Banking

Did Federal Deposit Insurance Corrupt the Banking System? [Reason Podcast]

George Selgin vs. Josh Barro at the Soho Forum.

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"Before the 1930s, you could open up The Wall Street Journal and see advertisements for different banks saying how much capital they had," said George Selgin, who's the director of the Center for Monetary and Financial Alternatives at the Cato Institute. "It's easy to have a market for safety when you don't protect people from losses…"

In today's podcast, we've got the audio from an April 12 live debate in which Selgin went up against Business Insider Senior Editor Josh Barro over whether the U.S. should do away with federal deposit insurance—a system in which the government guarantees bank balances of up to $250,000. A leading proponent of free banking, Selgin argued that deposit insurance has destroyed the incentive for banks to be fiscally prudent and contributed to the 2008 financial crisis.

Selgin vs. Barro at the Soho Forum ||| Jim Epstein
Jim Epstein

Barro, who has called Selgin's views on banking "kooky," made the case that even libertarians should support deposit insurance because in a financial crisis the government would step up and protect depositors regardless, so it's better to have a formal system in place.

The event was hosted by the Soho Forum, a monthly libertarian-themed Oxford-style debate series in New York City. At the beginning of the event, attendees get to vote on the evening's resolution. After the debaters have had their say, the audience votes again, and the side that's gained the most ground wins the contest.

Selgin came out on top: At the outset of the debate, 48 percent of the audience supported abolishing federal deposit insurance and 23 percent were opposed. At the end, 60 percent wanted it abolished, while the percentage of the audience opposed to the resolution didn't change.

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Next up at the Soho Forum: On Tuesday, May 16, Lawrence Ross debates Kmele Foster over whether "America's colleges have fostered a racist environment that makes them a hostile space for African American students." Get your tickets here.

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26 responses to “Did Federal Deposit Insurance Corrupt the Banking System? [Reason Podcast]

  1. I have nothing against deposit insurance… so long as it’s private.

  2. Unintentional Moral Hazard was my nickname in college.

  3. Barro, who has called Selgin’s views on banking “kooky,” made the case that even libertarians should support deposit insurance because in a financial crisis the government would step up and protect depositors regardless, so it’s better to have a formal system in place

    Under a free market system there is a formal system in place. It’s called the contract. You make a contract with a third party to insure you against your bank going belly up. That contract is enforceable by laws and precedents that long precede the FDIC. This idea that the FDIC can protect depositors “regardless” assumes that the federal government can set the value of money. Which, of course, it can’t. No one can protect depositors “regardless”. At least the free market has to be honest about that fact.

    1. And the fact that the FDIC protects consumers from risk is precisely one of the things that causes such crises.

  4. Blaming the FDIC for the financial crisis is a bit like blaming HRC’s failed presidential run on her voice. I’m sure it played some small role in turning off a tiny amount of voters, but it’s a pretty small slice of the pie chart.

    1. “Contributed to” not “caused” the financial crisis. I remember reading at the time that the FDIC would have laid out something like $4.4 trillion if all the banks had gone under. That was one argument for why the TARP bank loans were cheaper than letting the banks go under. At the margins, the higher the insurance, the more depositors could ignore the banking practices of the institutions where they had deposits. Lowered consequences usually mean more risky behavior.

      1. Well then FDIC did not cause the crisis. It caused the threat of extortion to succeed and therefore caused the bailout.

        Banks will always cause financial crises because their business model and their balance sheets cannot sustain the changes in time-preference when markets panic. No matter what banks promise, they will break that promise exactly when that promise is most relied on. And to the degree that govt relies on banks to distribute/create its money, then govt will be extorted to bail the banks out when the crisis hits. FDIC was created in the aftermath of the govt’s bailout of the banking system’s ‘promise’ that bank deposits were as good as gold. And every previous financial crisis aftermath was also the consequence of govt bailing out banks – just much less directly visible since a ‘depression’ can be blamed on all sorts of things.

    2. Actually that’s not necessarily true. Absent the FDIC savers would seek out banks that invest cautiously, so the economy would’ve been much less risk laden. The FDIC did likely play a big role, indeed plays a big role in general in the boom-bust cycle.

    3. YOU MUST BE KIDDING! Hilary Clinton’s horrible voice is one of the biggest factors contributing to her defeat. Let’s list the problems she had: (1) She’s crooked and she lies, (2) She refused to follow protocol for a State Department server, (3) She espoused no coherent plan, and (4) Her voice is irritating has hell. Show me your pie chart!

  5. So if someone denies the efficacy of forcing tax payers to subsidize bad business decisions, they’re the “kooky” ones in the room.

  6. I think Barro’s argument is pretty solid, and I would have liked to see Selgin more directly address the political challenges of reforming towards free banking. Especially since the response he offers – that there will be fewer or less severe shocks, so there won’t be huge deposit crises – depends on having a ‘sane’ monetary policy more broadly. Moving to a private insurance system is only one component of that, and what if the other reforms stall out? Or the Fed does follow his preferred policy for a while, but then changes course for political reasons, and the boom-bust cycle gets restarted?

    I still agree with Selgin; you got to start somewhere, after all. But I think Barro’s right that a democratic government will ultimately bail out insurance companies once a severe recession hits. Hoping there won’t be such a recession, or that there will be enough political will to resist the cries for bailouts, is a wee bit optimistic.

