Thoughts on Deposit Insurance

Government guarantees have become the norm in the financial system. According to the latest Federal Reserve Bank of Richmond (2017) estimate, the U.S. government’s safety net covers 60% of private financial liabilities in the United States. Serious underpricing of government guarantees gives intermediaries the incentive to take risk that can threaten the entire financial system: the Great Financial Crisis of 2007-09 is the most obvious case in point.

Deposit insurance is arguably the oldest and most widespread form of government guarantee in finance. In the United States, Congress established the Federal Deposit Insurance Corporation (FDIC) at the depth of the Great Depression in 1933 to help prevent bank runs. Today, more than 140 countries have some type of deposit insurance scheme.

In this post, we briefly review the evolution of FDIC deposit insurance pricing. We highlight evidence that, largely because of Congressional mandates, the federal insurance guarantee was underpriced for many years. It is not until 2011, following the crisis of 2007-09, that the FDIC introduced the current framework for risk-based deposit insurance fees, bringing insurance premia closer to what observers would deem to be actuarially fair.

Going forward, as with any insurance regime, keeping up with the evolution of bank (and broader financial system) risks will require a willingness to update the deposit insurance pricing framework from time to time. That means adjusting pricing to reflect both the range of bank risk-taking at a point in time and—to ensure the sustainability of the deposit insurance fund without taxpayer subsidies—the evolution of aggregate risk….

FSOC and Systemic Risk: Treasury's Report

In response to the financial crisis of 2007-2009, Congress created the Financial Stability Oversight Council (FSOC), a committee of the chiefs of the U.S. regulatory agencies, chaired by the Treasury Secretary, to monitor and secure the stability of the financial system. Critical to this task is the FSOC’s authority to designate nonbanks as “systemically important financial institutions” (SIFIs).

On November 17, the U.S. Treasury issued a report assessing the FSOC’s designation process. Treasury calls on the FSOC to adopt a strategy that prioritizes the regulation of activities or functions—affecting whole sectors of the financial industry—over regulation based on entity or legal form (such as the designation authority). For the most part, we find this sensible, as this focus reduces the scope for regulatory arbitrage that an entities-only approach may foster (see here).

However, we doubt that activities-based regulation alone will be sufficient to limit systemic risk. Our overall conclusion is that the Treasury’s approach sets the bar for FSOC designation too high, diminishing its deterrence effect on undesignated nonbanks. In the end, a sensible focus on both entities and activities is needed to fulfill one of FSOC’s key objectives—to restore market discipline. Adopting the Treasury’s proposed framework will not meet the goal, set out in the President’s Core Principles for Regulating the U.S. Financial system (see Executive Order 13772), of preventing taxpayer-funded bailouts....

Saving for retirement

The biggest question facing anyone considering retirement is financial: are my savings sufficient to provide for my lifestyle for the rest of my life? For the fortunate among us, the answer is yes. But for a large fraction of the population, the answer is likely no.

The typical U.S. household has few retirement savings. The National Institute on Retirement Security reports that the median for near-retirement households is $12,000, while that for all households is only $3,000. Most people are relying on government social security to meet their retirement needs.

There are many reasons for this. One is the reduction in the fraction of employers offering any retirement plan at all, and another is the shift away from defined-benefit (DB) and toward defined-contribution (DC) pension plans. The result is that many individuals face risks that they are not equipped to bear, and many households need to save substantially more than they would have had these changes not occurred....

Financial Innovation and Risk Management

In 2013, Robert Shiller shared the Nobel Prize for Economics with Eugene Fama and Lars Peter Hansen for their research on asset pricing. While Shiller is known as a critic of the efficient markets hypothesis and as a proponent of behavioral finance, less appreciated is his work on advancing financial technology to help societies manage fundamental economic risks.

At a time when the recent crisis has given financial innovation a bad name, Shiller’s contrarian message is that well-designed financial instruments and markets are an enormous boon to social welfare. We agree.

Do U.S. Households Benefit from the Great Moderation?

Something odd has happened to the U.S. economy over the past 30 years. Aggregate income (measured by real GDP) has become more stable (even including the 2007-2009 Great Recession). But, at the household level, the volatility of income has gone up. Put differently, families face greater income risk than in the past despite generally fewer or smaller economy-wide wobbles. What should we make of this?

Commentary

Money, Banking, and Financial Markets