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Eugene N. White

Working Paper 6063

1050 Massachusetts Avenue
Cambridge, MA 02138
June 1997

I am especially grateful for helpful suggestions from Michael Bordo, Hugh Rockoff, Anna Schwartz,
Larry White and the participants at the NBER Conference, "The Defining Moment: The Great
Depression and the American Economy in the Twentieth Century," and to the NBER for the support
of this research. This paper is part of NBER's research programs in the Development of the
American Economy and Monetary Economics. Any opinions expressed are those of the author and
not those of the National Bureau of Economic Research.
© 1997 by Eugene N. White. All rights reserved. Short sections of text, not to exceed two
paragraphs, may be quoted without explicit permission provided that full credit, including © notice,
is given to the source.

The Legacy of Deposit Insurance: The Growth,
Spread, and Cost of Insuring Financial Intermediaries
Eugene N. White
NBER Working Paper No. 6063
June 1997
JEL Nos.N22, G21,G28
Development of the American Economy
and Monetary Economics


Without the Great Depression, the United States would not have adopted deposit insurance.
While the New Deal's anti-competitive barriers have largely collapsed, insurance has become deeply
rooted. This paper examines how market and political competition for deposits raised the level of
coverage and spread insurance to all depository institutions. A comparison of the cost of federal
insurance with a Counterfactual of an insurance-free system shows that federal insurance ultimately
imposed a higher cost but achieved political acceptance because of the distribution of the burden.

Eugene N. White
Department of Economics
Rutgers University
New Brunswick, NJ 08903
and NBER

One enduring legacy of the Great Depression was the creation of deposit insurance for
financial intermediaries. Deposit insurance was a real innovation in federal regulation of the
financial system. While the New Deal's anti-competitive barriers have largely collapsed, deposit
insurance has become deeply rooted.1 Coverage of the banking system has expanded steadily and
it has spread to otherfinancialsectors. Economists have inveighed against government insurance
offinancialintermediaries' liabilities; and yet even in the wake of costly insurance disasters, there
is little political interest in altering this pillar of the New Deal.
Without the Great Depression, the United States would not have adopted the New Deal
package of financial regulations that prominently featured deposit insurance.

The New Deal's

regulations limiting competition had profound effects on the financial system; however these
regulations, with some exceptions, have disappeared while insurance of financial intermediaries
appears to be permanent. Insurance began with the New Deal's limited explicit guarantee of bank
deposits. This protection has grown considerably and is now granted implicitly to protect the
deposits of all large banks.

Furthermore, as Table 1, shows, insurance has spread to other

financial sectors. Although some features of deposit insurance have changed recently, there is no
evidence of a rollback. With the important exceptions of mutual funds and money market mutual
funds, the insurance offinancialinstitutions liabilities is pervasive.
There is no ready model to explain the growth and spread of federal insurance of

Political economy offers models of logrolling (Shattschneider, 1935) and

cascading regulation (Bernard and Leidy, 1992; Feinberg and Kaplan, 1993) that are not applicable
here. In logrolling, sectors of an industry or related industries bargain in Congress for favorable
legislation combined in one bill. Regulation "cascades" when one industry upstream secures


protection industry inducing the downstream firms to follow them later and push for their own
protection. Cascading regulation in international trade vertically moves from industry to industry.
In contrast, the spread of insurance in the financial sector from banks and thrifts to credit unions,
broker-dealers, life insurance companies and pension funds represents horizontal movement.
Although competition between types of intermediaries had increased in the 1920s, the New Deal's
regulations tried to ensure very imperfect competition between the various sectors of the financial
industry. Over time, competition within each segment and between each type of intermediary
increased. The advantages conferred on banks by deposit insurance were then eagerly sought by
uninsured intermediaries and weaker institutions pushed up the level of insurance.
In this paper, I examine how insurance spread from one group of institutions to the next
and how the level of insurance was gradually raised.

Although deposit insurance has often been

discussed as an important guarantor of the stability of the banking system and hence the economy
(Friedman, 1959), the expansion of deposit insurance cannot be justified on macroeconomic
grounds. The general view today is that while the failure of individual banks might begin a panic,
a systematic collapse may be prevented by proper intervention by the Federal Reserve as the lender
of last resort (Friedman and Schwartz, 1986). Instead, it is its redistributive features that have
made insurance a permanent feature of the financial system while other New Deal regulations
disappeared. Redistribution of the costs of failures, hidden in the insurance premiums, has gained
public acceptance and allowed financial intermediaries to successfully lobby for expanded
coverage. If insurance was not necessary for securing macroeconomic stability, substantial costs
may have been incurred. I explore the cost of insurance with a Counterfactual of an insurance
free post-Great Depression financial system to assess the burden imposed by this legacy of the


New Deal.

The Origins and Establishment of Deposit Insurance
While deposit insurance today enjoys broad public support, proposals for federal insurance
before the Great Depression were viewed as special interest legislation. States had experimented
with insurance of bank liabilities before the Civil War and after the panic of 1907. These state
systems had, at best, mixed results, establishing a strong policy prejudice against federal
insurance (Golembe 1960, White 1983, Calomiris 1990, Wheelock 1992). Nevertheless, a wellmotivated lobby of predominantly rural, unit bankers was keen on securing a federal guarantee
system. Hoping to increase depositor confidence while preserving the existing banking structure,
these bankers opposed the liberalization of branching laws and other regulations, which could
have produced a more stable banking system of larger, diversified institutions (Calomiris, 1993).
Studies of the origins of deposit insurance from Golembe (1960) to Calomiris and White
(1994) emphasize that deposit insurance would have had little chance of adoption if the 1930-1933
banking collapse had not frightened the public into supporting the pro-insurance bankers' cause
in Congress. Even so, the hurtles faced by backers of deposit insurance were high. From earlier
state experiments, the problems of moral hazard and adverse selection were well known and
debated in Congress (Flood, 1991).

Aware of the potential problems,

the Roosevelt

administration, the bank regulatory agencies, and the larger banks were resistant to any proposal.
In the face of such opposition, credit for the adoption of deposit insurance belongs largely to Rep.
Henry Steagall (D.-Alabama), Chairman of the House Banking and Currency Committee, who
refused to permit the passage of any banking legislation unless it included an insurance system.


Far from being a high-minded policy aimed at protecting the depositor, the design of the
Federal Deposit Insurance Corporation (FDIC) was the product of a lengthy legislative struggle,
pitting smaller state-chartered, often unit banks, against larger banks, often members of the Federal
Reserve System. Under the Banking Act of 1933 (often called the Glass-Steagall Act), the
Temporary Deposit Insurance Fund was organized and scheduled to begin operations on January
1, 1934. The coverage per account was set at a maximum of $2,500. All Federal Reserve
member banks were required to join. Non-member banks could receive insurance only if they
joined the Fed within two years.

The last provision was resented by the non-member banks

because they would be forced to meet the higher requirements and stricter regulations imposed
on members. Banks joining the system were to pay a 0.5 percent assessment of insurable
deposits, half upon joining and half subject to call. (FDIC, 1984, p. 56-7)
When the Temporary fund was extended for a year in 1934, Steagall attempted to increase
coverage of accounts to $10,000 against Roosevelt's objection that 97 percent of depositors were
already covered. Congress raised the limit to $5,000 and postponed compulsory Federal Reserve
membership until July 1, 1937—a victory for the small banks. (Burns, 1974), The temporary
system became permanent under Title 1 of the Banking Act of 1935, which created the FDIC. All
Federal Reserve members were still required to join; but in a major concession, non-members,
while subject to approval of the FDIC, were no longer required to become members of the Fed.
The permanent plan required an annual assessment on total, not just insured, deposits. This shift
was opposed by the larger banks whose shares of uninsured deposits were much greater.2
The Banking Act of 1935, based largely on the draft legislation of the FDIC staff, set a flat
annual assessment rate of one-twelfth or 0.0833 percent of a bank's total deposits, eliminating


the original capital contribution by banks. To ensure that the insurance fund was not depleted,
the FDIC was given authority to borrow up to $975 millionfromthe Treasury. Banks contributed
premiums as a fraction of all their deposits but only received protection on deposits up to a
maximum of $5000 per account. Small banks and lower income individuals with small deposit
accounts benefitted while bigger banks with larger depositors provided a subsidy. The smaller
banks' competitive position was improved, and there was less pressure to build stronger, larger
The requirement that all Federal Reserve members join the new FDIC guaranteed that the
bigger banks, many of whom had opposed federal deposit insurance, joined the system rather than
lose the benefits of Fed membership. The non-member banks, almost all smaller state-chartered
banks, had pushed for deposit insurance. Happy with the design, they signed up immediately. In
1935, 91 percent of the 15,488 commercial banks with 86 percent of assets joined the system.
Only mutual savings bank membership was low. Of the 566 mutual savings banks, 11 percent
with 11 percent of total assets took out membership. Most mutual savings banks preferred to
remain in existing state insurance systems that offered higher levels of coverage. Nevertheless,
the nearly universal coverage of commercial banks and the subsequent disappearance of bank
failures was seen as triumph for the New Deal.

