What is FDIC Insurance and how does it work?  Why do my tax dollars pay for FDIC Insurance?

FDIC stands for Federal Deposit Insurance Corporation.  It was formed in 1933 by the Glass-Steagall Act.  Don’t confuse corporation though, you won’t find them on the New-York Stock Exchange.  They are a government entity, but remain independent.  Similar to the Federal Reserve.  They are not funded by the government, the FDIC makes all of its money from premiums paid by the member banks.  Let me restate - the FDIC is not funded by the government, Congress, or taxes, their revenue comes from premiums paid by banks.  When a bank fails, the FDIC loses money, just like any corporation would, not the taxpayers.  If you don’t get it yet I’ll have to escort you to the Weakonomics door, which opens to the vacuum of space.

The FDIC was the result of the massive bank failures in the early 1930s.  It is a stabilizing mechanism just like The Federal Reserve and all the other banking law that came out of the Great Depression.  Since the FDIC was created, not a penny of insured deposits have been lost as a result of bank failure.  What are insured deposits?  The FDIC’s product is deposit insurance.  When I open an account at my local bank, I might deposit $12,000.  The bank uses that $12,000 to invest or loan out at their discretion, this is how they make money.  Well that technically means that my $12,000 is currently not sitting in a safe waiting to be withdrawn.  The bank pays a fee (percentage of the balance of my account) to the FDIC to insure the deposits.  If I go to the bank and they can’t give me my $12,000 the FDIC can.

Its just like any other insurance.  If it were car insurance, you would be the guy that got hit.  The drunk that hit you is the bank, and his car insurance company will buy you a new car.

There are limits on the amounts of money they can insure.  They’ll do just about any deposit account, checking, savings, CDs, and even IRAs, but you can only put so much into an account before the FDIC cuts you off.  If you are a single person and no one is on your accounts, FDIC will cover the first $100,000 in any account at a specific bank.  Say you have a Savings, Checking, and CD account at Bank of America.  The sum of their balances is $150,000.  The FDIC will insure $100,000 of that and $50,000 will not be.  The FDIC site has a great chart at the bottom of this link that provides another example.  If the accounts are joint (as in two people own the accounts) then the insurance is for $200,000.  In my example if you and your spouse owned those accounts, your covered completely.  If the sum of the balances were $250,000 and you are joint then (1. y’all have way too much cash on hand and 2.) y’all are covered for all but $50,000.

They don’t just sit around and rake in insurance premiums, they are a government agency after all.  The Chairman Sheila Blair and her Jedi Council Board of Directors are also a crack team of investigators.  Through their various offices across the country, the FDIC reviews the specific situations of every bank they insure.  Various financial ratios and monitoring mechanisms are used to identify the strong and weak financial institutions.  If a bank is at risk they move in and take over.  Every once in a while a small bank will collapse and they do their thing.  Since banking is so uniform, the bank can fail on a Friday, sell on Saturday, and a new bank will be open on Monday.  Most customers wouldn’t even notice until the sign on the building changed or if the press gets a hold of the news.  Its an efficient and trouble-free process for most everyone, hear the FEMA?

Independence from the Congressional oversight has its advantages, but the representatives on the Imperial Senate House and Senate will sometimes change the rules.  In 2005 they passed a bill that was basically a bit of accounting work.  A couple of different insurance funds were combined to create the current FDIC Insurance fund known as the DIF (Deposit Insurance Fund).  Currently the fund is hanging out just below $50 billion after IndyMac failed (previously it was about $52 billion).  When the fund becomes less than 1.15% of all insured deposits, the FDIC is required to come up with a process to increase that percentage above the threshold again, usually in the form of increased premiums.  The FDIC should be working on this now, as IndyMac and a few other failures brought them down to just over 1%.  Since the FDIC is a government agency, it doesn’t do them much good to make a profit.  The rules thusly say if the DIF grows above 1.50% of insured deposits they must distribute the excess back to the banks.

There are a few final bits I need to wrap together with the FDIC.  First of all, you’ll notice the interest rate on deposit accounts usually gets sweeter once you crest the $100,000 mark.  ING Direct’s checking account goes from 3.2% to 3.4% at this mark.  This is partially due to the fact that the bank will not have to insurance on the funds above $100,000.  However there are very few people on this planet (no you aren’t one of them) that needs to keep that kind of cash on hand.  Invest it and keep your deposits below the threshold.  Likewise, if you’re the type that does need this kind of cash, keep it at a smaller bank.  Why?  Because IndyMac, despite its medium size wiped out about 9% of the fund.  If one of the big banks fails, the fund is toast.  If the fund is wiped out then FDIC Insurance won’t mean much.  If a small bank fails, the FDIC can easily deal with it.  Besides, the smaller banks will usually offer better rates anyway for reasons I won’t go into today.

FDIC Insurance is one of the few government bodies that makes sense.  They do their job, and stay out of the way to let capitalism work.  They’re efficient, reliable and smart.  Do I think the insurance fund should have more than 1.5% in it?  Maybe.  But then again we all know what the government does with a surplus.

Related posts:

1. Weakon 152: How Insurance Companies Make Money
2. Weakon 151: Banking Industry Explained, Part 2
3. Weakon 151: Banking Industry Explained, Part 1
4. Weakon 231: How the Mortgage Industry Works (or Worked!)
5. Why Do Accounts Have Minimums?

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