The Northern Rock Bank Run & Outdated FDIC Limits

Photo By
Dominicspics, Used Under CC licence.

When I was in high school, I remember reading about how the Federal Deposit
Insurance Corporation was set up
during the Great Depression as a way to ensure people that their deposits would
be safe. FDIC
guaranteed up to $100,000 would be protected no matter if a bank failed. It
was an amazing sum to a kid earning $3.35 an hour flipping burgers. Who would
ever hit that limit?

Well, I earn more than $3.35 these days. Moreover, due to the oddities of how
the UK takes in tax payments from self-employed workers (you don’t pay for up to
a year after earning), that limit has been something I’ve had to think about
for. It actually seems low to me now.

The corresponding type of bank insurance in the UK — the
Financial
Services Compensation Scheme — is less generous. It covers about $63,000 –
and only the first $4,000 of that is fully covered. The remaining $59,000 is
only covered up to 90 percent.

The limit in the UK is getting a fresh look in the wake of the Northern Rock
bank run. This is a major UK bank that needed the Bank Of England to promise
support as it ran short of funds. That freaked depositors out,

who swooped in over the weekend and lined up to make withdrawals.

Today, I

read in the Daily Telegraph on how the limit might be raised.

Those that designed the scheme argue that the limit of £31,700 should be
ample cover for most people. According to the British Bankers Association, the
average saver has £8,500 deposited in their bank.

However, as one Treasury insider said yesterday, "we are in a whole
different territory with Northern Rock", pointing out that no one envisaged a
run on a high street bank. Most of those queueing had savings well over
£31,700, some had more than £1 million.

Hector Sants, the chief executive of the Financial Services Authority,
admitted yesterday that the scheme does have limitations, particularly with
large deposits. "It does seem reasonable to conclude that that may well have
been a contributing factor here to the loss of confidence with Northern Rock
depositors."

While 25 out of 27 European countries have lower limits than the UK, France
and Italy are more generous, with Italy promising to pay out £70,000.

In the US, 100 per cent of savers’ deposits are guaranteed up to £49,000,
with financial institutions funding an insurance fund of £29?billion. The Bank
of England has hinted that it would like to adopt a US-style approach,
guaranteeing 100 per cent of someone’s savings and raising the limit.

Raising the UK limit would be nice, but the US limit itself is low for even
average earners. Need some proof of this? Consider Emigrant Direct. This is an
online bank for the US that offers very high interest rates. That means plenty
of people want to shove money into it. So much money, in fact, that the

FAQ page talks about how to get more out of FDIC insurance:

Safe and Secure – FDIC Insured Your deposits at Emigrant Direct are FDIC
insured up to $100,000 per depositor. Keep in mind that individual and joint
accounts are insured separately, so if you have both types of accounts with us,
your total deposits can be insured up to $200,000; that’s up to $100,000 in all
of your individual accounts, and up to an additional $100,000 in all of your
joint accounts.

Heck, they’ve even made a special

chart (PDF) to guide people more. You simply don’t address this type of
question in a FAQ and with special materials unless you’re getting asked a lot
about it.

Consider also this. The limit was last set in 1980, raised from $40,000 to
$100,000. The last
reform bill
passed in 2006 kept the $100,000 level, with the next review of possibly
raising the limit not happening until 2011, and then that would be based on
inflation.

Ah, inflation. So that $100,000 of coverage set in 1980? Let’s head over
to this
conversion calculator to see how much that’s worth in today’s dollars. Turns
out, around $41,000.

Now, I came across one
argument from back
in 2002 suggesting that’s all fine:

The ABA conveniently ignores the earlier history of deposit insurance. From
1934, when coverage first took effect, to the early 1970s, the level of
insurance more or less tracked inflation. When the limit rose to $40,000 from
$20,000 in 1974, that increase was more than enough to compensate for any loss
in the dollar’s purchasing power. And when the limit increased again to
$100,000, the coverage actually outpaced inflation by $70,000. Even now,
assuming a 3% annual inflation rate, the current limit will maintain its value
until 2020.

Alan Greenspan

argued at that time that relatively few depositors hit that limit, and those
that did were good at splitting up larger amounts between banks, and that
raising the limit would just cause depositors to gamble on risky banks.

The Congressional Budget Office, in 2005, apparently also recommended not
raising the limit for some of the same reasons. This
paper has
arguments, plus this interesting chart:

That shows you the relative amount of FDIC insurance over the years. IE, when
FDIC started in 1933, it was for $2,500 — which was about $50,000 in in 2000
dollars, which the chart above is based around. That big spike is when the limit
rose from $40,000 in 1980, which was worth around $200,000 of 2000 dollars.

The argument is that even today, the rate is well above some historic limits.
Ah, economists — I guess they got me. But then again, it still feels like that
rate should come up. Perhaps a run on a US bank might change things.