The author is a former president of the US Federal Deposit Insurance Corporation and a senior member of the Center for Financial Stability
In times of financial turmoil, big banks get bigger. Their massive balance sheets have allowed them to gobble up struggling competitors. Uninsured depositors flock to the security of their state perceived as too big to fail. This happened during the 2008 financial crisis when I chaired the Federal Deposit Insurance Corporation. It’s happening again today such as America’s largest bank, JPMorgan Chaseit grows thanks to both the inflow of deposits and the takeover of a failed bank.
The FDIC is legally obligated to sell a failed bank to the highest bidder, but during the 2008 crisis we had emergency powers to stem the flows of deposits to mega banks. We provided targeted and temporary increases in deposit insurance ceilings that helped healthy regional and community banks retain their most valuable commercial accounts. Unfortunately, under the Dodd-Frank Act, Congress must now authorize the FDIC to take such action. Given the persistent, if unwarranted, hysteria over the health of regional banks, it should act quickly to do so.
To be sure, today’s turbulence is exaggerated. Accounts describing three recent bank failures as greater than those of 2008 are misleading. In 2008, it was big banks like Citigroup that were in trouble. The government has not let them fail. These three recent bankruptcies add up to $532 billion of assets in a $23 trillion system made up of more than 4,000 banks. There is no crisis, unless media hype and short-selling pressure undermine confidence so that depositors flee otherwise healthy banks. Polls show they are nervous.
Insured depositors have traditionally kept faith in the FDIC’s perfect 90-year record of protection. The problem is with deposits of $7 trillion above the $250,000 deposit limit. But universal coverage for all accounts isn’t the answer. We need richer and more sophisticated depositors to monitor the banks and exercise market discipline on the mismanaged ones. With universal coverage, reckless banks could offer high yields to attract large depositors who would ignore the risks, knowing the FDIC would protect them. It could also distort capital flows from money market funds and short-term Treasuries to bank deposits that can offer quicker access to funds.
It makes sense to provide unlimited coverage for transaction accounts used by businesses and other organizations to receive and make payments. These typically pay little or no interest because they are used by depositors to support operations, not generate returns. Protecting these accounts ensures that employers with uninsured deposits at a failing bank can continue to access funds for payroll and other expenses. However, transaction accounts cannot always be moved quickly. During times of uncertainty, corporate depositors consider preemptively transferring their business to a too-big-to-fail bank even if their bank isn’t in trouble.
To address this issue, we launched the Transaction Account Guarantee (or TAG program) during the crisis. It successfully reassured depositors that their transaction accounts were safe. We didn’t limit coverage because with little or no return on accounts, depositors had an incentive to only hold balances needed for trades. Also, a key objective of TAG was to stem the growing concentration of deposits in mega banks. With the caps, larger employers would continue to move their accounts away from smaller banks.
While the Dodd-Frank Act now requires Congressional authorization for TAG, there is a fast track. During the Covid emergency, the Trump administration secured the temporary reinstatement of the FDIC’s TAG authority, which the FDIC fortunately never had to use. But today, given the political polarization, the Biden administration has not asked for a green light from Congress. Instead, it’s working with regulators to implicitly hedge uninsured accounts using special emergency powers unsuitable for that purpose. Whenever a bank fails, a two-thirds majority of the FDIC and Federal Reserve boards must approve the use of those powers. It’s highly questionable whether Republican appointees will continue to provide votes to bail out the uninsured.
Regional banks have a target on their backs and perhaps deserve retribution for their 2018 lobbying to weaken oversight. However, the vast majority are solid, well managed and play an important role in providing credit. They and community banks were heroes during the 2008 crisis, continuing to lend even as many mega banks pulled out. To foster banking competition and mitigate concentrations of power, we need to help them protect their core corporate accounts. Congress must reinstate TAG.
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