The Growth of FDIC and FSLIC Insurance
For the next fifteen years, the FDIC's insurance of commercial banks and mutual savings
banks appeared to be an unqualified success. By 1949, commercial bank membership crept up
to 95 percent, accounting for 49 percent of deposits; mutual savings bank membership increased


to 36 percent, holding 70 percent of all assets. Bank failures declined, no panics occurred, banks
were more profitable, and the insurance fund grew. At the same time, inflation had reduced the
real value of insurance. World War II inflation shrank the real value of coverage per account
from $5000 in 1934 to $2807 by 1949. Figure 1 depicts the real value of the maximum coverage
offered per account from 1934 to 1995, with the changes in the nominal levels of coverage
indicated by vertical lines. However, this decline in protection elicited no outcry by depositors for
more protection. As seen in Figure 2, the percentage of total deposits covered by FDIC insurance
had climbed from 45 percent in 1934 to 50 percent in 1950.3 The absence of big failures and the
growth of deposits kept the total insurance fund at about 1.5 percent of all insured deposits, as
shown in Figure 3, in spite of repayment of the Treasury and Federal Reserve Banks initial
contributions in 1949. (FDIC, 1984, pp. 5-7).
By any measure, the vast majority of "small depositors" were well protected by this level
of insurance, and there was no public demand for a big increase in coverage. In 1949, only 4.4
million of the 104 bank accounts were not fully protected (FDIC, Annual Report 1949). Some
of these accounts were government (293,000) and interbank deposits (127,000), which had high
average balances of $40,000 and $90,000 in contrast to the average demand deposit balance of
$1,911 and savings and time deposit balance of $824. The FDIC (Annual Report 1949) calculated
that any increase in coverage would offer little additional protection. A rise in coverage to
$10,000-which would have returned coverage to its real 1934 value-would have fully covered
another 3 million accounts or 97 percent of the total. The percentage of insured banks deposits
covered would have risen from 50 to 57 percent. An increase to $25,000 would have covered
99.5 percent of all accounts and 65 percent of all deposits.


Mutual savings banks were a shrinking component of the banking industry and played no
significant role in the politics of deposit insurance. By 1949, the FDIC insured only 192 of the
531 mutual savings banks. Most of the remainder (190 of 339) were in Massachusetts and were
insured by a state fund. The FDIC-insured mutual savings banks had 12.6 million accounts in
1949 with $13 billion of deposits.4 Ninety-four percent of these accounts were fully insured, and
61 percent of all deposits were insured. While this profile looks similar to commercial banks,
mutual savings banks were not at the same risk. In commercial banks, 68 percent of all deposits
were held in the 3 percent of the accounts with over $5,000; for mutual savings banks, only 39
percent of all deposits were in the 6 percent of accounts with over $5,000. Very few accounts,
representing 3.6 percent of deposits, exceeded $10,000, whereas 57.7 percent of commercial
banks' deposits were in accounts in excess of $10,000. Mutual savings banks were not as
vulnerable as commercial banks and did not join the demand for a rise in insurance.
Demand for an increase in coverage was driven by the small banks fear of losing deposits.
Figure 4 shows the drop in fully insured accounts from 98.5 percent at the inception of insurance
to just under 96 percent by 1949. The smallest banks felt this change acutely. Table 2 shows that
in 1936 35.4 percent of banks had 90 to 100 percent of their deposits insured. The number of
banks enjoying this high level of coverage collapsed to 5.7 percent in 1949. The search for
protection by large depositors threatened smaller banks. In the 1950 Senate hearings on deposit
insurance, Sydney J. Hughes of the Industrial Bank of Commerce of New York City and member
of the Consumer Bankers Association explained that: "when a depositor's balance exceeds the
$5,000 insure maximum, he shifts the surplus to another bank and becomes one of what must be
millions of multiple deposits." (U.S. Senate, 1950, p. 90)


There were good reasons for deposits in excess of the insured maximum to worry bankers,
as one recent study suggests. Using a special sample of wealthy households from the 1992 Survey
of Consumer Finances, Kennickell, Kwast, and Starr-McCluer (1996) found that while large
depositors keep substantial shares of their assets in insured depositories, they often fail keep them
within insurance limits. According to the survey, a sizeable 17.3 percent of household deposits
were uninsured. Kennickell, Kwast, and Starr-McCluer found that any reduction or restriction in
insurance coverage would substantially increase the uninsured deposits of households and increase
the likelihood of withdrawals.5
In 1950, bills to raise the coverage were introduced by Senators John W. Bricker (ROhio), Claude D. Pepper (D-Florida), Charles W. Tobey (R-New Hampshire), Hugh A, Butler
(R-Nebraska), William Langer (R-North Dakota) and Burnet R. Maybank (D-South Carolina)
who was Chairman of the Committee. All of these bills contained increases up to $15,000 and
Pepper's would have removed the limit altogether.

In his plea for a rise to $10,000, Senator

Butler noted that "from my correspondence, I judge that it is primarily the smaller country banks
that are anxious for this change. It seems that under the present system a good many depositors
maintain part or all of their funds in the city banks at some distances, perhaps from their homes."
(U.S. Senate, 1950, p. 101) Ben Dubois, the Secretary of Independent Bankers Association, made
an explicit appeal to protect the small banks, stating that "the Federal Deposit Insurance
Corporation has been a powerful instrument in the perpetuation of independent banking. It has
put the small bank on a part with the large bank in the eyes of the average depositor...The
Corporation has been helpful indeed in establishment independent bank to continue in spite of the
trend toward banking concentration" (U.S. Senate, 1950, pp. 87-8).


Federal regulators supported the increase but tended to cloak their support in terms of the
ideology of guaranteeing the continued protection of the small depositor. In the 1950 hearings,
there was general support from federal regulators to raise the ceiling to $10,000. The Secretary
of the Treasury John W. Snyder and the Comptroller of the Currency, Preston Delano, favored
an increase to $10,000. Delano argued that $10,000 was justified on the grounds that prices had
risen, lowering effective coverage, even though he admitted that $5000 still covered 96 percent
of accounts. The Chairman of the FDIC, Maple T. Harl also supported the increase on the
grounds that protection of the small depositor required it; but he was also clear that "the
preservation of the American banking system... As you very well know, the survival of the dual
banking system in large measure depends on Federal deposit insurance" (U.S. Senate, 1950, pp.
22-23). The Former FDIC Chairman Leo Crowley testified that he favored the increase from
$5000 to $10,000 because it would help small savers and the small banks in their home
Larger banks were generally willing to support a rise but they were less enthusiastic and
were more concerned about the fact they subsidized the system. American Banking Association
officials testified in favor of $10,000 coverage but warned that any further increase would
endanger the system (U.S. Senate, 1950, p. 66). Frederick A. Potts, President Philadelphia
National Bank and a representative of the Reserve Bankers Association, testified that limited
deposit insurance was a sound idea. However, he warned that a rise in protection to $10,000
would undermine good bank management and stimulate demands for more coverage. (U.S.
Senate, 1950, pp. 80-81). The most striking testimony against the proposal came from one of the
founding fathers of the FDIC, Senator Arthur Vandenberg (U.S. Senate, 1950, p. 50-51). In a