  7. Wonderfully pragmatic argument from Barro. You should have to have a very compelling argument for making large changes to policy, even if the existing system is imperfect, because at least we know something about how the existing system works.

    1. There is a compelling argument: the FDIC encourages banks to invest riskily by destroying customers’ only incentive to put their money in safe banks.

      You don’t get to just pretend your opponent never made an argument; you actually have refute it.

      But I’ll be sure to use this ‘argument from status quo’ next time you say you want something changed. Is it now a consensus among progressive that the status quo in banking regulation for the past 15 years is great? Interesting 180.

    2. Bad but consistent policy is better than vacillating, good policy.

      That’s why tax reform always fails. It is presented as an either or proposition. The only way to exact reform without revolutionary events is in small, incremental steps.

  8. The argument that government guarantees did not lead the 2008 crisis is BS. The government guarantees are called Fannie and Freddie.

    1. Could you explain this in much more detail in your own words?

    2. Actually the FDIC and tax policy favoring leveraged home buying probably dwarf the GSEs in quantitative significance. The FDIC just gets less blame because it’s more of a sacred cow and far more popular.

  9. I often make this same argument about employer provided, tax free health care for employees. It corrupted our health care system.

    People did not have to pay, and thus had no concern for what they spent on health care. Health care providers didn’t have to do much cost/benefit analysis of the goods or services they would provide. The demand was effectively unrestricted.

    The insurers were caught in the middle, but free to raise rates for a long time to compensate.

    Finally, the balloon burst and we ended up where we are today, arguing about health care as a right, vs health care as a consumer item.

    1. More like people knew they were “paying” through lower wages, but had no way to opt out, so they took what was there. BUT that meant no one was actually shopping for a policy that actually met their needs, and there was no pressure on insurance companies to be competitive at the individual level. From there, insurance companies came up with a great idea to “control costs”, and began bullying doctors into networks by holding the employees business hostage.
      So now there is no price pressure in health care services, because the customer is not the patient, it is the insurance company. And most providers have a multitude of prices for the same service.

  10. The FDIC prevents disaster from when bank runs happen

    but bank runs weren’t a problem before the government mandated that all money in banks be free to withdraw immediately on demand.

    Yeah, no shit. You can’t have a system where almost all the money people “have” is lent out and not actually there and ALSO give it back to them whenever they want. It’s only sustainable if they are only promised to get it back EVENTUALLY. You know, like how all investments work?

    Is it that hard to imagine a system not of a one-size-fits-all policy for all banks, but a system of meta-rules. You know, like governments are SUPPOSED to be involved in?
    Criminalize certain behaviors, such as not keeping reserve rates you claim, as a strong disincentive. Stop one-size-fits-all policies, and create a system of smaller courts that deal with these issues more efficiently, like with rental issues. They could mostly side with the little guy, but still enforce the basic rules. We have these systems for other things too, why do we keeping jumping to one-size-fits-all for so many issues in this country?

    You wouldn’t be able to get your money immediately, but so what? Who the hell needs thousands of dollars instantly without thinking about it? People would have to wait a few days. WOOOOOAAHHHHH!!! So inconvenient! It would force people to think harder about spending! Didn’t we just have an economy collapse because people were able to easily spend frivolously?

  11. The FDIC prevents disaster from when bank runs happen

    but bank runs weren’t a problem before the government mandated that all money in banks be free to withdraw immediately on demand.

    Yeah, no shit. You can’t have a system where almost all the money people “have” is lent out and not actually there and ALSO give it back to them whenever they want. It’s only sustainable if they are only promised to get it back EVENTUALLY. You know, like how all investments work?

    Is it that hard to imagine a system not of a one-size-fits-all policy for all banks, but a system of meta-rules. You know, like governments are SUPPOSED to be involved in?
    Criminalize certain behaviors, such as not keeping reserve rates you claim, as a strong disincentive. Stop one-size-fits-all policies, and create a system of smaller courts that deal with these issues more efficiently, like with rental issues. They could mostly side with the little guy, but still enforce the basic rules. We have these systems for other things too, why do we keeping jumping to one-size-fits-all for so many issues in this country?

    You wouldn’t be able to get your money immediately, but so what? Who the hell needs thousands of dollars instantly without thinking about it? People would have to wait a few days. WOOOOOAAHHHHH!!! So inconvenient! It would force people to think harder about spending! Didn’t we just have an economy collapse because people were able to easily spend frivolously?

    1. Your bank contract would have scales for amounts of money corresponding to how quickly theyre obligated to get you that much of your money. Under a certain amount there would be a guarantee immediate withdrawal.

      The bank could even put wording in your contract covering bank runs. Like “in the event 50 people try to withdraw money on the same day, we reserve the right to get your money by 10 days, not 4” Yes, by itself, hard to enforce/prove in court, but the government could mandate a computerized system for all requests where everything gets logged, accessible by the government later for court cases, so they can make sure the banks are doing what they promise and not coming up with excuses (activating clauses in contracts based on lies). Again, governments are supposed to be META-.

      The banks could even set up payments by their debtors to be staggered throughout the week/month to cover their bases.

      I mean really, am I the only one with an imagination?

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