The Trouble With Deposit Insurance
The Dissenting Views of Ron Paul
by Ron Paul
The purpose of reconciliation is to identify suitable targets for budget reductions in order to reduce spending. Therefore, it is quite odd that the Financial Services Committee would use reconciliation as a vehicle to consider the Federal Deposit Insurance Reform Act, as this act could increase the possibility of future bank failures, and thus increase federal expenditures. The bill does this by expanding the federal government's unconstitutional control over the financial services industry. This bill also raises taxes on all financial institutions. Therefore, I must oppose this bill.
I primarily object to the provisions in this legislation which may increase the premiums assessed on participating financial institutions. These "premiums,'' which are actually taxes, are the premier sources of funds for the Deposit Insurance Fund. This fund is used to bail out banks who experience difficulties meeting their commitments to their depositors. Thus, the deposit insurance system transfers liability for poor management decisions from those who made the decisions, to their competitors. This system punishes those financial institutions which follow sound practices, as they are forced to absorb the losses of their competitors. This also compounds the moral hazard problem created whenever government socializes business losses.
In the event of a severe banking crisis, Congress will likely transfer funds from the general revenue into the Deposit Insurance Fund, which could make all taxpayers liable for the mistakes of a few. Of course, such a bailout would require separate authorization from Congress, but can anyone imagine Congress saying "No'' to banking lobbyists pleading for relief from the costs of bailing out their weaker competitors?
Government subsidies lead to government control, as regulations are imposed on the recipients of the subsidies in order to address the moral hazard problem. This is certainly the case in banking, which is one of the most heavily regulated industries in America. However, as George Kaufman, the John Smith Professor of Banking and Finance at Loyola University in Chicago, and co-chair of the Shadow Financial Regulatory Committee, pointed out in a study for the CATO Institutes, the FDIC's history of poor management exacerbated the banking crisis of the eighties and nineties. Professor Kaufman properly identifies a key reason for the FDIC's poor track record in protecting individual depositors: regulators have incentives to downplay or even cover-up problems in the financial system such as banking facilities. Banking failures are black marks on the regulators' records. In addition, regulators may be subject to political pressure to delay imposing sanctions on failing institutions, thus increasing the magnitude of the loss.
Immediately after a problem in the banking industry comes to light, the media and Congress will inevitably blame it on regulators who were "asleep at the switch.'' Yet, most politicians continue to believe that giving more power to the very regulators whose incompetence (or worst) either caused or contributed to the problem will somehow prevent future crises!
The presence of deposit insurance and government regulations removes incentives for individuals to act on their own to protect their deposits or even inquire as to the health of their financial institutions. After all, why should individuals be concerned with the health of their financial institutions when the federal government is ensuring that banks follow sound practices and has insured their deposits?
I would also like to reiterate the irony that this is being considered as part of reconciliation designed to achieve budget savings. While the technical changes made in the deposit insurance program may provide some minor budget savings, increasing the risk of a taxpayer bailout of financial institutions is the equivalent of recommending someone take up smoking to avoid lung cancer. If this committee, and Congress, really wanted to cut spending, they would look at ending the numerous subsidies to large corporations and financial institutions provided by programs under this committee's jurisdiction.
Finally, I would remind my colleagues that the federal deposit insurance program lacks constitutional authority. Congress' only mandate in the area of money and banking is to maintain the value of the money. Unfortunately, Congress abdicated its responsibility over monetary policy with the passage of the Federal Reserve Act of 1913, which allows the federal government to erode the value of the currency at the will of the central bank. Congress' embrace of fiat money is directly responsible for the instability in the banking system that created the justification for deposit insurance.
In conclusion, this Deposit Insurance "Reform" imposes new taxes on financial institutions, forces sound institutions to pay for the mistakes of their reckless competitors, increases the chances of taxpayers being forced to bail out unsound financial institutions, reduces individual depositors' incentives to take action to protect their deposits, and exceeds Congress's constitutional authority. I therefore urge my colleagues to reject this bill. Instead of extending this federal program, Congress should work to defund programs that distort the market and enrich powerful special interests and work to prevent the crises which justify government programs like deposit insurance, by fulfilling our constitutional responsibility to pursue sound monetary policies.
November 22, 2005
Dr. Ron Paul is a Republican member of Congress from Texas.