letter, he denounced the proposed rise to $10,000 coverage, arguing that was imprudent: "There
is no general public demand for this increased coverage. It is chiefly requested by banker demand
in some quarters for increased competitive advantage in bidding for deposits." He predicted that:
"If we extend the cover to $10,000, how long will it be before we confront demands for total
coverage? Total coverage would virtually socialize out private banking system. It could involve
many of the vices which so often wrecked previous well-meaning adventures in this field."
The willingness of larger banks to support an increase in the level of coverage did not arise
out of any hope to improve their competitive position by insuring more deposits. Their position
changed very little in terms of insurance coverage after the 1950 act went into effect. At the very
beginning in 1936, large banks received very little protection, as seen in Table 3. While the more
than ten thousand banks with under $1 million in deposits had 86 percent of their deposits insured
and the banks with $1 to $5 million of deposits had 74 percent of their deposits protected by the
FDIC, the two hundred largest bank had only 28 of their deposits insured. Coverage for them
grew; yet by 1949, coverage was still only 36 percent. What concerned the larger banks was not
the fact that they still had large uninsured deposits but that they were assessed on their total, not
just their insured, deposits. To cover a much larger fraction of their deposits would have required
a huge increase in coverage that would have interested few smaller banks.
Furthermore, a big increase in coverage would have decreased the ratio of the insurance
fund to insured deposits, depicted in Figure 3, perhaps requiring an increase in assessments. The
insurance fund had grown thanks to the virtual disappearance of bank failures. The fund easily
repaid the initial contributions ($289 million) of the Treasury and the Federal Reserve Banks
(FDIC, 1984, pp. 58-60). There was concern that the assessment rate was too high, not too low,


cutting into bank profits. Although banks' net earnings rose steadily over the decade of the 1940s,
net profits had recently declined from $906 million in 1945 to $831 million in 1949. At the same
time, the FDIC assessment climbed from $86 million to $109 million, following the rise in total
deposits (FDIC, Annual Report 1949, p. 40). Cutting the assessment could easily buoy profits,
Not surprisingly, the larger banks lobbied Congress for a reduction in assessments while
they grumbled about the increase in coverage. The smaller banks returned the favor. The
Independent Bankers Association was set against any reduction in the premium and protested that
big banks had no right to complain as they had obtained the interest prohibition on demand
deposits under the New Deal. But, the end result was a compromise of an increase in coverage
and a change in assessment that satisfied both parties and ensured swift passage of the 1950 act.
Figure 2 shows that the new level of $10,000 coverage protected an additional 5 percent of
deposits. More importantly for banks concerned about protection, the shares of protected
accounts, shown in Table 3, returned to their earlier level. The more exposed banks who had lost
their high level, 90 to 100 percent, of protected deposits, regained ground lost in the previous
The larger banks also benefitted. The basic assessment rate was not reduced because the
FDIC feared this might set the stage of a depletion of the fund. Instead, it was lowered by a rebate
system. The FDIC deducted the operating expenses and insurance losses from gross assessment
income, then shared the remainder, returning 60 percent to the banks and keeping 40 percent.
As seen in Figure 5, this rule produced some fluctuation in assessment rate around 0.035 and
0.037 percent of total deposits, far below the original 0.0833 percent. Total assessments reached
in 1951 $124 million, but $70 was rebated to the banks (FDIC, Annual Report. 1951). Net profits


for 1951 were $908 million but they would have stood at only $838 million without this change.
The 1950 act was a well-crafted compromise. Insurance coverage of all deposits was on
the rise, Larger banks who had initially opposed deposit insurance now "signed on" to support
insurance thanks to the reduction in the effective assessment rate. The 1950 increase in insurance
coverage was the last time that commercial banks appear to have been the primary movers behind
insurance legislation. While commercial and mutual savings banks covered by the FDIC continued
saw the nominal coverage rise and the percentage of funds insured increase, greater competition
and inflation put more pressure on other financial intermediaries who clamored more loudly for
higher coverage.

Evaluating the Rise in Coverage for Commercial Banks
Legislation raising the level of coverage is only one factor leading to a higher level of
protection. To explain the percentage of deposits in FDIC- insured institutions that were covered
by FDIC insurance in Figure 2, four factors were considered: (1) If the real maximum deposit
insurance coverage per account is increased, the percentage of covered deposits should rise, (2)
Failures, measured either as the number of failing banks or the percentage of deposits in failing
banks, might induce depositors to shift their uninsured deposits to new accounts or banks for
complete coverage, (3) A rapid growth in deposits might decrease coverage if individuals'
balances quickly rise above insured levels, and (4) If individuals open new accounts to ensure
coverage of their deposits, the increase in the number of accounts should raise the percentage of
deposits covered.6

Data on the number of accounts was difficult to obtain, as it was only collected by the

FDIC in occasional special reports until 1981. This data is displayed in Table 4. Beginning in
1990, some data on commercial banks' accounts was collected by the FDIC.7 Accounts of all
banks appear to have grown at a very rapid rate between 1934 and the mid-1970s. The average
rate of growth exceeded the real rate of growth of the economy. Starting in the late 1970s and
certainly in the early 1980s, this growth slows down, with some years of decline. The stagnation
between 1981 and 1990 may be attributable to the high level of coverage provided by the jump
from $40,000 to $100,000 insurance and the increase in alternatives to bank deposits, such as
money market mutual funds. A continuous time series of accounts for the period 1934 to 1981
was constructed by regressing the number of accounts on time and time squared to fill in the
missing observations, but no attempt was made to fill the gap between 1981 and 1990 when the
trend growth abruptly changed.
Unit root tests and an examination of the partial autocorrelations indicated that the
percentage of insured deposits, the real insurance per account, and the measures of bank failures
needed first differencing for stationarity. It was difficult to judge whether the growth of deposits
also required first differencing, but the results were similar so only the first differenced results were
reported in Table 5. Regressions (1) and (2) are for the whole period, 1934-1994, and exclude
the variable for accounts. As hypothesized, an increase in the real value of maximum deposit
insurance coverage per account, raises the percentage of covered deposits.

A rise in real

coverage of $10,000 would drive the percentage of insured deposits up by about 6 percent,
suggesting that this factor alone can only account for a modest portion of the increase.

Also, as

conjectured, an increase in deposits tends to lower the percentage of covered deposits. An
acceleration in deposit growth of one percent pushed down coverage approximately 1.7 percent.


The most notable example of this effect was during World War II, when the rapid growth of
deposits outweighed other influences and temporarily halt the upward trend in coverage. Neither
variable for bank failures helps to explain the rising coverage of deposits, probably because there
is little variation in failures. For depositors, it may have been a minor consideration given the
FDIC's practice offrequentlyproviding full insurance to depositors whose accounts were over the
limit (FDIC, 1984).
The constructed time series on accounts was used in the regressions (3) and (4) for the
years 1934-1981. The variable does not help explain the behavior of the dependent variable.
However, this should not be taken as evidence that account-creating activity of depositors had no
effect on coverage. The correlation between the number of accounts and the percentage of
coverage deposits from 1934 to 1981 is high, 0.93, reflecting a common trend. In the regression,
the percentage of insured deposits is first differenced, but the application of this procedure to
accounts is first differencing a variable, many of whose observations are fitted to the trend, thus
rendering it relatively weak in the regression. While the quality of the data on accounts does not
permit very robust tests of the effects of individual account-creating activity, qualitative evidence
implicates account creation an important factor from the beginning of the FDIC until at least the
Although account creation may have been more important, the regressions only identify
the FDIC's increased coverage per account in 1950, 1966, 1969, 1974, and 1980 as a key factor.
The first increase in real coverage in 1950 was the product of lobbying by the unhappy sectors of
commercial banking. Afterwards it was not the needs of the commercial banks but rather their
rivals that pushed for expanded coverage.


