Evolution of Deposit Insurance in America – The FDIC

This is the first of a series of articles that look at the evolution of deposit insurance in America. This article presents an overview of deposit insurance in America, with an emphasis on the Federal Deposit Insurance Corporation (FDIC).

There’s nothing like failure to inspire change. The run on banks during the Great Depression led to the creation of federal deposit insurance. It protects depositors, completely or partially when banks find themselves so financially strapped they cannot pay their debts. The Glass Steagall Banking Act of 1932 and the National Housing Act of 1934 launched the federal deposit insurance system. For commercial banks and savings bank the agency was the Federal Deposit Insurance Corporation (FDIC) and for savings and loan institutions, it was the Federal Savings and Loan Insurance Corporation, (FSLIC), which was administered by the Federal Home Loan Bank Board (FHLBB). In the 1980s, the FSLIC went bankrupt which lead to the FDIC assuming responsibility for the Savings Association Insurance Fund (SAIF).

It’s ironic that nearly as many deposit insurance systems have closed as have opened in the United States, according to the paper, American Share Insurance: The Sole Surviving Private Insurer in the United States. Today the remaining primary deposit insurers include the FDIC, the National Credit Union Share Insurance Fund (NCUSIF) and the privately owned American Share Insurance (ASI).

The role of the FDIC is huge. No depositor has ever lost a penny of insured deposits since the FDIC was created in 1933. The FDIC went into temporary effect on January 1, 1934 and the deposit insurance level was $2,500. By 1950 the limit increased to $10,000 and continued to climb until 1980 where it went from $40,000 to $100,000 and stayed there until 2008 when the limit was raised to $250,000 where it remains today.

During the 1940s, the federal government’s funding of World War II contributed to the rise of banking assets. U.S. securities made up 57% of total banking assets. By 1946, the FDIC insurance fund had a balance of $1 billion. By 1960 that amount had more than doubled.

It was the 80s though, that would prove the testing ground for the FDIC. In the 70s, the economy slowed because of “stagflation,” the economic problem of excess capacity and unemployment coexisting with inflation and no economic growth. Things came undone. The S&L industry had massive amounts of low, fixed-rate mortgages from the 50s and 60s. Trouble was, the gap between what the S&Ls earned on those mortgages and what the S&Ls paid for new deposits eroded the capital of the S&Ls. They tried to make up for it largely with wild bets on real estate. The weakening real estate market and the fall in oil prices was the one-two punch that knocked many S&Ls out of play as they went bankrupt. During the 80s the FSLIC’s capital was depleted. To make a long story short, S&L and bank failures rose due to economic, financial, legislative and regulatory activities.

Just look what happened in 1984. That year, Continental Illinois National Bank in Chicago, with $34 billion in assets failed. Up to that year, it was the largest bank to fail in the FDIC’s history. The bank was weakened by its participation in Penn Square energy loans. Continental experienced a high-speed electronic bank run. Bank regulators propped up the bank with a $2 billion assistance package. The FDIC promised to protect all of Continental’s depositors and other creditors, regardless of the $100,000 limit on deposit insurance. It was deemed “too big to fail”. Also, that year was an ominous first – the FDIC spent more on resolving failures than it received in premiums.

The 80s also brought the Competitive Equality Banking Act of 1987 (CEBA), which was the first legislation to explicitly say that insured deposits are backed by the full-faith-and-credit of the U.S. government. CEBA authorized $10.75 billion to recapitalize the FSLIC over a three-year period and granted the FDIC bridge-bank authority.

Toward the end of the decade, in 1988, First Republic in Dallas and Houston, Texas, with $31.2 billion in assets, failed. It was the costliest FDIC resolution to date at $3.7 billion. A year later, the most important banking law since the Great Depression, the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) was created. This was one of the first statutory attempts to re-regulate the banking and S&L industry. This act authorized the use of taxpayer money to resolve S&L failures. Of much importance, it abolished the FSLIC, which had provided deposit insurance to S&Ls since 1934.

In 1989, 206 FDIC-insured banks with $29.2 billion in assets failed – the most in FDIC history. Two-thirds of the banks were in Texas. The S&L crisis which began in the early 1980s ended by in the mid-90s. The toll was devastating – 1,600 bank and 1,300 S&L failures.

The early 90s were rocky too. By the end of 1991, the FDIC’s Bank Insurance Fund (BIF) was insolvent to the tune of $7 billion. Among the many things, the Federal Deposit Insurance Corporation Improvement Act of 1991 did, was to give the FDIC the ability to borrow $30 billion from the U.S. Treasury to replenish BIF. By 1993 though, banks were rebounding with record profits of $43.1 billion. Only 41 FDIC-insured banks failed, the lowest in more than a decade.

The next crisis would come in 2008 when the economy tanked. That year, WaMu, with assets of $307 billion and $188 billion of deposits had the distinction of being the largest bank to fail in the U.S. To stem the potential bloodbath, JPMorgan Chase acquired WaMu’s banking operations in a deal facilitated by the FDIC. Depositors were fully protected and there was no cost to the Deposit Insurance Fund.

Soon after WaMu’s failure, a bailout of the U.S. financial system was enacted into law. Part of the bailout temporarily raised the standard maximum deposit insurance amount from $100,000 to $250,000 until December 31, 2009. In May 2009, another law extend the temporary increase in deposit insurance to December 31, 2013. Finally, the standard maximum deposit insurance amount was permanently raised to $250,000 on July 21, 2010 as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The financial crisis took a toll on the nation’s banks. The number of bank failures increased from 25 in 2008 to 157 in 2010. The year 2010 marked a turnaround for the bank industry and the FDIC. The number of bank failures started to fall after 2010. Also, the FDIC Deposit Insurance Fund began to climb out of a large deficit ($20.9 billion). By the end of 2010, the deficit had been reduced to $7.4 billion.

The bank industry and the FDIC Deposit Insurance Fund have continued to slowly improve since 2010. Each year since 2010, fewer banks have failed. Only eight banks failed in 2015, and as of the third quarter of 2016, only five banks have failed for the year and the FDIC Deposit Insurance Fund had a surplus of $80.7 billion.

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