Why limitless universal deposit insurance could be our safest bet

This week, Congress in all likelihood will confront a most fateful decision: Will it reform our system of Federal Deposit Insurance by raising or removing coverage caps, or will it not?  

I hope that Congress will do the right thing, both for the present and for the future of non-“Big Four” banking. It must remove caps entirely. 

Begin with a bit of history. Congress introduced Federal Deposit Insurance almost 90 years to the day back in 1933. Then, as now, the nation confronted a banking run crisis more liquidity-rooted than solvency-rooted. The danger, in other words, was a self-fulfilling prophecy of the kind we have seen since the March 10 failure of Silicon Valley Bank (SVB), not “toxic assets” of the kind we were fleeing in 2008.  

President Roosevelt accordingly spoke literally, not merely with a rhetorical flourish, when he said, “the only thing we have to fear is fear itself.” 

That’s the fear now.  

While SVB’s risk-management practices were assuredly deficient in face of the suddenness of Jerome Powell’s interest rate hikes over the past 14 months — the fastest since Paul Volcker’s 45 years ago — the irony of SVB’s plight is that in many ways it was the “boring” bank Paul Krugman called for in 2009. Its portfolio comprised loans to tech startups — all of them apparently performing — on the one hand, and in essence the quantitative easing-pursuing Fed portfolio on the other hand — Treasurys and AAA-rated mortgage-backed securities of the kind that Powell holds on the Fed balance sheet. 

Powell’s rate hikes of course brought a temporary fall in the value of SVB’s Treasurys, at the same time that it squeezed many of SVB’s tech firm depositors. This, of course, brought stress to the short-term demand-liability side of the balance sheet even as it depressed the value of SVB’s hold-to-maturity Treasury assets — the makings of a run, absent insurance. 

But wait, isn’t there deposit insurance? Assuredly there is. But SVB’s depositors, big firms that they are, have huge payrolls and large daily operating expenses. These make mere chump change of the low $250,000 per deposit at which the Federal Deposit Insurance Corporation (FDIC) currently caps coverage.  

But wait, you ask now, could SVB’s depositors not have used sweep accounts or have brokered their deposits? Well, yes and no. For one thing, that requires a “financialized” focus that it seems silly to press upon industrial firms devoted to developing new products in the most innovative and dynamic sector of the economy, at least if there are easier means of securing their accounts — which there are, as we’ll see. For another thing, SVB appears to have required its loan proceeds be held in SVB accounts for some clients — a requirement that those seeking in’s into the Silicon Valley tech ecosystem, for which SVB as a de facto tech credit union served as a gatekeeper, had little power to rebuff.    

What, then, to do? This isn’t actually hard. 

When Federal Deposit Insurance was established in 1933, accounts were smaller and assessments far more haphazard than now. Premiums were not risk-priced, and assessments were levied on the banks only when the Deposit Insurance Fund (DIF) dropped below certain thresholds. This was a bit odd, inasmuch as non-risk-priced premiums are as morally hazardous as they are unjust, and inasmuch as assessing during correlated bank failures, which DIF threshold benchmarking amounted to, was pro-cyclical. It was as if Joseph had advised Pharaoh to make grain requisitions during the seven lean years rather than the seven fat years.  

Against so risky a set of funding mechanisms, coverage caps in the early days might have made sense. 

All of that changed, however, with the Federal Deposit Insurance Corporation Reform Conforming Amendments Act of 2005, through which Congress mandated risk-pricing premiums and regularizing assessments. With those changes in place now for nearly 18 years, retaining caps is anachronistic and vestigial — a bit like the human tailbone.  

It’s also quite dangerous now, with more bank runs imminent, and imposes a Hobson’s choice upon the kinds of banks we should want to see flourish again in the era of Building Back Better and Green New Deals.  

During our nation’s previous “growth miracles,” sector-specific industrial and regional banks played key roles. They knew the needs of their sectors and regions and focused on financing production in primary markets rather than speculation in secondary financial and tertiary derivatives markets.  

The end of interstate bank branching restrictions and the repeal of the Glass-Steagall Act in the late 1990s upended much of this great tradition of U.S. industrial banking, concentrating and financializing the banks as it deindustrialized the economy. We are living the populist consequences of that now. 

But some of the old-style banks lived on, and we can both save them and grow more if we uncap deposit insurance now. Gone will be the diversification and “too big to fail” advantage of Wall Street banks, which even now is draining deposits from our regional banks. Full protection for specialized Main Street banks will be back. 

What is more, we will have better bank regulation. The FDIC, as trustee of the Deposit Insurance Fund, is far better situated to oversee bank safety than is the ever more multitasking Fed. 

Let’s do it now, then, and have better-built banks both tomorrow and forever.       

Robert Hockett is the Edward Cornell Professor of Law at Cornell Law School. He is former counsel at the Federal Reserve Bank of New York and the International Monetary Fund.