Bailing Out a Bailer-Outer

Lessons of the FDIC's predicament

AMERICANS have faced scary scenarios during this financial crisis but not, thankfully, the ultimate catastrophe: a run on the banks. Even as bank after bank failed, or came close, depositors remained calmly at home, safe in the knowledge that they would ultimately get their cash. For this, credit the Federal Deposit Insurance Corp., established during the Great Depression to prevent a repetition of the bank runs in that miserable era.

So it is disconcerting to learn that the FDIC has, for all intents and purposes, run out of cash. Buffeted by the greatest number of financial institution failures since the savings and loan crisis of the 1980s and 1990s -- 97 this year -- the FDIC has run through $50 billion in reserves. It projects another $50 billion in losses before the wave crests sometime next year. Consequently, the FDIC has turned to banks themselves for a bailout, seeking $45 billion in accelerated insurance contributions that would otherwise have fallen due over the next three years.

The plan enables the FDIC to reassure taxpayers that it is not hitting them up directly, which it could have done by tapping its line of credit with the Treasury Department. To be sure, some of the biggest projected contributors to the FDIC, such as Bank of America and Citigroup, are themselves being propped up with Treasury funds. Otherwise, they would have crashed and quite possibly brought the FDIC down with them. Also, if things get even worse than the FDIC assumes, it can and probably will turn to the Treasury anyway. One way or another, the U.S. government stands behind the banks and their depositors, up to $250,000 per account.

Now is hardly the time to rethink the FDIC from the ground up. But its parlous situation is a reminder that, for all its success, the institution must adapt to modern circumstances. The FDIC probably should hold bigger reserves; it has addressed that by permanently raising the insurance premiums for banks starting in 2011. One cause of the current crisis was moral hazard: Assuming government would ride to their rescue, investors and managers took too many risks. The FDIC, in its own small and mostly necessary way, contributes to moral hazard by building a safety net under the banks. As part of a regulatory overhaul, Congress should consider a proposal by Gary Stern, the former president of the Minneapolis Federal Reserve: Guarantee the largest depositors -- companies, foundations, government agencies and wealthy individuals -- for slightly less than the amount small depositors are guaranteed. Imposing a modest but meaningful "haircut" on these relatively sophisticated parties would not drive them away from banks; rather, it would give them more incentive to police the soundness of institutions where they park their cash. In that job, government can use all the help it can get.