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A regulatory regime that makes depositors whole when a bank fails due to not managing their interest rate risk appropriately but not when they mismanage their c

A regulatory regime that makes depositors whole when a bank fails due to not managing their interest rate risk appropriately but not when they mismanage their credit risk feels even stranger than just admitting that the fdic cares more about some depositors than others.

FreakLegion 4y ago
First Republic now has a sweep account that spreads up to $100m across 400 banks in increments of up to $FDIC_INSURANCE_LIMIT. What's the difference between the FDIC insuring all deposits at US banks directly and US banks doing it themselves by forming a complete graph? (Other than there being a clear upper limit in the latter case, which is currently greater than $1b per account.)
- mercyandgrace 4y ago
  Insurance only pays out to $FDIC_INSURANCE_LIMIT if a bank fails. I can't say what the scenario looks like where 400 banks fail simultaneously, but I can image it would not be good. I'm not sure the current FDIC payout models account for that, either.
  - Gunax 4y ago
    I agree about 400 banks failing would likely be due to some greater catastrophe. But financially I think it's the same. If 400 customers each use 1 bank each, then a single bank failure means the FDIC needs to make whole one customer. But if every customer put 1/400th of their wealth into each of the 400 banks, then FDIC has to cover all customers for 1/400th each. The cost to us as depositors/taxpayers is equal.
    - mercyandgrace 4y ago
      I'm not sure I'm following. If the FDIC only needs to insure 1/400 of all deposits, then they only need to have on balance 1/400 of the total funds. So the cost to all accounts is in effect 1/400, no? If customers are only utilizing a single bank, and the FDIC will insure all deposits regardless of amount, they would need 400 times as much than would be necessary if the balances were swept.
      - FreakLegion 4y ago
        The FDIC insures the entirety of the deposits either way. > Insurance only pays out . . . if a bank fails That's a good point. So one difference is that while the money is equally insured in both cases, the payout dynamics would change. Very roughly, the amount of a payout might be expected to go down in the cross-bank case (smaller account values, but then also more accounts per bank, so it isn't quite so simple), and the likelihood of a payout might be expected to go up (higher chance of failure with more and smaller banks). But this all depends on how interlocked the banks become; in the extreme they could end up functionally a single bank. The first thing that came to mind for me is somewhat related: Spreading deposits across banks is relatively better for small banks and worse for big ones, since the small banks gain deposits and the big banks lose them. So you can definitely argue there's some advantage to keeping a lower insurance limit, although it gets murkier when we bring behavioral considerations and "too big to fail" into the picture.
        mercyandgrace 4y ago
        >The FDIC insures the entirety of the deposits either way. This is new with SVB. I get the whole "250K minimum" argumemt, but this is the first where we are seeing major 10M++ depositors getting 100% guarantees. I don't see issue with spreading money across smaller banks - other than perhaps they may not be able to assess risk as well as larger banks. But again, SVB. I think one thing to keep in mind is that most bank depositors hold far, far less than the 250K guaranteed by FDIC. By a large margin. Id be surprised if the average was above 10K. There are $17T in deposits across the country [1]. The FDIC at the beginning of the year had $128B in balance as insurance to depositors [2]. [1] https://fred.stlouisfed.org/series/DPSACBW027SBOG https://fred.stlouisfed.org/series/DPSACBW027SBOG [2] https://www.fdic.gov/analysis/quarterly-banking-profile/index.html https://www.fdic.gov/analysis/quarterly-banking-profile/inde...
        FreakLegion 4y ago
        If you look through the thread I replied to and the broader conversation, some people objected to backstopping deposits without limit and think rates have to go up if this is the new status quo. The question is in what way(s) does it matter whether deposits are insured without limit in a single account, which is new, or with limits when spread across an arbitrary number of accounts, which isn't? If one costs 1x, why should the other cost > 1x? It's a serious question. FDIC assessment rates aren't as simple as tax brackets and for example it's possible that the act of spreading deposits across more accounts in more banks would increase the fees paid into the existing system anyway.
    - lmm 4y ago
      > But if every customer put 1/400th of their wealth into each of the 400 banks, then FDIC has to cover all customers for 1/400th each. Seems like having everyone use at least 400 different banks achieves one of the core goals of the FDIC guarantee - making small/midsize banks viable and preventing everyone from piling into the big four megabanks.
btilly 4y ago
That's not an accurate summary. The regulatory regime is one that makes depositors whole when doing otherwise seems likely to cause a major crisis in the banking system. Which we've had for a long time. It merely seems inconsistent because evidence of "likely to cause a major crisis" differs by current possible crisis. As https://www.bitsaboutmoney.com/archive/banking-in-very-uncertain-times/ https://www.bitsaboutmoney.com/archive/banking-in-very-uncer... explains in painful detail, the reasons why they likely concluded that there is systemic risk. But long story short, rising interest rates caused the banking sector to have $620 billion in unrealized losses. Unsurprising since the interest rate rise was *INTENDED* to make people lose money, making money more valuable relative to goods and services, which reduces inflations. But $620 billion is substantially more than the $130 billion in the FDIC insurance fund. It is substantially less than the $2 trillion in equity in the banking sector, but both losses and equity are unevenly spread. Therefore there are banks under water, and others that are fine. But nobody is sure which are which. And given cash outflows from worried people, we were about to find out the hard way. And once there is a bank panic, even fine banks become not fine. Like Wile E. Coyote, running off this cliff works fine until you look down. But we've looked down. And now the whole sector needs saving. Thus these actions. They will go back to normal behavior once the crisis is over.

