cancel fdic insuranceSo the economy is in terrible shape, no one is spending money, everyone is saving. Banks have money, but aren’t lending. The government, whether is be the White House, Congress, or The Fed, have all tried to stimulate the economy and at best they’ve prevented a depression (so far). Should the economy continue to slow down and re-enter recession, I have a great idea to bring us back:

Cancel the FDIC

Okay, maybe just the insurance they provide. Sounds stupid right? Maybe not so much. Look at what FDIC insurance provides. It allows banks to lend out deposits in the form of mortgages, car loans, and even government bonds. The bank may loan out 75 cents of every dollar so if everyone came looking for their cash at the same time the bank wouldn’t be able to pay everyone back (Remember the scene from It’s a Wonderful Life?). FDIC insurance makes depositors whole. When recessions hit, we cut our spending and increase savings. We put our money in banks because (now) we can be promised to be paid back $250,000 if the bank runs out of money; which is backed by the faith and credit of the US government.

By canceling FDIC insurance, I’d create a run on the bank. People would pull their money out of banks and put it under their beds. The FDIC would make people whole using their fund and the line of credit they have with the Treasury. The Treasury was going to print money anyway, so why not do it this way and put the money back in the hands of the people? The banks weren’t lending anyway. Canceling FDIC insurance would shock the system.

The shock would be nothing short of the most widespread economic panic in the history of man, but sometimes you got to hit the reset button. Banks would fall, the stock market would collapse, or would they? The flight of cash out of deposits will end up under beds. But people will also start spending because of inflation concerns. Banks would survive because The Fed would keep interest rates low and allow them to borrow for essentially nothing to keep operations afloat. The money supply would double in a matter of weeks. Deflation concerns die. Inflation takes off, which increases the value of assets, including real estate. All of a sudden, people aren’t underwater on mortgages anymore. They can’t afford iPhones anymore because they spend $100 a week on bread, but like I said we’re shocking the system.

Over time the stock market outpaces inflation so people may be tempted to give their deposits to Wall Street to protect their money. But the stock market can’t beat hyperinflation. To return the economy to stability the FDIC will be rolled out again. You won’t see a mass of returning deposits because people will fear the system. So over a decade we see things calming down as the trust returns. The FDIC will collect premiums on the deposits from the banks, and with The Fed slowly decrease the money supply. Economic growth would be limited by this, but the stabilizing system alone should provide the source for growth.

Is canceling the FDIC really a good idea? Of course not. It’s not fair to the people that would suffer the hit a reset button. But this walk through what would happen to the economy if the FDIC was shut down is an interesting way to look at the economy. Instead of trying to boost spending or save the economy by stimulus, why not at least have a conversation about what would happen if the economy was forced to take a cold shower instead?

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categories: banking, economics, government