Deposits Guaranteed Up to $250,000—MaybeWhat does it mean to be ‘Backed by the full faith and credit’ of the U.S.?May 28, 2013, 6:53 p.m. ET
By ALEX J. POLLOCK
http://online.wsj.com/article/SB10001424127887323744604578472770934666526.html?mod=WSJ_Opinion_LEADTopThe banking and government-debt crisis in Cyprus has focused everyone’s attention on the fact that it is possible for bank depositors to take losses on their deposits. This has surprised many people, who assumed that governments will always bail out depositors in full. But what if the government itself needs a bailout, as Cyprus did?
All over the world, the public has a deep desire for their deposits to be riskless. Governments feed this desire by creating deposit insurance and by continually promoting public “confidence” in the banking system, whether or not such confidence is warranted. Yet deposits—and the guarantees that government makes to insure those deposits—fund loans and investments that are inherently risky, and subject to losses that are far greater than most bankers, governments or the public imagine.
The crises that result from banking losses are common, historically speaking, not rare. The losses occur notably in financing real estate and also in financing governments, as they did in Cyprus—or Ireland, Greece, Spain and Portugal.
The International Monetary Fund has tracked 147 banking crises since 1970. Around the world there have been more than 250 defaults on government debt since 1800, an average of about one sovereign default per year.
The U.S. has had two housing finance disasters in the past three decades alone, the Savings and Loan Crisis of the 1980s and the subprime mortgage crisis that began in 2007.
Yet one peculiar characteristic of deposit guarantees in the U.S. is not as well known or appreciated as it should be—especially as federal debt reaches stratospheric levels. When Congress created the Federal Deposit Insurance Corporation in 1933, the fathers of the Banking Act assured the public explicitly that the federal government, i.e., taxpayers, were not on the hook for losses to depositors.
“This is not a government guaranty of deposits,” said Carter Glass, chairman of the Senate Banking Committee. Henry Steagall, chairman of the House Banking Committee agreed. “I do not mean to be understood as favoring a government guaranty of bank deposits,” he said. “I do not. I have never favored such a plan.” Instead, banks were to insure their own deposits through contributions to an insurance fund.
Today, FDIC stickers in every bank in America proclaim “Each depositor insured to at least $250,000,” a promise “Backed by the full faith and credit of the United States government.” How this promise came to be—and if it is really a legally binding promise—is not generally understood.
The story goes back to the S&L Crisis of the 1980s when, thanks to lending long and borrowing short while interest rates soared, hundreds of savings and loan associations went under. The Federal Savings and Loan Insurance Corporation—the U.S. government’s deposit insurance fund for the savings and loan industry—also became insolvent.
Congress did not want to legally guarantee deposits but did want people to have “confidence” that their deposits were safe. So it adopted a joint resolution in 1982 stating that it was the “sense of Congress” that insured deposits were backed by the credit of the United States.
This resolution was not legally binding, nor did it become legally binding when, as the S&L problems grew worse, Congress passed the Competitive Equality Banking Act of 1987, which included these oddly phrased words: “it is the sense of the Congress that it should reaffirm that deposits up to the statutorily prescribed amount in federally insured depository institutions are backed by the full faith and credit of the United States.”
Next, in 1989, came the taxpayer bailout of FSLIC. Congress wrote into the Financial Institutions Reform, Recovery and Enforcement Act of that year the requirement that every savings bank must “display at each place of business a sign” saying that “insured deposits are backed by the full faith and credit of the United States Government.” As the housing bubble was inflating in 2005, Congress amended the Federal Deposit Insurance Act to require all banks to display this statement, as they now do.
And yet, window stickers notwithstanding, Congress apparently has never enacted a provision in a law simply stating that insured deposits are guaranteed by the full faith and credit of the government—at least I have diligently searched for it, including asking the FDIC for such a statutory citation, without success.
Nonetheless, the government—and not just a bank insurance fund—has gotten itself firmly on the hook for the risk of most deposits. It has not thereby made the risk of these deposits disappear—that is impossible—but merely moved it to the taxpayers.
Mr. Pollock is a resident fellow at the American Enterprise Institute. He was president and CEO of the Federal Home Loan Bank of Chicago from 1991-2004.
