At the end of this month, a federal deposit insurance program created during the crisis and extended by Dodd-Frank is scheduled to come to an end. Under the so-called TAG (transaction account guarantee) program, the Federal Deposit Insurance Corporation provides unlimited insurance for noninterest-bearing transaction accounts, such as business checking accounts. Fans of the program are asking for its renewal. Rather than allow TAG to become a lasting, troublesome feature of our already flawed deposit insurance regime, the program ought simply to expire as planned.
Federal deposit insurance is generally defended as a way to prevent bank runs and protect small depositors. It is designed to avoid scenarios in which Mom and Pop - if they don't beat a fast enough path to the door when a bank is failing - lose their nest egg. Under our current deposit insurance scheme, Mom and Pop can pick any bank they want without thinking about how well it is managed.
Deposit insurance, however, has a nasty unintended consequence - moral hazard. The deposit insurance system doesn't reward bankers for being sensible and doesn't punish them for being careless, so bankers are inclined to think less carefully about risks they are taking than in a world without deposit insurance. The deposit insurance fund, with its taxpayer (a.k.a. Mom and Pop) backstop, stands ready to eat the losses incurred by careless bankers.
Deposit insurance systems can be designed to minimize their harmful side effects. For example, sensible caps can be set on the amount that deposit insurance will cover. If deposit insurance is set at a level that fully covers the average family's deposits, but leaves larger depositors partially exposed to losses, the latter have an incentive to keep their deposits in prudently run banks. Banks, in order to compete for large depositors, will behave more prudently. Subjecting banks to monitoring by large depositors, in addition to regulators, is good for the banks and for taxpayers.
The U.S. federal deposit insurance system does not employ a meaningful cap. To the contrary, the current non-TAG cap is $250,000 per depositor, which is far more than the average family has in its bank account. While it might not be reasonable to expect everyone to interview bankers about their risk management practices, it is quite reasonable to ask depositors with $50,000 or $100,000 cash on hand to do a little due diligence before deciding where to put their money.
The TAG program, with its unlimited cap on coverage, is an even more egregious violation of the rules of sound deposit insurance than is the $250,000 cap. The absence of a cap sends a very clear "don't worry; the government has your back" message to all depositors, including the very largest. As a consequence, banks are monitored less and taxpayers are exposed to more losses. This attitude could cause serious pain for the taxpayers this program intends to protect.
The most sophisticated depositors have taken this message to heart and are not giving a second thought to how sound their banks are. In October, the Wall Street Journal quoted the assistant treasurer of Lululemon Athletica, who observed that once TAG ends, "we'll have to go back to evaluating credit risk, rather than sovereign risk." Corporations should not feel put out by having to consider the financial well-being of the banks at which they have accounts. They make similar assessments every day about other companies with which they do business.
If Congress does nothing more, the TAG program will simply expire. Although by no means a comprehensive solution to the absence of market accountability in the banking sector, allowing TAG to end would at least be a small step toward market accountability.