I assumed this was obvious, but it’s clear from some reader feedback that it needs reiterating: Bank runs tend to beget more bank runs, which is why you can’t have bank runs.
During the course of America’s latest financial crisis (which will be three weeks old as of Wednesday), more than a few readers have suggested that “all” banks could theoretically fail and the vast majority of Americans wouldn’t have anything to worry about. Small deposits are insured by the government, after all.
In the normal course of business, I don’t employ the straw man fallacy. That’s not to say I never do (sometimes it’s too tempting), but I try to avoid it, because it’s disingenuous and you can’t win a debate by mischaracterizing your interlocutors’ position.
In this case, though, I’m not the one positing the straw man. I’ve never suggested that all US banks might fail. But, as noted, several readers have, so I’ll be forgiven for dispensing with the patently absurd notion that everything would generally be fine if all US banks collapsed in a short period of time.
All banks can’t fail, because if all banks fail, there wouldn’t be any buyers for the assets. And you do need buyers. As of the end of 2022, the FDIC’s insurance fund had just under $130 billion in it. America has around $18 trillion in total deposits. The FDIC-insured share of that is around 55%.
The FDIC’s insurance fund “covers” roughly $10 trillion in deposits with $130 billion. The only way that math works is if assets from banks that fail can be sold to someone, typically other banks that haven’t failed.
So, no, all banks can’t fail. If all banks fail, the FDIC’s insurance fund isn’t anywhere near large enough to cover all deposits below $250,000, let alone the rest of them.
The US would need to create money to cover the difference, or sell the banks’ assets to private equity, distressed debt investors or foreign banks, and I think it’s safe to say that in the event of a complete and total failure of the US banking system, no one, anywhere, would be in any mood to buy anything.
The total gross assets of the Treasury’s Exchange Stabilization Fund (which Janet Yellen does have broad authority to deploy) are around $200 billion. It’s probably (but not necessarily) true that the entirety of that sum could be pledged to back deposits in an emergency.
But, again, $200 billion isn’t $10 trillion. If you add the gross assets of the ESF to the total balance of the FDIC insurance fund, you still only have enough to cover 3.3% of the deposits you claim are insured.
Bottom line: In an absolute worst-case scenario, insured deposits aren’t covered.
Fortunately (and ironically), in that absolute worst-case scenario (i.e., all US banks failing at once), deposits would be low on the list of most people’s concerns.
So, the government will run out of dollars?
You wanted the math, now you have it. And that’s the last response you’re going to get from me on this topic. I don’t care how many comments you leave.
In case you haven’t heard, they already have. Because the thin majority in the House wants to “put it to” the other side, it has allowed us to reach and breach the debt ceiling and unless this is remedied soon, the Treasury will begin defaulting on existing obligations, putting our standing as a reserve currency in jeopardy and opening the door to the Chinese to step in.
The question was largely facetious. H knows well that the government can’t run out of money unless, as you pointed out, it’s voluntary. As such the answer, in a worst case scenario, would appear to be money creation. Maybe not the worst solution in a scenario where velocity would be crashing through the floor.
The FDIC has essentially completely emptied itself and when it did banks were pretty much on their own. As a result of that mess nearly half of all small banks were closed or acquired. The insurance premiums banks paid tripled immediately and it was all hands on deck for the remaining banks. I was working for a bank CEO as a strategy consultant when this happened and our profits took a pretty big hit trying to do our part to fix this. No government help.
Here’s the way to view this. Deposits are an asset to an individual who has an account. I currently have nine of these at various places and of various types. To the bank deposits are a liability they owe you. They are not, as some believe, a product. A product produces revenue, and/or assets. Deposits do none of this, per se. Neither the Treasury nor the regulators care much about your assets. There is no mandate for anyone to prop up the asset markets. That is a private sector problem which, in a market system, is expected to take care of itself. The FDIC is an insurance agency that was established to protect depositors, after many lost everything during the depression. Banks couldn’t pay depositors because their assets (loans of various types) were mostly worthless. They couldn’t pay depositors because borrowers couldn’t pay them. No government stepped in directly. Originally, FDIC covered 25k per depositor. In the huge S&L crisis in the early eighties the amount of insurance was raised to 250k while bank failures were running amok. Again, no bailout ensued, but FDIC premiums skyrocketed to keep the fix, fixed. This bailout idea came into being during the great unpleasantness in 2008 when we messed up too much. We can’t let our banking system fail because there would be no money. However, we can’t really keep propping up asset markets because that’s not our system, and no there isn’t enough money.
FDIC Insurance was increased from $100K to $250K per depositor in October 2008. It was initially a temporary increase that was later made permanent.