Car Insurance

The damage might have been contained but for another unwise move during the Carter Administration’s last year: the increase in the federal deposit insurance limit from $40,000 to $100,000. This attracted more deposits than the S&L system could reasonably invest, setting the stage for the con artists that eventually killed much of it.

Not that deposit insurance is inherently bad. In principle it can be privatized, with premiums varying according to the risk involved, much like auto or theft insurance. Such insurance would be quickly terminated whenever, in the eyes of the insurer, the risk became excessive.

The problem with federal deposit insurance is that premiums are the same for all lenders, conservative and high flier alike. As a result, incompetent S&L managers, engaging in the most irresponsible investment strategies, are being subsidized by risk-averse professionals. This subsidy also creates perverse incentives for depositors, who are induced to shift funds out of healthy S&Ls to the riskier institutions which typically offer higher rates. Subsidized insurance allows both the institutions and their depositors to play the “heads I win, tails you lose” game.

Unfortunately, in pounding out the bailout bill last summer Congress paid obsessive attention to whether the costs should be on- or off-budget, to capital requirements, and to junk bonds. Federal deposit insurance was, ominously, untouched.