Bank and Thrift Deposit Insurance and Regulation

Question 1

Were bank suspensions and losses to depositors prevalent from 1900 - 30s?

Answer 1

Suspensions prevalent, losses were small due to deposit insurance.

Question 2

Examples of legislation introduced int he 1930s in the wake of the GD?

Answer 2

1932: Interest on DD prohibited.
- Used to increase profit margins
- Anti-competitive measure such as the National Industrial Recovery Act (hoover)
DIDMC reversed this.
Eventually repealed by Dodd Frank, which reinstated interest on demand deposits (although insignificant due to low interest rate environment)

Question 3

Explain the 1933 Glass Steagall Act

Answer 3

Separated Investment Banking from Commercial banking
Commercial banks allowed to take insured deposits, may not underwrite securities
Investment banks allowed to underwrite new securities, not take deposits
BHCs also prohibited (no sharing of ownership)

Eventually repealed by Gram Leach Bliley Act, CB separately incorporated, allowed BHCs, firewalls however still in place.

Question 4

Explain the legislation surrounding the 1935 FDIC

Answer 4

Insures deposits up to 100,000 (now 250,000) per depositor per bank
Paid for by levies of 1-12% on insured funds
Temporarily raised in 1990s to restore fund
Hasn’t cost taxpayers anything
Ended free banking by refusing to insure additional banks
Bank charters, therefore, became more valuable
Banks would pay the FDIC to take over insolvent banks, which would allow them to acquire valuable bank charters.

Question 5

How did the FDIC fare from the 1940s to 80s?

Answer 5

Rarely lost money, even on resolutions.
Succeeded in its role in providing deposit insurance
Reduced the number of bank failures, rarely did any FDIC banks fail.

Question 6

Describe legislative developments in the 1960s

Answer 6

Fed regulation Q for banks capped interest payments, thereby increasing the profit margins of both banks and thrifts.
This was futile, however, since many depositors just moved their funds to MMMFs, which were introduced in 1971 and which provided higher returns.
Since MFs were regulated by the SEC, they were able to bypass interesting ceilings.

Question 7

How did the DIDMC Act (Depository Institutions Deregulation and Monetary Control Act) change things?

Answer 7

Deregulation:
Allowed NOW accounts nationwide: interest bearing non business checking accounts (reversed reg q to some extent)
Phased out ceilings (blatant reversal of reg q status quo)
Deregulation of transportation fares, which had been price floored during the Hoover admin.
Monetary Control:
Set uniform reserve requirements for banks - greatly simplified
Gave insured banks, thrifts access to Discount Window (emergency lending)

Question 8

What happened during the 1982-93 Bank Crisis?

Answer 8

Saw the failure of many thrifts and banks due to interest rate hikes.
Farm, real estate, business failures, which naturally led to bank failures as well.
1982: oil prices collapse, causing the meltdown of Penn Square Bank
1982: debt defaults of emerging market economics such as Brazil, Mexico and Argentina. Expected inflation to erode debt - instead, deflation caused debt appreciation.
DIDMC dereg caused a reduction in the profit margins of banks and thrifts, which previously did not have to compete on interest rate payments.

Question 9

When did TBTF become the unofficial US policy?

Answer 9

Ever since 1984 failure of Continental Illinois
Then 7th bank in US.
Failed as a result of oil price collapse, which meant that oil related futures and assets became worthless.
Fed advanced 7 billion via discount window
Seized eventually by the FDIC.

Question 10

What happened to the FDIC fund after the failure of Continental Illinois?

Answer 10

Funds fell below target of 1.25% of insured deposits, even went negative in 1991.

Question 11

What type of legislation was introduced as a result of the FDIC 1991 depletion issue?

Answer 11

FDICIA: Federal Deposit Insurance Committee Improvement Act
- Created multiple capital zones
- Imposed risk based deposit insurance premia
Restricted protection of uninsured depositors (to lessen burden of FDIC bailouts)

Question 12

Describe the capital zones that were introduced in 1991 FIDICA

Answer 12

> 5% min. trh

Question 13

Peak of the FDIC cents per 100USD of insured funds?

Answer 13

In 1993 at 25

Question 14

How did FIDICIA solve the banking crisis of the 1990s?

Answer 14

Bank Insurance Fund restored to target 1.25%, risk based deposit insurance premia raised from banks, not public expensive.
Unlike FSLIC, which had to be bailed out at public expense.

Question 15

How did the FIDICIA force bank compliance?

Answer 15

Capital zone requirements incentivized banks to uphold strong capital standards.

Question 16

Explain the Riegle Neal Interstate Banking and Branching Efficiency Act

Answer 16

Restart of free banking, allowed interstate branching on grounds of 
Better diversification
Efficiencies from economics of scale
More competition - better rates?
Fewer small local banks

However, exacerbated too big to fail by creating bank giants.

Question 17

Explain the principal agent problem

Answer 17

Shareholders (principal) may lose control of agents (managers).
Barings Bank: rogue trading
AIG: rogue CDS

More of a problem for larger banks, where management is too large to be supervised without roguishness.

Question 18

Explain the 1999 Glass Steagall Repeal

Answer 18

Repealed the separation of CBs and IBs, BHCs allowed.
CBs still incorporated separately with limited liability. BHCs not liable for CB debts, BHC debts not FDIC insured.

Firewalls still in place, were supposed to protect CB from IB risks but obviously did not work.

BHCs created a new problem of ownership dilution: hard to find CBs in BHCs balance sheet.