The FDIC and Hurricane Henry

Outside of being a furious weather phenomenon, hurricanes have helped in the past to explain some very basic laws of economics. Shortly after the destructive winds and waves come ashore, government agencies directed by FEMA roll into the devastated areas with money in hand to help rebuild the lives of those suffering property damage. But this seeming act of compassion on the outside may lead individuals to take undue risk.

Without a government agency to pick up the tab, property owners in hurricane prone areas would be faced with high insurance rates that would surely discourage some from living in such a danger zone. If by chance a hurricane did strike, premiums would most certainly climb ever higher making the coastal area affordable to very few. For those that chose no insurance, the consequences would be financial ruin.

In effect government assistance becomes a cheap substitute for insurance, which the property owner is able to pass on to others in the form of taxation. Since the individual cost for property destruction is rather low, individuals are in effect lured into a risky proposition.

Part of the financial bailout proposal before Congress increases the allowance for FDIC insurance from $100,000 to $250,000 in deposits per account at a covered financial institution. Amounts above the existing limit of $100,000 could possibly be lost in case of a bank failure.

During these financial times, prudent depositors with over $100,000 have taken to spreading their money among many accounts in different banks, thus through institutional diversification they have minimized risk of a bank failure. But this process caused highly leveraged banks such as Washington Mutual and Wachovia further stress to their fragile reserve ratios. Risk diversification by wealthy individuals tolled these banks demise.

Just like our example of government insurance for hurricanes, raising the FDIC deposit coverage will lure people into the risky behavior of keeping a greater amount of their money in a single bank. The deposit insurance no more lessens the dangers of a poorly run bank than FEMA diminishes the destructive force of a hurricane. The increased government insurance metaphorically attempts to keep you in the path of the storm instead of moving to safer ground.

Currently the FDIC holds funds for coverage of approximately $48 billion. Just a few days ago the agency requested that the Treasury make additional funding of $150 billion available. The new limit increases the initial request to $375 billion. Congress against common sense and the wishes of many in this country is prepared to pass a $700 billion bailout package that has been littered with pork. Combining the new FDIC request along with the bailout plan, the total for the week in new funding will top $1 trillion, and this is on top of the hundreds of billions already spent on Bear Stearns, Fannie and Freddie, and AIG.

If you think the new FDIC coverage makes your deposits safer, then I ask; where is the money coming from? You may recover some of your wealth, but it will be in much cheaper dollars.

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