How Large Is the Federal Financial Safety Net

Abstract

In the 1980s and early 1990s, U.S. taxpayers paid $130 billion to make good on the federal government’s guarantee to protect depositors in thrift institutions (U.S. GAO 1996: 14). The crisis affecting thrifts in the late 1980s exhausted the funds that had been set aside by the deposit insurance agency, and made it necessary for Congress to allocate new funds. This period marked the first major test of the federal deposit insurance system since its inception in 1933. The system was badly stressed, but it did succeed in one sense. Although there were a large number of bank failures, the type of bank runs and widespread panics seen in crises prior to the creation of the Federal Deposit Insurance Corporation (FDIC) did not occur. Deposit insurance gave the average bank depositor a sense of safety not previously enjoyed. With this protection, however, depositors have little interest in paying attention to the riskiness of their banks ’ lending activities. Many observers argue that a lack of depositor scrutiny contributed to the problems experienced by banks and thrifts in the 1980s. The government’s interest in the safety of private savers and private financial institutions did not begin with the creation of deposit insurance. Indeed, in the earliest years of the republic the government sometimes reallocated the deposits it held with private banks in order to provide additional funding to a distressed institution (Studenski and Kroos 1963: 72–73). Even J. P. Morgan received government assistance in his efforts to rescue troubled institutions in the wake of the panic of 1907. While this episode is often cited as a case in which

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