The Great Deposit Insurance Debate

Abstract

The ongoing proliferation of bank and thrift failures is the foremost current issue for financial regulators. Failures of federally insured banks and thrifts numbered in the thousands during the 1980s. The problem is especially important for public policy, because of the potential liability of the federal taxpayer. For example, by 1989, the Federal Savings and Loan Insurance Corporation (FSLIC) was so deeply overextended — on the order of $200 billion — that only the US Treasury could fund its shortfall. The significance of insurance is seen elsewhere as well: economists are quick to point to flat-rate deposit insurance as a factor in causing the high failure rates. Flat-rate deposit insurance is said to create a moral hazard: if no one charges bankers a higher rate for assuming risk, then bankers will exploit the risk-return trade-off to invest in a riskier portfolio. These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

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