The FDIC Has a Proven Way to Avoid Moral Hazard

In the ’80s, it paid off uninsured depositors at 80%

By William M. Isaac. He was chairman of the Federal Deposit Insurance Corporation (1978-86). Excerpts:

"But putting a 100% guarantee of those banks’ rich mega-depositors on the FDIC’s tab was terribly unwise. If the government protects every depositor in a bank failure, even those who are rich and sophisticated enough to have known better, it erodes marketplace discipline and makes banks less stable going forward.

Instead, the FDIC should have turned to its 1982 innovation: the modified deposit payoff. The idea was that when a bank closed, the FDIC would pay uninsured depositors the full insured amount—today $250,000—and give them receivership certificates for 80% of their uninsured funds, which was the minimum amount large depositors historically recovered from failed bank receiverships. Large depositors could then take that certificate to Federal Reserve banks and exchange it for cash. If the FDIC ultimately collected more than the 80% from the failed bank receivership, it’d pay large depositors those extra funds until they were made whole."

"It would be even better if Congress passed the provision explicitly into law, with another critical reform: All non-interest-bearing checking accounts held by individuals or businesses should be fully insured—no matter how large. Such funds aren’t chasing high yields or taking large risks. This reform would protect business accounts that are essential to keeping the economy moving and would reduce substantially the risk of panics."