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Boom deja vu meme2/13/2024 In contrast to the systems that went broke, where bank examiners were government employees, in the solvent systems examiners were largely chosen by and responsible to the banks. However, strong industry pressure counteracted the temptation, in effect, to play fast and loose with other banks’ capital. Hence, severe losses at a few banks could have wiped out all banks in the state. Healthy banks were liable for paying failed banks’ creditors if the insurance funds should be exhausted. Oddly, the solvent funds had more potential for causing trouble than the others. Indiana, Ohio, and Iowa had funds that stayed solvent. Michigan, New York, and Vermont effectively closed their insurance funds when the funds went broke. Creditors there got less than two-thirds the value of their claims. A single failure was enough to bankrupt Vermont’s fund in 1857. But some creditors waited as long as 21 years for payment. The state government eventually issued bonds to bail it out, much as the Bush administration has proposed doing for the FSLIC. A few years later, 11 bank failures depleted the New York fund. Payments into Michigan’s insurance fund barely covered supervisory costs, so creditors of failed banks got nothing. It had been in operation only a year when the panic of 1837 dragged down most of the state’s banks. Five other states imitated New York in setting up compulsory bank insurance systems before the Civil War. (Apparently, the legislature did not intend deposits to be covered, but they were because the law it enacted was careless on that point.) The safety fund benefited rural banks most, because their profits depended more on note circulation. The safety fund’s purpose was to instill public confidence in bank notes, although it also covered deposits. However, the more numerous rural banks influenced the state legislature to establish it. Banks paid a tax of 3 percent of their capital into a common “safety fund.” New York City banks, which were among the largest and most stable in the nation, opposed the fund. New York State started the first deposit insurance system in 1829. A brief look at their history shows what we can expect again if Congress doesn’t use the current Federal bailout as an opportunity to free our financial system from the stranglehold of regulation. Nearly half operated before the Great Depression, and half since. Besides Federal deposit insurance, the United States has had about 30 state deposit insurance schemes. The Federal Savings and Loan Insurance Corporation’s current problems have many precedents. Indeed, deposit insurance crises are almost as old as deposit insurance itself. In the United States, deposit insurance has been rarely self-financing because government regulation has prevented competition from evolving the strongest banks possible. This has resulted in the creation of large banks that are very secure because they spread their risks among many regions and types of activity. Competition has forced foreign banks to develop nationwide branch networks and to diversify into lines of business forbidden to American banks. Outside the United States, deposit insurance, even where it exists, has not been needed. But the history of deposit insurance in the United States and other countries indicates that it is neither necessary nor desirable. The rationale of deposit insurance is that it is cheaper than the banking panics that supposedly would result without it. And the cost is rising by $1 billion for every month that the federal government lets 350 bankrupt savings and loans stay open because it hasn’t budgeted the money to pay off their depositors.Īmerican taxpayers will be footing the bill for this because the federal government guarantees almost all bank deposits. As an indication of how severe the problem is, government estimates of the cost of bailing out bankrupt savings and loans, which were $30 billion a few months ago, rose to $60 billion, then to $160 billion. The mess in the savings and loan industry is the worst thing to happen to the American banking system since the Great Depression. Kurt Schuler is a graduate student in economics at the University of Georgia.
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