Raising Deposit Insurance in 1966 and 1969: the role of the S&Ls
S&Ls originally had little interest in deposit insurance. They were very cautious about
advocating any guarantee system and probably would never had supported one if commercial
banks had not obtained the FDIC (Ewalt, 1962). S&Ls were given the opportunity to obtain
federal deposit insurance at the same time as Congress established the FDIC. The National
Housing Act (1934) established the Federal Savings and Loan Insurance Corporation, almost as
an afterthought, to provide a full set of institutions to S&Ls to parallel those for banks.8 Many
thrifts had found it advantageous to join the Federal Home Loan Bank system. The purchase of
shares in one of the 12 regional Federal Home Loan Banks gave them access to FHLB credit
facilities but did not impose any additional regulations on them (Grossman, 1992). Many fewer
took out charters to become federal mutual savings and loan associations. Supervised by the
FHLBB and narrowly constrained in lending, a federal charter appeared relatively unattractive to
most S&Ls. Although federally chartered S&Ls were required to join the FSLIC, members of the
FHLB system were not so obliged. This regulation contrasted insurance for banks where all
Federal Reserve members—national banks and state banks—were required to obtain FDIC
insurance. Thus, by 1940, half of all S&Ls had joined a FHL Bank; but only 20 percent took out
federal charters. Unlike the banks, where deposit insurance was almost universal from the outset,
only 30 percent of the S&Ls with 50 percent of assets (See Figure 6) had obtained FSLIC
insurance by 1940.
The initial responses of banks and S&Ls to deposit insurance reflected their different
experiences during the Great Depression and the costs and benefits of insurance they faced. Both
industries suffered severe withdrawals of deposits between 1929 and 1933. Commercial banks


lost 17 percent of their deposits and S&Ls 28 percent. S&Ls were forced to endure a larger
contraction, but it was more orderly. Between 1929 and the end of 1933, the number of banks
fell from 24,504 to 14,440; yet S&Ls only declined from 12,342 to 10,596. Unlike the banks who
had to wait for state and then federal bank holidays to refuse customers payment, the S&Ls had
a right to put depositors "on notice" and refuse to meet demands for withdrawals until loan
repayments came in. Thus, S&Ls had a device to ward off the runs that devastated the banks and
saw less advantage to insurance that required acceptance of more federal regulation. In addition,
FSLIC insurance came at a higher price. The FSLIC premium was 0.125 percent of deposits,
whereas FDIC insurance was 0.0833 percent. The FSLIC rate was only reduced to the FDIC level
in 1951 (Grossman, 1992).
After World War II, the thrifts were one of the fastest growing groups of financial
intermediaries. The New Deal conferred a variety of advantages on thrifts, whose share of all
financial intermediaries assets rose from 6 percent in 1950 to 13 percent in 1970. Although
imperfect substitutes for commercial banks' demand deposits, which paid no interest, S&Ls'
interest-bearing passbooks were attractive to small savers and competed with banks' time deposits.
By 1950, 50 percent of S&Ls with 80 percent of all assets had joined the system (see Figure 6).
However, unlike the banks, FSLIC-insured institutions had almost all their accounts insured. In
1941, 86 percent of all savings capital (deposits) in S&Ls were insured, rising to 94 percent by

This high level of insurance is attributable to the predominance of small savers with

balances averaging well below $1000 (FHLBB, Annual Report 1947). This nearly complete
coverage helps to explain why the insured S&Ls did not participate in the 1950 deposit insurance
debate. Ten years later, conditions had changed dramatically. When S&Ls' surging inflow of


savings deposits came to an abrupt halt in the credit crunch of 1966, they became interested in
deposit insurance. The similarity of coverage among thrifts assured a fairly uniform view of the
desirability of increased insurance in contrast to the wide divergence of opinion among banks.
Neither banks nor S&Ls saw the erosion in the real value of deposit insurance per account
as a threat. The decline in real deposit insurance in Figure 1 was slight compared to what
happened before the 1950 increase. Furthermore, total coverage of deposits, shown in Figure 2,
was fairly stable. However, there was a significant drop in the number of fully insured accounts
that especially affected small banks. Although coverage dropped for most classes of banks, the
three smallest categories of banks in Table 3 show very large declines in coverage of deposits
between 1951 and 1966. Inflation and the shift between groups make comparisons between years
difficult, yet the danger posed by this decline in coverage is clear in Table 2. Here, the percentage
of commercial banks with 90 to 100 percent of their deposits insured by the FDIC dropped from
23.2 percent in 1951 to 9.9 percent in 1964. Thus, a small but significant fraction of the banking
industry was feeling increasingly exposed.
By the mid-1960s, banks and thrifts were also worried that interest rate restrictions
reduced their ability to attract deposits.

While banks had been subject to Regulation Q interest

rate ceilings since 1935, FHLB member thrifts were constrained by FHLBB rules, which imposed
a variety of restrictions on the "dividends" paid on savings account (FHLBB, Annual Report
1965). In 1965, the limit on the interest charged on bank's time deposits stood at 5.5 percent, yet
very few S&Ls could offer rates in excess of 5 percent. In this year, market rates moved above
the ceilings and both banks and thrifts began to lose funds.9 Thrifts experienced a 4 percent fall
in funds available for new investment, followed by a 28 percent fall in 1966, when savings inflows


and loan repayments fell off. The big demand for advances from the FHLBB, led the Board to
ration lending to S&Ls who then slashed mortgage lending by one third. In response, the Board
adopted a more flexible dividend policy; and by the end of 1966 over 20 percent of S&L deposits
were paying 5.25 percent (FHLBB, Annual Report. 1966).
Interest rate regulations needed some unification to preserve the system. The Treasury and
the FDIC proposed that the Federal Home Loan Bank Board be given more supervisory authority
and power to set maximum interest and dividend rates. Many S&Ls were not enthusiastic about
the prospect of new FHLBB regulation, but they were willing to countenance more control if it
would ensure that deposit inflows resumed. Of considerable concern to the S&Ls was that savers
were showing great reluctance to hold deposits in excess of the $10,000 level of coverage. One
Board study showed that there was an "artificial bulge" in S&L's account at the $10,000 level,
indicating that people were limiting their deposits (Congressional Record. August 23, 1966).
Efforts to raise insurance predated the 1966 credit crunch, but demands more urgent now.
Hearings in Congress were held in 1963 to consider a rise in insurance coverage to $25,000 for
banks and S&Ls. Over the next three years, Congressmen wrangled over the level of coverage
and whether the FHLBB should be granted additional regulatory powers. In Congressional
hearings, there was no protest by the FHLBB, the Board of Governors of the Federal Reserve or
the FDIC about the increase in insurance. They were much more concerned about the effects of
changing the supervisory practices.

Rep, Wright Patman (D-Tex), chairman of the House

Banking and Currency Committee, vigorously argued for a simple increase in coverage. He
brushed aside arguments that individuals could easily secure coverage by creating multiple
accounts and claimed that the current $10,000 maximum coverage encouraged everyone from


businessmen to widows to firemens' funds to put their money in out-of-town banks once the
ceiling was reached in local banks. Patman slammed the big banks for pressuring their
correspondent banks to block an increase in insurance, portraying them as predators anxious to
drive the S&Ls out of business (Congressional Record. August 23, 1966).
Congress navigated through the complex, competing interests in writing the Interest Rate
Control Act of 1966. The act extended Regulation Q to thrifts, but gave them a favorable
differential. Thrifts were allowed to pay 3/4 of one percent in interest more than banks, in the
hope of channeling funds back to the mortgage market. Congress also gave more supervisory
authority to the FHLBB. The legislators settled on increasing deposit insurance for persons
holding accounts in banks and thrifts to $15,000, a relatively low number as far as many thrifts
were concerned. Following the 1950 deal, the 1966 package provided a sweetener for the larger
banks in the form of an increase in the assessment rebate to 66 2/3 percent. Although interest rate
flexibility was clearly of greatest concern to intermediaries, the rise in insurance did help. No data
exists on insurance coverage among thrifts, but the level of insured deposits rose for all sizes of
banks in Table 3.
These adjustments to the New Deal system did little to alleviate the underlying problems.
Once again in 1969-1970, tighter monetary policy pushed market rates above the Regulation Q
ceilings. S&Ls saw virtually no net inflow of new funds while commercial banks lost funds,
contrasting the 1966 experience when S&Ls were in greater distress. S&Ls were in better shape
thanks to the favorable differential in interest rate ceilings. Still, there were gaps in the interest
rate controls. A substantial number of mutual savings banks in the Northeast who were not
members in the Federal Reserve or the FDIC avoided the controls, as did non-FSLIC member


