Bank Deposit Bailouts Could Cost Taxpayers Billions

FDIC’s Ability to Repay Depositors Is Limited, Taxpayers Would Pay Shortfalls

People rush to a saving bank in Millbury, Mass., on Oct. 24, 1929, as Wall Street in New York crashed, sparking a run on banks that spread accross the country. OFF/AFP/Getty Images

Following a string of regional bank failures over the past several weeks, bank regulators were quick to guarantee all depositors for the full balance of their bank accounts, even beyond the $250,000 limit set by the Federal Deposit Insurance Corp. (FDIC).

At the time, the Biden administration assured Americans that taxpayers would not be on the hook.

Lauding the bailout, President Joe Biden wrote in a tweet: “Thanks to actions we’ve taken over the past few days to protect depositors from Silicon Valley and Signature banks, Americans can have confidence that our system is safe. People’s deposits will be there when they need them—at no cost to the taxpayer.”

Silicon Valley Bank (SVB) was particularly exposed to deposit withdrawals because it had a relatively small number of depositors, with heavy concentrations in large tech companies like Roku, which makes streaming devices and which reportedly had deposited nearly half a billion dollars at SVB. Despite the administration’s claims, however, the FDIC’s ability to make depositors whole is not unlimited, and taxpayers would be on the hook once the FDIC’s cash runs out.

The FDIC backstops its deposit guarantees through a Deposit Insurance Fund (DIF), to which all member banks contribute. But the DIF has enough assets to cover only a small fraction of insured deposits, let alone deposits beyond the $250,000 cap.

“At the end of fourth quarter 2022, the FDIC reported $128.2 billion in the DIF,” economist William Luther told The Epoch Times. “It estimated insured deposits at $1.556 trillion. That means it was in a position to cover about 8.2 percent of all insured deposits from the DIF. Beyond that, the FDIC would have to rely on its Treasury backstop, putting taxpayers on the hook for bank losses.”

To put this in perspective, SVB alone, the sixteenth largest bank in the United States, had about $190 billion in deposits before customers began fleeing the bank. On March 12, the Treasury Department and the Federal Reserve jointly announced that they would provide a lending facility to banks, effectively a taxpayer-funded backstop to FDIC guarantees.

Because banks have assets—in the form of loans or bonds they hold, plus equity capital—that they can use to repay depositors, the FDIC would only have to cover a fraction of deposits. However, at a time of rising interest rates, many banks currently have losses in their asset portfolios that are significantly greater than their capital.

A March joint report by analysts at the University of Southern California, Columbia University, and Stanford University found that “the U.S. banking system’s market value of assets is $2 trillion lower than suggested by their book value of assets accounting for loan portfolios held to maturity. Marked-to-market bank assets have declined by an average of 10 percent across all the banks, with the bottom fifth percentile experiencing a decline of 20 percent.”

According to bank accounting rules, assets that are deemed to be “held to maturity” do not need to be marked to market. But if the current market value of bonds held by banks is taken into account, 10 percent of banks have larger unrecognized losses than SVB. In addition, 10 percent of banks have lower capitalization than SVB, the report states.

“Even if only half of uninsured depositors decide to withdraw, almost 190 banks are at a potential risk of impairment to insured depositors, with potentially $300 billion of insured deposits at risk,” the authors wrote. “If uninsured deposit withdrawals cause even small fire sales, substantially more banks are at risk.

Established in 1933, the FDIC was set up to restore public trust in banks following the financial collapse and bank runs of the Great Depression. The idea was that by pooling risk, the banking system could step in and shore up failing banks before depositors’ loss of trust spread to the system at large. Even then, however, there were concerns about a loss of market discipline and that riskier banks would be able to game the system by offering higher interest rates to attract depositors, who no longer had to be concerned about bank solvency.

President Franklin Roosevelt told Americans in his first fireside chat that “there is an element in the readjustment of our financial system more important than currency, more important than gold, and that is the confidence of the people.” Soon thereafter, the Bank Act of 1933 was passed and the FDIC was established, giving all insured depositors $2,500 in coverage. Bank failures declined from 9,000 between 1930–33 to nine in 1934.

Over time, the coverage limit was increased to $100,000, and then in 2008, during the mortgage crisis, it was “temporarily” increased to $250,000. That temporary increase has effectively become permanent, and now there are calls to have all bank deposits guaranteed without limit.

After initially telling Congress on March 22 that federal regulators had no intention of insuring deposits beyond the $250,000 limit, Treasury Secretary Janet Yellen seemed to contradict herself on the following day, stating that the Treasury was “prepared to take additional actions if warranted.” Advocates of raising the cap or removing it include Sen. Elizabeth Warren (D-Mass.), Rep. Maxine Waters (D-Calif.), and the Mid-Size Bank Coalition of America.

Currently, there are about $17.5 trillion in total deposits in the U.S. banking system, meaning that the DIF has the ability, including the Treasury credit line, to cover only about 1.3 percent of all deposits. Attempting to insure all deposits, beyond the $250,000 limit, could put the FDIC’s ability to insure average Americans at risk, in order to bail out companies.

“The vast majority of Americans do not have more than $250,000 in the bank,” Luther said. “Many small businesses keep large cash positions to facilitate routine inventory purchases and payroll expenses. If that puts them over the FDIC max, they can purchase private insurance to protect the difference. Larger businesses can also purchase private deposit insurance.”

According to Luther, “It is not obvious why the American taxpayer should cover the deposit risks businesses face. It is a cost of doing business, which businesses should take into account when making operation and production decisions.”