still be vulnerable under both the McCain and Obama proposals.
Here is the reform that makes a difference: 100% of all funds in non-interest bearing accounts, commonly known as checking accounts, should be covered by the FDIC.
In most cases, these funds are just float waiting for people to receive checks and cash them. Or the funds represent cash being held for a specific purpose, say to meet a payroll.
If people are looking for an investment, we have to make them run the risk of loss — otherwise they will always put their money in a high-yield/high-risk situation because we are collectivizing the risk but letting the investor keep the high yield.
As long as companies are just doing business and not speculating to get a higher yield, the public interest is in encouraging a sense of security regarding banking.
The McCain and Obama proposals provide too much incentive to speculate on getting the best yield — without providing businesses and citizens the assurance that their checking account balances are completely safe.
How can all the smart people surrounding both candidates come up with such obviously inadequate proposals? If we don’t solve that problem, this financial crisis will be the least of our worries.