thrifts. These institutions' higher rates were drawing funds away. Congress responded to the
complaints of controlled banks and thrifts by extending Federal authorities' control of all
institutions in states where over 20 percent of savings were held by non-federally regulated
institutions (FHLBB, Annual Report 1969).
With no debate, Congress also raised deposit insurance coverage for banks and thrifts on
December 23, 1969 from $15,000 to $20,000.10 This hike halted the new decline in fully insured
accounts depicted in Figure 4. The real value of nominal coverage of $20,000 was now higher
than it had ever been (Figure 1), reaching approximately $7,000 in 1934 dollars. The percentage
of insured accounts and deposits of FDIC institutions were at all time highs of 99.1 and 63.1
percent (Figure 2), with institutions of all sizes (Table 3) benefitting from the increase. By 1969
there were only 208 noninsured commercial banks and nondeposit trust companies and 166 mutual
savings banks, virtually all of the latter being located in Massachusetts and covered by its deposit
insurance system. (FDIC, Annual Report. 1969). In the thrift industry, over 70 percent of the
S&Ls with over 90 percent of assets were covered by 1969. Deposit insurance coverage in the
1960s had grown considerably for the banks and thrifts, well beyond the initial intentions of the
New Deal.

The Spread of Insurance
Greater interest rate volatility and increased competition in the 1960s created difficulties
for all financial intermediaries.

Facing these new challenges, credit unions, broker-dealers,

pension funds, and insurance companies sought the benefits of government provided insurance for
their liabilities. As they held relatively modest or no funds on deposit and no claim could be made


that insurance would serve to prevent a panic, the history of these intermediaries demonstrates
how, even in the absence of concern about macroeconomic instability, new classes of
intermediaries were successful in lobbying Congress to expand insurance far beyond its New Deal
Designed to assist the small saver, credit unions grew rapidly in the postwar period. The
Federal Credit Union Act of 1934 made federal credit union charters available, as an alternative
to state charters, and they soon dominated the industry. The number of all credit unions—federal
and state—more than doubled from 10,571 in 1950 to 23,656 in 1970, with deposits climbing
from $880 million to $15.5 billion.11 Like the S&Ls, credit unions were initially reluctant to press
Congress to create institutions for them. But, competition from federally assisted and protected
banks and thrifts coupled with increased financial difficulties led the credit unions to aspire for
parity with banks and thrifts. Between 1934 and 1969, over 5,600 federal credit unions were
liquidated.12 Failures were increasing and in 1969, 274 federal credit unions were closed, 35 of
them at a loss of $95,000 to their members. Some assistance for failing firms came from credit
union leagues, bailing out another 280 other credit unions; but these private reserve funds were
very small. Failures induced Massachusetts in 1961 and later Wisconsin and Rhode Island to
create state funds; but they were restricted to state chartered credit unions, a small fraction of the
industry (Congressional Record. September 2, 1970).
Prompted by the credit crunches of 1966 and 1969, credit unions pressed for lending and
insurance institutions to parallel the Federal Reserve, the FHLB system, the FDIC and the FSLIC.
In 1970, Congress obliged them with the Federal Credit Union Act, creating the National Credit
Union Administration (NCUA), an analog to the Federal Reserve and FHLBB. While this bill was


making its way through Congress, an amendment was added to create a system of insurance for
credit unions.13 The amendment was initially sponsored by several Senators and there was no
apparent opposition from either banks or thrifts. A simple rational was given by one sponsor,
Senator Wallace F. Bennett (R.-Utah), who pointed out that federally chartered credit unions
were the only depository institutions not covered by a federal insurance program. The Senator
admitted that the absence of insurance posed no threat to the stability of the financial system and
that the losses of credit unions had been small, Insurance coverage for credit unions was almost
a matter of pure competitive equity.
Established in 1970, the National Credit Union Share Insurance Fund (NCUSIF) gave the
credit unions an insurance system. At the same coverage per account of $20,000 as the FDIC and
the FSLIC of $20,000, the 22 million credit union members, who had an average of $650 on
deposit, gained ample protection. Like the FDIC and the FSLIC, the NCUSIF was mandatory for
federally chartered credit unions and optional for state institutions. Administered by the NCUA,
the fund charged an annual premium of 0.0833 on the aggregate of members' accounts and
creditor obligations.

Adoption of federal insurance was not initially universal. Many state-

chartered credit unions did not want to accept the federal regulations necessary to obtain NCUSIF
insurance. At the behest of these institutions, more states created their own insurance funds. In
1981 when California established the California Credit Union Share Guaranty Corporation, there
were sixteen state funds, covering 3,150 credit unions with $12 billion of deposits (NCUA,
Annual Report 1982), However, in the wake of widespread failures banks, S&Ls and credit
unions in the 1980s, there was a flight to the NCUSIF, which afforded greater protection. In
1981, NCUSIF-insured credit unions held 82 percent of all credit union shares. By 1985 this


figure jumped to 92 percent, rising to a nearly universal 99 percent in 1995 with the demise of the
state insurance plans (NCUA, Annual Reports. 1989, 1995).
In the same year that credit unions secured federal protection for their depositors,
customers of broker-dealers received guarantees for their funds on deposit—protection that the
original New Deal had never countenanced. The Securities Exchange Act of 1934 tried to protect
customers from brokers' dishonesty but not their incompetence.

Protection from the

incompetence was the responsibility of the relevant self-regulatory organization (SRO)--the New
York Stock Exchange or the NASD. These organizations could intervene and transfer customer
accounts from a weak to a strong member firm, liquidate failing members or merge weak firms
with stronger ones (Teweles and Bradley, 1987).
The rising volume of activity on the exchanges during the 1960s' bull market put an
enormous strain on brokerages' ability to handle the complex paperwork that accompanied every

The number of "fails" or failures to deliver security certificates or complete

transactions produced a "back office" crisis. Manyfirmswere swamped by business and could not
manage their operations well. Firms used customers' free credit balances for any business purpose,
including trading or underwriting, putting these funds on deposit at risk. When Ira Haupt and
Companyfoiledin 1963, as a result of a huge default on commodity contracts, the NYSE stepped
in and assisted with the firm's liquidation (Teweles and Bradley, 1987). Anticipating more
problems, the NYSE created a Special Trust Fund of $10 million and a $15 million line of credit
in 1964 to assist troubled members and protect customers (Sowards and Mofsky, 1971). AMEX
followed the NYSE's lead and by 1968 all the exchanges had established special funds. (Sobel,
1972 and U.S. Senate, Report No. 91-1218, 1970).


When the bull market broke in 1969 and prices and volume fell, many brokerages held
large inventories.

Falling revenues and costly inventory losses led 129 NYSE member firms to

be liquidated, merged, or acquired and another 70 required some assistance from the Exchange.
The Special Fund ran out of funds in the summer of 1970 and was unable to pay out customers'
accounts infoiledbrokers. In this emergency, the NYSE transferred $30 million from its building
fund to its Special Fund. However, it was clear that if a large brokerage went under, the resources
of the Special Fund would be inadequate (Sobel, 1975). The free credit balances—in effect, the
funds customers held on deposit with broker-dealerfirms—stoodat $3 billion in 1970 for NYSE
member firms. In addition, broker-dealers had custody of the $50 billion of customer securities
(U.S. Senate, Report No. 91-1218, 1970). Although there were no runs on brokerages, the
exchanges appeared unable to provide sufficient protection on their own. Insurance equivalent
to FDIC and the FSLIC was viewed as a reasonable solution by the securities industry and the
public. (Seligman, 1982). The House Report on insurance legislation was explicit: "Failures may
lead to loss of customers' funds and securities with an inevitable weakening of confidence in the
U.S. securities markets. Such lessened confidence has an effect on the entire economy....The need
is similar in many respects to that which prompted the establishment of the Federal Deposit
Insurance Corporation and the Federal Savings and Loan Insurance Corporation" (U.S. House of
Representatives Report, No. 91-1613, 1970, p. 2). This misreading of history put macroeconomic
stability as the prime reason for insurance, when special interests in the financial industry always
had the keenest interest in the establishment of insurance funds.
A proposal was put before Congress to establish a Securities Investor Protection
Corporation (SIPC) to act as an FDIC or FSLIC for the securities industry. The bill had the


