ABSTRACT
By the end of the 1980s, it had become apparent that the U.S. government’s role as a financial guarantor posed an unprecedented threat to the taxpayer. President George Bush’s 1991 budget proposal acknowledged that all deposits held in U.S. banks, thrifts, and credit unions—approximately $3 trillion—are a contingent liability of the federal government. With this admission, the Administration registered both its concern about the escalating costs of financial failures and its ignorance about how to stop the rising numbers of bailouts. 2 According to the U.S. General Accounting Office (GAO), taxpayer exposure may be as high as $5 trillion if other financial guarantee and credit programs are taken into account. 3
Financial guarantee programs were originally designed to pay off depositors of failed institutions. But in the 1980s, they took on a different function: financing the buy-out of failed or failing banks. Mixing these two functions vastly escalated the government’s potential liability.
This chapter proposes a new system for providing financial guarantees—one that both insures individual savers and protects the capacity of financial institutions to support the transactions essential for economic stability and growth. A new system is needed for the obvious reason that the size of the government’s liability has gotten out of hand; whatever gains may accrue to individuals in their role as savers may well be lost when they are required, as taxpayers, to foot the bill. But there are other reasons as well: to separate the different purposes that government guarantees serve in protecting consumers/savers, communities, and the economy as a whole; to ensure that financial guarantees enhance, rather than impede, the role of the financial system in promoting economic growth; and to clear the way for revitalizing the government’s function as a guarantor and regulator in a new and different financial environment.
In the case of financial guarantee programs intended to protect savings, this chapter argues that coverage should be based on the aggregate holdings of individual 202savers rather than on individual accounts or institutions. Individuals would be protected from loss of a set amount, independent of whether their assets are confined to one institution or spread throughout a variety of accounts in federally regulated institutions: bank, thrift, or credit union deposits; mutual funds; or pension plans governed by the Employee Retirement Income Security Act (ERISA).
Providing equal coverage for different types of savings instruments held in federally regulated institutions means that all institutions must be regulated with equal attention to soundness and stability. That will require a corollary agenda for reform—an overhaul of the regulatory framework that revitalizes the tools of regulation to reflect current needs and practices.
In the case of protecting the funds needed for current transactions (e.g., payrolls, purchases, bills, and other payments that support ongoing economic activity), this chapter argues that limiting insurance for these accounts is unrealistic. For example, if even the smallest institution fails, the current $100,000 in coverage will not ensure that local payrolls are met. The subsequent interruption in payments down the line will result in a widening circle of losses.
Thus, all transactions accounts must be 100 percent insured. Insured transactions balances must be held in the form of non-interest-bearing demand deposits, in a federally regulated depository institution, and invested in a portfolio of loans and liquid assets that meets accepted standards of diversification in terms of economic sectors and maturity. Depository institutions will be allowed to deduct a reasonable amount from earnings on their investments for profits and to cover the cost of reserves that are held in the Federal Reserve banks. The remainder—the interest forgone by depositors—will be paid into the insurance fund.
To make the case for this new approach to federal financial guarantee programs, this chapter first outlines the history and purposes of financial guarantees and describes the structural changes that have undermined a system that worked so well in the past. It then presents detailed proposals for reforming federal insurance of savings and transactions deposits.
