Most Americans assume that the money they deposit into commercial banks is safe. Sure, it hasn’t earned any interest in six years, but—so the conventional wisdom runs—that money is rock-solid guaranteed to be there. Even if the bank should fail, the FDIC (Federal Deposit Insurance Corporation) will swoop in to make the depositors whole, up to $250,000 per account. That’s why nobody needs to “run” on the bank anymore, and why we don’t need to worry about a horrible panic such as the one that occurred in the early 1930s when thousands of banks failed.

Yet if we peel back even just the first layer of this typical story, we see that the comforting façade collapses. The FDIC represents just a tiny sliver of defense against bank failures. Moreover, the whole system perversely makes the banks more prone to failure.

To see just how razor-thin the FDIC’s resources are, look at this screen shot from page 116 of the FDIC’s 2013 Annual Report:

As the table shows, back in 2009 and 2010, the FDIC had to make whole so many depositors from failing banks that its overall fund went into the red. Indeed, in 2009 FDIC was in the hole almost $21 billion.

Since then, FDIC recovered a bit, and as of 2013 had $47 billion back in its fund. This small defense was insuring some $6 trillion in insured bank deposits, a coverage ratio of 0.79 percent.

Now when I brought up this alarming situation at my personal blog, some people scoffed in the comments. Why, if there is ever another wave of bank failures, the FDIC can just borrow from the Treasury. Ultimately, the government can just turn to the Federal Reserve to create new money and make everybody whole. Now that we’ve gotten rid of that pesky gold standard, Uncle Sam can hand out unlimited amounts of dollars.

Such a reaction is shocking in its glibness. Remember that FDIC is supposed to be an insurance program. It doesn’t get its fund from taxpayers, but from premiums assessed on the insured banks themselves. Indeed, in order to replenish its fund, back in 2009 FDIC made the banks “prepay” thirteen quarters (i.e. a little more than three years) worth of premium payments. Once the immediate danger was past, FDIC issued refunds of these overpayments in 2013.

Nobody doubts that the government has the technical ability to create billions or even trillions of dollars and hand them out. But that isn’t a way for society as a whole to become richer. Yes, if a small number of depositors lose money on a few failed banks, then the rest of us can—via the government—act as a backstop, and spread the losses around, so that any individual feels just a slight amount of pain.

Yet having government-imposed deposit insurance makes the system as a whole far more vulnerable, particularly when the banks are being assessed such low premiums (in normal times). Precisely because people think, “My money is 100% guaranteed in the bank,” nobody ever does research on what exactly his or her bank does with the funds it lends out. People care about monthly fees, branch hours, and ATM locations, but they don’t ever inquire, “Does my bank make wise investments?”

FDIC as implemented thus gives us the worst of both worlds: It lulls depositors into a false sense of security, so that there is little market discipline reining in reckless lending by the banks. Yet at the same time, given that the system is pushed to embrace risk, FDIC nonetheless carries a very paltry defense against defaults. In the event of a major downturn, the government would have to freshly dip into taxpayers in order to take money from us, so that it could give us our money back.

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