support of the SEC, the Department of the Treasury and Congress' Joint Securities Industry Task
Force. An old New Dealer, Emmanuel Celler (D.-N.Y.) questioned the intention of insuring all
firms registered with the SEC without any inspection or further regulation. These qualms were
repeated by other congressmen; but like the bill for credit unions, the idea of insuring customer
accounts had wide support in Congress (Congressional Record. December 1, 1970).
Congress passed the Securities Investor Protection Act (SIPA) in December 1970. This
act created the SIPC, which was charged to administer a fund providing protection up to a
maximum of $50,000 for both cash and securities with a limit of $20,000 for cash. This insurance
was mandatory for broker-dealers registered with the SEC, making coverage nearly universal from
the outset. All SIPC members were assessed 3/16 of 1 percent per year of gross revenues from
the securities business for the SIPC fund (Matthews, 1994). If needed the corporation could
borrow up to $1 billionfromthe U.S. Treasury with the approval of the SEC (Seligman, 1982).14
Under SEC oversight, the SIPC has no authority to examine or inspect its members, Instead the
securities exchanges and the NASD are the examining authorities for its members, and the SIPA
gave the SEC additional authority to adopt rules relating to the acceptance, custody and use of
customers' securities, deposits and credit balances.15
The examples of insurance for credit unions and broker-dealers reflect the low tolerance
for even small losses to the customers of financial intermediaries and the drive for equal
competitive advantage.

Although concern about the effects of failures on the stability of the

financial system were often discussed, it motivated few of the participants in the legislative
process. The spread of insurance to non-depository intermediaries, where afinancialpanic or run
is not a concern, highlights this fact. Both pension funds and insurance companies responded to


the favorable political circumstances to demand insurance. Underfunding of private definedbenefit pension plans left workers without pensions when their employers went bankrupt. The
Pension Benefit Guaranty Corporation (PBGC) was established by Title IV of the Employee
Retirement Income Security Act (ERISA) in 1974 to protect retirement incomes from defined
benefit pension plans. Financed by premiums collected from companies, the PBGC's coverage of
pensions reached over one third of work force by 1995 (PBGC, Annual Report, 1995). While
insurance of pensions became a federal responsibility, the guarantee of life insurance became a
state responsibility as the federal government had never ventured to regulate life insurance. Before
1970, only New York had a guarantee system to protect policy holders. A rise in failures of life
insurance companies prompted the National Association of Insurance Commissioners to
recommend a model guarantee system to state legislatures in 1970. Although the plans varied
from state to state, funds guarantee insurance in all 50 states (Brewer and Mondschean, 1993).
By the early 1970s,financialpressures had pushed the insurance of liabilities beyond the
banking system to the securities, pension and insurance industries. There was no anticipation that
the FDIC, FSLIC, NCUSIF, SIPC, PBGC, or state insurance systems could fall into trouble. In
fact, the spread of insurance helped to prompt new demands from depositories for increased

The 1974 Increase in Insurance
In 1973, Fernand St. Germain (D.-R.I.) offered a bill to increase deposit insurance from
$20,000 to $50,000 and provide 100 percent insurance for all government deposits, amending the
FDIC Act and the National Housing Act, and the Federal Credit Union Act. Where did this


demand for more protection come from? Once again, there was no cry by the public for increased
protection. As seen in Figure 1, inflation had reduced the real value of insurance after the 1969
increase, but a $50,000 increase would have been a huge increase in real coverage. Total FDIC
coverage of deposits in Figure 2 had sagged a bit, but it was slight for all sizes of banks in Table
The interest group at work behind this new proposal was the thrift industry, although some
banks were also eager for higher levels of coverage. An appeal was made to raise coverage to
$50,000 to achieve parity with the securities industry—even though the brokerage accounts only
had insurance of $20,000 for cash. Frank Willie, Chairman of the FDIC took the view of the small
banks in testifying that more insurance was required because "depositors seem to believe that their
money is safest in the largest institutions....a depositor is more likely to put funds exceeding the
insured limit in a large commercial bank than a small one." (U.S. House of Representatives,
Hearings 1973 p. 14). In addition, he pointed out that more insurance would reduce the flight of
funds from depository institutions to non-deposit institutions and markets.
The thrifts appeared to be especially eager to attract state and local deposits and were
relentless in their Congressional testimony about the need for 100 percent insurance government
deposits (U.S. House of Representatives, Hearings 1973). The representative of the U.S. Savings
& Loan League described the cumbersome process of depositing county or state funds into
multiple accounts, none exceeding the $20,000 limit, to ensure full protection. In addition, many
states required that bonds be used to collateralize deposits, with requirements varying from one
locality to the next. Donald P. Lindsay of the National League of Insured Savings Associations
gave an example from the King Country treasurer of Washington State who kept 552 S&L


passbook accounts to ensure that county funds were fully protected. He also gave the example
of a city treasurer in Washington State who mistakenly calculated the FSLIC coverage within one
S&L and lost funds. The National Association of Mutual Savings Banks supported 100 percent
insurance of government deposits, hoping for more business (U.S. House of Representatives,
Hearings. 1973). The Vice President of the Credit Union National Association, William D. Heier,
supported the St. Germain bill. Since the Federal Credit Union Act prohibited federal credit
unions from receiving funds from state and local governments, he proposed an amendment to
allow credit unions to receive such funds.
While Willie favored higher individual coverage, he resisted full coverage for government
deposits. The Chairman of the FDIC pointed out that public depositors losses had been very
small and they had recovered 99 percent of funds from failed banks. He was concerned that this
innovation would imperil the insurance fund.

An increase in coverage of all deposits to $50,000

would have caused the ratio of the insurance fund to insured deposits to fall from 1.28 to 1.13
percent. Willie did not find this alarming, except when coupled with 100 percent insurance for
public units. The full coverage for public units would have driven the coverage of the insurance
fund to 1.04 percent. At such a level, the fund might be easily exhausted if large banks continued
to fail.


In contrast, Thomas R. Bomar, head of the FHLBB, was more sanguine and fully

supported the position of the thrift industry, testifying that the FSLIC fund would not be put at
risk by 100 percent insurance of government deposits (U.S. House of Representatives, Hearings.
In spite of the growing demands from many parts of the financial industry for more and
more insurance, some sectors resisted. One official of the American Bankers Association, H.


Phelps Brooks, Jr. president of the Peoples National Bank of Chester, South Carolina made their
case: "Full insurance coverage of public accounts will open the door to pressure for 100 percent
insurance of all accounts. Account holders with quasi-public responsibility could well ask why
their savings or checking accounts above $20,000 are any less important than Government
funds...When the county sewer district promptly receives 100 percent of its deposits upon closing
of the institution, the officials at the local private hospital will certainly feel entitled to special
consideration. Then other depositories with large accounts would not understand why their
accounts are not fully covered." Brooks concluded that 100 percent coverage would have
detrimental effects on the sound management of depository institutions (U.S. House of
Representatives, Hearings. 1973, p. 114).
Faced with these strongly held conflicting positions, Congress passed compromise
legislation in 1974. Insurance on accounts of individuals and businesses was lifted to $40,000,
while government deposits guarantee was hiked to $100,000. This legislation applied to
commercial banks, mutual savings banks, and thrifts. SIPC protection was raised to $100,000 in
cash and securities, with a $40,000 maximum for cash. The result was a dramatic rise in real
protection as seen in the data for the FDIC. The real value of insurance rose in Figure 1, as did
the total coverage of deposits in Figure 2. All sizes of banks, except the very largest, as seen in
Table 3, achieved much higher rates of protection for their deposits and accounts. Five years of
legislation, beginning in 1970, had spread insurance to institutions beyond the banking system and
dramatically raised the level of insurance for all accounts. Until the S&L crisis broke, a further
increased in insurance appeared unlikely.


