In all the recent brouhaha over American International Group, very few have pointed out that AIG is not just an insurance company but also a THRIFT HOLDING COMPANY...the fact that AIG was a thrift holding company meant that several of its subsidiaries were, of course, receiving the deposit-insurance subsidy. I have frequently suggested that deposit insurance has played a bigger role in causing the current crisis than is generally acknowledged, and this just reinforces my suspicion. Not only might the moral hazard from leaking deposit insurance have encouraged excessive risk taking on the part of AIG itself. But this is probably one reason that AIG's counterparties put so much confidence in its credit default swaps.Jeff's going to be posting a more detailed comment on this at Liberty & Power.
Although neither bank nor thrift holding companies qualifies for deposit insurance directly, the FDIC or Fed had often bailed them out along with their depository subsidiaries prior to the current crisis.
I'm with Jeff in his thinking on the moral hazard damage that has been caused because of government near-blanket insurance against bank failures. It has literally taken away the fear of losing money from hundreds of millions of depositors, and has also taken away the eyes and ears of hundreds of millions of potential monitors, who have no reason to fear losing their money. Thus, taking away a very important check on irresponsible bank management.
Do you want a new regulatory system? Forget the Geithner proposal which will result in more control by insiders, eliminate FDIC insurance and you will have literally hundreds of millions of people trying to find out, real fast, which banks are safe, and which are not.
UPDATE: I hasten to add that in the world of realeconomik, you wouldn't end FDIC insurance overnight but rather announce its slow demise 12 months out, so that in 12 months you start lowering coverage, month 13 only 90% coverage, month 14 only 80%, etc.
Chris Whalen writes 3/24/09:
ReplyDelete"Speaking of poor fundamentals, when AIG released information about the amounts and recipients of roughly $100 billion of its government loans from September to December 2008, almost utterly unreported was the fact that the staid, boring, heavily regulated insurance businesses managed to run up losses on securities lending requiring $44 billion of government support.
By way of contrast, the credit derivatives widely blamed for bringing down the world's financial system were consuming $27 billion of support; municipal investment agreements (essentially, deposits) made by municipalities with AIG Financial Products took another $12 billion, and maturing debt took $13 billion. We wonder, just which unit of AIG lent the securities? What did AIG purchase with the proceeds of the securities loan? Could it be that the big story at AIG is the unsoundness of the insurer, not the credit default swaps? Why the misdirected coverage?"