The Federal Deposit Insurance Corporation (FDIC) is deliberating shifting much of the financial burden of bank failures onto the nation’s largest banks….(read more)

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In 1933, during the Great Depression, the U.S. government established the Federal Deposit Insurance Corporation (FDIC) to restore faith in the banking system and protect depositors’ funds. The FDIC was tasked with insuring deposits in banks and in the event of a bank failure, reimbursing depositors for their losses. However, over the years, the FDIC’s approach to handling bank failures has shifted, resulting in a burden being shifted to the taxpayers.

Initially, the FDIC’s primary goal was to prevent bank failures through regulation and oversight. However, when banks did fail, the agency would step in to liquidate the failed bank’s assets and distribute the proceeds to depositors. This system worked well for many years, as the number of bank failures was relatively low and the costs to the FDIC were manageable.

However, in the 1980s, the landscape of the banking industry changed dramatically with the deregulation and expansion of the savings and loan associations. This expansion led to a high number of failures in the industry, which resulted in a significant strain on the FDIC’s resources. As a result, the FDIC implemented a new approach to handling bank failures, known as “too big to fail.”

Under this new approach, the FDIC would no longer liquidate failed banks but instead would arrange for a healthy bank to take over the failed institution’s deposits and assets. This was intended to prevent disruptions in the banking system and protect depositors, but it also shifted the burden of bank failures to the taxpayers.

The “too big to fail” approach meant that the FDIC would provide financial assistance to the acquiring bank to facilitate the takeover of the failed institution. This assistance often took the form of financial incentives and guarantees, which were ultimately funded by the taxpayers. This shift in approach had significant implications, as it meant that the costs of bank failures were no longer borne solely by the banking industry but also by the public.

Furthermore, the “too big to fail” approach created moral hazard within the banking industry, as it effectively signaled to banks that they could take on excessive risks without fear of failure, knowing that the FDIC would intervene to protect them.

The burden of bank failures being shifted to the taxpayers has had lasting consequences, as it has undermined market discipline and incentivized risky behavior in the banking industry. Additionally, the cost of bank failures has increasingly fallen on the shoulders of the taxpayers, creating a moral hazard and distorting the functioning of the financial system.

In conclusion, the FDIC’s shift in approach to handling bank failures has resulted in the burden being shifted to the taxpayers. This has had lasting implications for the banking industry and the broader economy, as it has incentivized risky behavior and undermined market discipline. Addressing this issue will require a reevaluation of the FDIC’s approach and the implementation of reforms that promote greater accountability within the banking industry.