$100,000 Insurance and Too-Big-To-Fail
The collapse of the S&L industry has been extensively chronicled (Barth, 1991; Kane,
1989; and White, 1991). By the end of the 1970s, the income and net worth of the thrift industry
was plummeting. Measured by book value in, net worth of the thrift industry fell from 5.7 to 4.0
percent between 1977 and 1982, but any market value method showed the industry as whole to
be insolvent by about $100 billion. The FSLIC possessed only $6.5 billion of reserves and could
have paid off only afractionof the deposits of insolvent thrifts. The housing industry did not want
massive S&L closures and the Reagan administration had no desire to see a doubling of the federal
deficit. A militant S&L lobby pressured the FSLIC into a policy of forbearance—putting off any
serious attempt to discipline or close thrifts. With generous PAC money, the thrifts also helped
to persuade Congress to give it another chance to recover.
The results of intense lobbying by the thrifts and other financial institutions were the
Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA) and the
Garn-St, Germain Act of 1982.

All financial institutions, banks and thrifts, began a phased

eliminated of interest rate ceilings over the next six years. The 1982 Act authorized banks and
thrifts to offer money market deposit accounts to compete with money market mutual funds.
Furthermore, S&Ls were given a whole new range of powers. They were released from their
traditional portfolio constraints and permitted to increase consumer loans, commercial real estate
mortgages and business loans. In addition to this legislation, the FHLBB diluted capital
Congress did not openly discuss the issue of deposit insurance.

There was considerable

opposition to any further protection. Federal bank regulators strongly opposed an increase in


coverage, emphasizing that it would cause some institutions to take more risks. Instead, the
increase in coverage was added quietly and quickly to DIDMCA in a House-Senate conference
session to placate the thrifts who feared the impact of interest rate deregulation (Litan, 1994).
The 1980 act raised federal deposit insurance coverage on individual accounts from
$40,000 to $100,000 for banks, thrifts, and credit unions. Customer accounts for broker-dealers
were now insured for up to a maximum of $100,000 in cash and $500,000 for both cash and
securities. The result of this legislation was a big increase in the real value of insurance per account
(Figure 1) to approximately three times the level of 1935. The percentage of insured deposits was
racheted up (Figure 2); and, as Table 3 shows, the leap from $40,000 to $100,000 brought a much
higher rate of protection for all classes of banks.
Deposit insurance was locked firmly in place, yet since 1980, there has been no further
increase in deposit insurance. As of 1996, it has been sixteen years since there was any nominal
increase in coverage. Unlike the end of two period s of similar length, 1934-1950and 1950-1966,
there is no swelling demand for a new rise. The real value of insurance per account has declined
with inflation, but it is still more than 50 percent higher than the 1934 level, Some constraints
have been placed on insurance. There been some additional limits placed on the coverage of
accounts to limit the creation ofjoint and multiple accounts to expand coverage.17 Following the
1986 increase in the minimum capital ratio to 6 percent (White, 1992), the Federal Deposit
Insurance Corporation Improvement Act of 1991 mandated the creation of risk-based insurance
premiums in an attempt to control the problem of moral hazard.
While the high real level of coverage may have reduced the demand for insurance, there
are other important factors at work, most notably, the "too-big-to-fail" policy providing de facto


100 percent insurance. Deposit insurance was a useful instrument for guaranteeing relatively
small deposits. The advent of very large denomination, uninsured certificate of deposits allowed
banks greater ability to manage their liabilities. But, it left them subject to the judgment of the
money market. Rumors of insolvency panicked large CD holders into a run on Continental Illinois
in 1984. The Federal Reserve and the FDIC intervened to protect all depositors, large and small,
because they feared that losses would precipitate runs on other banks, generating a system-wide
crisis. The bailout of Continental Illinois certified the too-big-to-fail policy that had been evoked
in the early 1970s in the case of selected banks, like Franklin National (Sprague, 1986). Although
initially aimed at only the money center banks, the doctrine was extended in varying degrees to
other big banks (Boyd and Gertler, 1993). This subsidization of risk taking by large banks
produced an incentive to grow. When combined with the reduction in geographic barriers to
branching and holding companies, a merger and acquisition wave began in the 1980s.


winnowing of weak institutions in the bank and thrift crises of the decade and this consolidation
of the banking industry has reduced the lobbies that previously pushed for higher coverage while
leaving deposit insurance firmly in place.

Conjecture and Conclusion
In the public's eye, deposit insurance was is still considered to be one of the great successes
of the New Deal. While many economists no longer hold it in such high regard, any serious
rollback is politically inconceivable. Public acceptance of deposit insurance for banks and thrifts,
even with numerous costly failures, has enabled these intermediaries to obtain higher levels of real
coverage and made it easier for other institutions to press their claim for insuring their liabilities,


A reasonable policy question is whether the cost of deposit insurance exceeded the cost of bank
failures in the absence of deposit insurance, following the Great Depression. This Counterfactual
is potentially complex, and I will only consider here the case with the available complete data for
the FDIC.
The New Deal greatly altered the structure of the financial system. The constraints that
were placed on banks allowed other intermediaries to capture what potentially would have been
banking business. Thus, the size of the banking sector is smaller than it would have been in the
absence of the New Deal. Similarly, the regulations on bank portfolios altered the liquidity and
risk of banks, affecting the probability of bank failure. Any attempt at constructing what the
banking system would have looked like and how many failures would have occurred in the absence
of the New Deal requires grand simplifying assumptions. Aware of these difficulties, I offer here
a simple, suggestive Counterfactual where macroeconomic policy continued to be generally
stabilizing after World War II, preventing any new great depression.
First, I estimated the real cost of bank losses under the FDIC from 1945 to 1994. The
cost here is taken to be the administrative and operating expenses of the FDIC plus the losses from
bank failures. To estimate the latter, I considered the losses from the three types of FDIC
interventions: deposit payoffs, deposit assumptions, and assistance transactions. For payoffs, I
took the estimated losses (disbursements less recoveries) plus the deposits not reimbursed by the
FDIC (estimated by the total deposits times fraction of uninsured deposits).18 For assumptions
and assistance transactions, the estimated losses to the FDIC were used. The total losses for each
year were converted into real dollars, employing the consumer price index where 1982-1984 is the
base year. As presented in Table 6, the total cost of resolving bank failures with the FDIC was


$39 billion for 1945-1994 or an annual cost of $770 million. The present discounted value of the
cost of bank failures from the beginning of the postwar era, 1945, was $7.8 billion. This starting
date was selected to omit the chaos and clean up of the thirties.
What the bank failures would have looked like in the absence of the New Deal is difficult
to estimate. Banking and Monetary Statistics (1943) reported the estimated losses to depositors
for all bank failures from 1921 to 1941. The average annual loss rate on total bank deposits for
1921-1928, the nearest period of stability without insurance, was 0.1032 percent. If we assume
that the structure of the banking system after 1945 remained essentially the same as it was in the
1920s and the shocks to the economy were the same, then we could use the loss rate to estimate
the losses to depositors in the absence of the FDIC. Multiplying the loss rate times the real
deposits of insured banks for each year of 1945-1994, yields a potential annual loss of $960 million
or a present discounted value of $12.8 billion. There is also reason to think that this is a high
estimate because the banking system was undergoing a shake out in the 1920s, as many small
banks were disappearing. The Great Depression accelerated this process and eliminated virtually
any bank showing signs of weakness. The recession of 1936-37 would have produced a further
winnowing of banks. Furthermore, the New Deal halted the process of merger and consolidation
that had started in the 1920s. This development would have certainly continued more vigorously
in the post-World War II period in the absence of New Deal banking regulation.