FreakLegion 4y ago

First Republic now has a sweep account that spreads up to $100m across 400 banks in increments of up to $FDIC_INSURANCE_LIMIT. What's the difference between the FDIC insuring all deposits at US banks directly and US banks doing it themselves by forming a complete graph? (Other than there being a clear upper limit in the latter case, which is currently greater than $1b per account.)

mercyandgrace 4y ago
Insurance only pays out to $FDIC_INSURANCE_LIMIT if a bank fails. I can't say what the scenario looks like where 400 banks fail simultaneously, but I can image it would not be good. I'm not sure the current FDIC payout models account for that, either.
- Gunax 4y ago
  I agree about 400 banks failing would likely be due to some greater catastrophe. But financially I think it's the same. If 400 customers each use 1 bank each, then a single bank failure means the FDIC needs to make whole one customer. But if every customer put 1/400th of their wealth into each of the 400 banks, then FDIC has to cover all customers for 1/400th each. The cost to us as depositors/taxpayers is equal.
  - mercyandgrace 4y ago
    I'm not sure I'm following. If the FDIC only needs to insure 1/400 of all deposits, then they only need to have on balance 1/400 of the total funds. So the cost to all accounts is in effect 1/400, no? If customers are only utilizing a single bank, and the FDIC will insure all deposits regardless of amount, they would need 400 times as much than would be necessary if the balances were swept.
    - FreakLegion 4y ago
      The FDIC insures the entirety of the deposits either way. > Insurance only pays out . . . if a bank fails That's a good point. So one difference is that while the money is equally insured in both cases, the payout dynamics would change. Very roughly, the amount of a payout might be expected to go down in the cross-bank case (smaller account values, but then also more accounts per bank, so it isn't quite so simple), and the likelihood of a payout might be expected to go up (higher chance of failure with more and smaller banks). But this all depends on how interlocked the banks become; in the extreme they could end up functionally a single bank. The first thing that came to mind for me is somewhat related: Spreading deposits across banks is relatively better for small banks and worse for big ones, since the small banks gain deposits and the big banks lose them. So you can definitely argue there's some advantage to keeping a lower insurance limit, although it gets murkier when we bring behavioral considerations and "too big to fail" into the picture.
      - mercyandgrace 4y ago
        >The FDIC insures the entirety of the deposits either way. This is new with SVB. I get the whole "250K minimum" argumemt, but this is the first where we are seeing major 10M++ depositors getting 100% guarantees. I don't see issue with spreading money across smaller banks - other than perhaps they may not be able to assess risk as well as larger banks. But again, SVB. I think one thing to keep in mind is that most bank depositors hold far, far less than the 250K guaranteed by FDIC. By a large margin. Id be surprised if the average was above 10K. There are $17T in deposits across the country [1]. The FDIC at the beginning of the year had $128B in balance as insurance to depositors [2]. [1] https://fred.stlouisfed.org/series/DPSACBW027SBOG https://fred.stlouisfed.org/series/DPSACBW027SBOG [2] https://www.fdic.gov/analysis/quarterly-banking-profile/index.html https://www.fdic.gov/analysis/quarterly-banking-profile/inde...
        FreakLegion 4y ago
        If you look through the thread I replied to and the broader conversation, some people objected to backstopping deposits without limit and think rates have to go up if this is the new status quo. The question is in what way(s) does it matter whether deposits are insured without limit in a single account, which is new, or with limits when spread across an arbitrary number of accounts, which isn't? If one costs 1x, why should the other cost > 1x? It's a serious question. FDIC assessment rates aren't as simple as tax brackets and for example it's possible that the act of spreading deposits across more accounts in more banks would increase the fees paid into the existing system anyway.
  - lmm 4y ago
    > But if every customer put 1/400th of their wealth into each of the 400 banks, then FDIC has to cover all customers for 1/400th each. Seems like having everyone use at least 400 different banks achieves one of the core goals of the FDIC guarantee - making small/midsize banks viable and preventing everyone from piling into the big four megabanks.

btilly 4y ago

That's not an accurate summary. The regulatory regime is one that makes depositors whole when doing otherwise seems likely to cause a major crisis in the banking system. Which we've had for a long time. It merely seems inconsistent because evidence of "likely to cause a major crisis" differs by current possible crisis. As https://www.bitsaboutmoney.com/archive/banking-in-very-uncertain-times/ https://www.bitsaboutmoney.com/archive/banking-in-very-uncer... explains in painful detail, the reasons why they likely concluded that there is systemic risk. But long story short, rising interest rates caused the banking sector to have $620 billion in unrealized losses. Unsurprising since the interest rate rise was *INTENDED* to make people lose money, making money more valuable relative to goods and services, which reduces inflations. But $620 billion is substantially more than the $130 billion in the FDIC insurance fund. It is substantially less than the $2 trillion in equity in the banking sector, but both losses and equity are unevenly spread. Therefore there are banks under water, and others that are fine. But nobody is sure which are which. And given cash outflows from worried people, we were about to find out the hard way. And once there is a bank panic, even fine banks become not fine. Like Wile E. Coyote, running off this cliff works fine until you look down. But we've looked down. And now the whole sector needs saving. Thus these actions. They will go back to normal behavior once the crisis is over.