Should We Guarantee All Bank Deposits?

Amar Bidhé says the FDIC should formally guarantee all short-term bank deposits rather than only those deposits of up to $250,000. That way we’d be inured to the possibility that some kind of mass panic triggering bank runs and “pave the way for reinstating interest-rate caps, ending the competition for fickle yield-chasers that helps set off credit booms and busts.”

Bidhé’s overall proposal has several different moving parts, but Felix Salmon takes strong exception to the bank guarantee part seemingly because he sees the experience of Ireland as a cautionary tale. Two responses. One is that I believe Ireland guaranteed all bank debt, not just short-term deposits, and bankrupted itself thusly. The second is that though he acknowledges the fact that the US government can manufacture unlimited supplies of dollars whereas the Irish government can’t manufacture any euros, he dismisses the relevance of this. But I think it’s of fairly overwhelming importance. Of course just because the US government can print up trillions of dollars at a moments notice doesn’t mean we should. But the reason we would hesitate to do that is that it might be inflationary. But a multi-trillion dollar bank run would be strongly deflationary, so counteracting it with a giant increase in the money supply would be no problem. Meanwhile, since we’re already guaranteeing trillions of dollars worth of deposits in some ways a run-halting blanket guarantee would reduce the likelihood of massive FDIC expenditures.

The traditional reason to be leery of a total guarantee, it seems to me, is that it would create moral hazard. The limit guarantee has the nice property of letting middle class savers not worry about bank runs while enlisting businesses and very wealthy individuals as market-based monitors of bank risk. Bidhé’s idea is to replace that partial surveillance from the market with much more robust direct regulatory supervision. But it seems to me that principles like “banks must therefore be restricted to those activities, like making traditional loans and simple hedging operatons, that a regulator of average education and intelligence can monitor” and “cease opaque activities that regulators cannot realistically examine and that top executives cannot control” are easier to write in an op-ed than to turn into actionable regulatory language. I like the spirit of the plan, in other words, but would want to see more plan before actually signing on. The risk is that we end up doing more guarantees without in any way improving the regulation of guaranteed entities and then all our problems get worse than ever.