Financial Hazard Once Again
by George Liebmann

Like the Bourbons, members of Congress in both parties have learned nothing and forgotten nothing. Notwithstanding the savings and loan crisis of the late 1980s, which cost the federal government hundreds of billions of dollars and the clean-up of which helped precipitate a serious recession, both houses have voted to increase the federal deposit insurance limits for retirement accounts from $100,000 to $250,000, though the bills have yet to be reconciled, almost exactly duplicating the earlier disaster.

This so-called reform rests on misplaced sympathy for retirees; those wanting safety are free to invest in government bonds. The bill is corporate welfare on a massive scale and invites a repetition of the savings and loan losses. Vast amounts of potential deposits will be up for grabs, including existing as well as new retirement accounts. As of 2003 IRA accounts alone amounted to 3.007 trillion dollars, of which $268 billion was in banks and thrift institutions. When added insurance is provided, their owners will invest them with the highest interest-payers without regard to risk. In 1990, 42% of IRA funds were invested in insured bank deposits, a percentage which has since fallen to 9% as funds are moved to mutual funds in whiuch investors assess their own risks. Many pension and Keogh accounts in mutual funds exceed $100,000; they will be special targets for banks eager for more deposits. When there last was a large increase in deposit insurance limits, more than a few high-bidding banks made unduly risky investments or embarked on thinly-disguised Ponzi schemes, in which insiders siphoned off points and front-end fees, and delayed recognizing bad debts.

Anyone who thinks that bank examinations or the FIRREA law passed in 1989 after the last savings and loan crisis will offer protection against the huge perverse incentive which the increase creates is living in a dream world. The situation is made worse by the fact that the larger banks have succeeded in limiting their contributions to the insurance funds, which will run out of money very quickly in 5-10 years time when the rottenness underneath initial glowing bank earnings reports comes to be revealed. Free markets are never more powerful than when perverse incentives are provided, and what is here provided is an incentive for huge sums of money to be invested without regard to risk and managed improvidently.

While concerns such as these appear to have led Congress not to increase the insurance limits on ordinary accounts from $100,000 to $130,000 as initially proposed, the increased limit for retirement accounts survives , apparently being viewed as a harmless compromise throwaway, in blissful ignorance of the huge amounts involved. Chairman Greenspan, with his trademarked understatement, told Congress that "It is unlikely that increased coverage would add to the stability of the banking system." Treasury Undersecretary Peter Fisher cautioned that "increasing the overall coverage limit would weaken market discipline and further increase the level of risk." Similar concerns were expressed by the Office of Thrift Supervision, the Comptroller of the Currency, and the Congressional Budget Office.

In spite of the warnings, the increase passed the Senate with no debate; in the House, the vote was 413 to 10. The bill was shepherded through the House by Congressmen Michael Oxley (R-Ohio) and Barney Frank (D-Mass), the latter hopefully declaring that the real cause of the last savings and loan crisis was not moral hazard but the loosening and then tightening of real estate depreciation rules and the relaxation of investment restrictions. It will not be long before a scramble for deposits ensues, with obscure associations in remote parts of the country paying higher rates for new deposits, and shovelling their new funds out the door to all and sundry, including their insiders. The hydraulic pressure of this sudden change will be too great to be contained by bank examinations.

The ten dissenters on the House floor, an eclectic group, included Representatives Cooper (D.Tenn.), Jo Ann Davis (R.Va.), De Fazio (D.Ore.), Flake (R.Az.), Paul (R.Tex.), Rohrabacher (R.Cal.), Royce (R.Cal.), Sanders (I.Vt.), Stark (D.Cal.), and Taylor (D.Miss.). Maryland's congressional delegation, headed by the ranking minority member of the Senate Banking Committee, Sen. Paul Sarbanes, appears to have been totally somnolent, though it has every reason to be well acquainted with this problem. One must hope that the numbers of the opponents will increase in January. Whatever good is done by the budget cuts in the Budget Reconciliation bill is likely to be more than undone by the ultimate effects of this change, if it is allowed to survive.

George Liebmann is volunteer Executive Director of the Calvert Institute in Baltimore, and the author of The Common Law Tradition: A Collective Portrait of Five Legal Scholars (Transaction Books,2005)

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