One of the most unappreciated lessons of the collapse of Northern Rock is the importance of America's deposit insurance system in times of crisis.
In September the Bank of England was driven to issue an emergency loan to the mortgage lender after it was unable to raise funds in the financial marketplace. The old-fashioned "run on the bank," complete with long lines of depositors clamoring to withdraw their funds, only exacerbated the problems.
Though the end of the Northern Rock story has yet to be written, and likely will end with a rescue by private investors, Northern Rock has borrowed $46 billion, or about $1,500 for every U.K. taxpayer, from the Bank of England to keep its operations afloat. Even if the new owner repays all that debt, it is a stark reminder of just how costly an unmanaged bank failure can be to the American taxpayer.
For nearly half a decade Sen. Mike Enzi, R-Wyo., and I worked in a bipartisan manner on the unglamorous issue of modernizing the federal deposit insurance system. We focused on how to craft comprehensive reform that responded to the critical weaknesses in the system, while respecting the needs of the financial services community and ensuring that people across the country could keep their money safe and local.
Many banks were unhappy at the prospect of being forced to pay premiums to insure their deposits, but it is increasingly evident that those premiums are a small price to pay for economic stability.
The overarching goal of the Federal Deposit Insurance Reform Act of 2005 was to manage the pro-cyclical nature of risk to the Deposit Insurance Fund. It calls on the Federal Deposit Insurance Corp. to require banks (based on individual risk profiles) to build up the fund in good times, so that in bad times institutions are not put under additional stress to prop the fund up.
The legislation merged the Bank Insurance Fund and the Savings Association Insurance Fund into one fund that would insure all banks and savings and loans. In addition, Congress gave the FDIC more flexibility to manage the fund and to charge true risk-based premiums, and it directed the FDIC to provide credits to banks that had helped build up the funds to ensure banks that had received free coverage for years would contribute their fair share.
Congress also mandated that the FDIC provide rebates when the fund exceeds certain thresholds.
Finally but significantly, the bill raised coverage levels for retirement accounts to $250,000, allowing retirees to keep their accounts safe and close to home. It likewise mandated indexation of both general and retirement account coverage every five years to create a predictable, nonpolitical mechanism for deposit coverage to keep pace with inflation.
In England, the deposit insurance system is very different from ours. The amount covered is much lower — roughly $4,000 is fully protected per individual, and Britons are covered for 90% of their next $68,000. This is compared to the FDIC's coverage levels of $100,000 for nonretirement accounts and $250,000 for retirement accounts.
Under the British system, most depositors stood to lose money if Northern Rock failed. Additionally, many feared that reimbursement for insured deposits could take up to six months. It is no wonder, then, that depositors lined up to withdraw their money. The anemic British deposit insurance system may well have accelerated the runs on Northern Rock.
There is no denying that the U.S. banking system has been affected by the global credit crunch. However, even if conditions deteriorate further, we can have confidence that failures will be dealt with in an orderly fashion.
Depositors should have well-founded confidence that their insured assets, whether they be cash for everyday expenses or a retirement nest egg, are safe and accessible.