Both the

destruction of weak banks and the formation of larger banks would have produced a stronger
banking system with fewer losses.
An alternative approach to estimating the losses to depositors in the absence of the FDIC
is to using varying bank failure rates and recovery rates. The percentage of deposits in suspending


banks to total deposits for the period 1921-1928 was 0.291 percent. For a slightly longer period
for just national banks, 1907-1929, it was 0.283. Table 6 offers four possible failure rates.
Beginning in 1907, the Comptroller of the Currency (U.S. Comptroller of the Currency, Annual
Reports and see Calomiris and White, 1994) produced detailed records of the recoveries and
losses for national banks. No single detailed source exists for state chartered banks. The recovery
rates used are the percentage paid out on proved claims three years after suspension. After three
years, recoveries are very low. The average recovery rate for suspended national banks from
1907 to 1927, weighted by bank deposits, was 48 percent.19 The recovery rate for the FDIC on
its disbursements for failed banks from 1934 to 1994 was 65 percent (FDIC, Annual Report.
1994). Whether the FDIC was more efficient than the receivers under the national banking system
or the nature of the failures or economic conditions were different is difficult to determine. Rather
than hazard a guess, Table 6 offers several recovery rates, ranging from 20 to 80 percent and
including the FDIC and national bank suspension rates.
Table 6 provides a range of Counterfactual estimates. If banks in the post-1945 period
continued to fail at the same rate as national banks had in 1921-1927 and had the same low
recovery rate, depositors might have been hit with losses of $1.86 billion per year, much more than
under the FDIC. However, this estimate is certainly an upward bound. If failure rates were lower
and recovery rates were higher-both plausible facts with a stronger banking system-then costs
to depositors would have been similar or even lower than under the FDIC. For a broad range of
estimates, it appears that the FDIC did not reduce costs

and may have raised them.

Unfortunately, given the absence of comparable data, it was not possible to conduct this exercise
for the FSLIC.

However, the sheer magnitude of the S&L disaster of the 1980s relative to the

calm of the 1920s strongly suggests that the FSLIC imposed very high costs compared to an
uninsured system.
Even given the tenuous nature of these estimates, it is hard to escape the conclusion that
deposit insurance did not substantially reduce the aggregate losses from bank failures and may
have raised them. What it did do was to alter the distribution of losses. Instead of a small number
of depositors bearing the losses of a relatively small number of banks, costs were distributed to
all depositors and hidden in the premia levied on the banks. While these costs remained large in
aggregate, they appeared to have vanished to the individual depositor. The change in the
distribution of the costs of failure made the FDIC a widely accepted program and has ensured the
continuance of deposit insurance into the next century.


1. For complete descriptions of the New Deal's banking regulations and their evolution over time
see Golembe (1986), Macey and Miller (1992), and White (1992).
2. In 1936, the 10,014 batiks with deposits of under $1 million had 85 percent of their deposits
insured, while the 209 largest banks with deposits over $25 million had only 28 percent of their
deposits covered. See Table 2.
3. The large decline of coverage in the 1940s from 45 to 35 percent in 1942 was a consequence of
the rapid growth of total deposits. Coverage bounced back to 50 percent thanks to the accountcreating activity of depositors. Between 1941 and 1949, total deposits increased 117 percent and
insured deposits by 174 percent, with the number of fully protected accounts rising by 47 percent,
(FDIC Annual Reports').
4.The non-FDIC insured mutual savings banks had $5.7 billion in deposits.
5.Employing a probit model, Kennickell, Kwast and Staff-McCleur found that lowering the
deposit insurance ceiling from $100,000 to $75,000 would increase total household uninsured
deposits by 29 percent. Smaller effects were found for eliminating separate coverage of existing
IRA and Keogh accounts.
6.The data was obtained from the Federal Deposit Insurance Corporation's Annual Reports. The
Consumer Price Index was used to obtain the real value of deposit insurance.
7.The 1990-1996 data was obtained from correspondence through the FDIC's Website.
8.In 1932, Congress passed the Federal Home Loan Bank Act which created the Federal Home
Loan Banks and Federal Home Loan Bank Board, which paralleled the Federal Reserve System.
The Home Owners Loan Act of 1933 gave the FHLBB authority to charter a new class of
intermediary, federal mutual S&Ls, thus creating for the thrift industry a dual federal-state
regulatory system that paralleled the dual banking system.
9. Some aggressive thrifts employed brokers to advertize and collect funds for them. Marvell, pp.
10. Initially, the FDIC and FSLIC relied on state laws to define what constituted different deposit
ownership, allowing people in some states to set up multiple accounts within banks and attain
coverage many times the limit intended for individuals. In 1968, the FDIC and FSLIC joined
together to produce a consistent set of rules on how to treat multiple accounts, placing some
limits on protection. Marvell, 106-111.
11. However, they were small by comparison to the 5,669 S&Ls who held $146 billion in deposits
and the 14,187 banks which had $505 billion in deposits in 1970.


12. Adequate data exist only for federally regulated credit unions.
13. The legislation enjoyed wide support among credit unions, and when the Credit Union
National Association surveyed its membership, 92 percent supported the bill,
14. Some brokerage firms carry additional commercial insurance on accounts exceeding SIPC
15.Before this act, there were no SEC or exchange rules regarding the use of customers credit
balances or other balances in possession of broker-dealers. After 1973, the SEC limited the use of
customers funds to finance margin loans to other customers and other customer related activities.
(Matthews, 55-56).
16.The Bank of the Commonwealth in Detroit and the United States National Bank in San Diego
had recently failed. Each bank had over $1 billion in deposits.
17. See WWW.FDIC.GOV for the details of these restrictions.
18.Data on the losses to customers whose accounts were over the maximum level of coverage
was not apparently obtainable.
19.If the rates are weighted by the number of banks, the average rate is 42 percent. I stop in 1927
for any later year collections were being made during the depression.


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Table 1
The Spread of Financial Intermediary Insurance

Liability Insured
and Intermediary


Coverage Begun or Increased
Nominal Value of Insurance per Customer
Jan 1934

Deposits of
Commercial Banks &
Mutual Savings Banks
Deposits of
Savings and Loan


Shares in
Credit Unions


Customer Accounts
Held by


State Funds
Life Insurance
Policies from Life
Insurance Companies
Defined Benefit



Sept 1934







$10,000 $15,000 $20,000

$40,000 $100,000


$10,000 $15,000

$40,000 $100,000


$20,000 $40,000 $100,000

Cash & Securities

$20,000 $40,000 $100,000
$50,000 $100,000 $500,000


Table 2
Percentage of Insured Commercial Banks
by their Percentage of Insured Deposits

Percent of Insured
Less than


20 to 59%

0 to 89%

90 to 100%


Source: Federal Deposit Insurance Corporation
Annual Report, 1951, p. 76; 1955, p. 68; 1964, pp. 102-3,

Number of
Insured Banks

Table 3
Insurance Coverage by Size of Bank
$1 million to
$5 million
$5 million to $25 million
$25 million

$1 million

$100 million

$1 billion

Number of Banks
Percent Deposits Insured
Percent Accounts Insured





Number of Banks
Percent Deposits Insured
Percent Accounts Insured






Number of Banks
Percent Deposits Insured
Percent Accounts Insured






Number of Banks
Percent Deposits Insured
Percent Accounts Insured


69 3





Number of Banks
Percent Deposits Insured
Percent Accounts Insured







Number of Banks
Percent Deposits Insured
Percent Accounts Insured







Number of Banks
Percent Deposits Insured
Percent Accounts Insured







Number of Banks
Percent Deposits Insured
Percent Accounts Insured







Number of Banks
Percent Deposits Insured
Percent Accounts Insured

























Number of Banks
Percent Deposits Insured
at 40000
at 2100000
Percent Accounts Insured
at 240000
at 2400000

Source: FDIC, Annual Reports and Reports of Deposits, selected years.

Table 4
Number, Growth, and Insurance of Bank Accounts

Number of
Number of
Fully Insured
Accounts in Annual
Accounts in
All Insured
All Insured
Rate of (1)
Rate of (3)
(percent) (millions)













Number of
Number of
Fully Insured
Accounts in All
Accounts of
Percent of
Growth All Commercial
Accounts Fully
Rate of (6)
Rate of (8)
Insured (3/1)

Source: FDIC Annual Reports and Reports of Deposits, 1934-1981
FDIC Webmaster Communication, 1990-1996











Percent of
Accounts Fully
Insured (8/6)


Table 5
Determinants of FDIC Insurance Coverage
of Commercial Bank Deposits

1934-1994 JÔ34-1ó8J






Real Value of Insurance
Per Account





Percentage of Deposits in
Failing Banks



Number of Failing
Growth in Bank






Growth in Number of
Bank Accounts





Adjusted R-Squared










Durbin-Watson Statistic





The numbers in parentheses are t-statistics.

Table 6
The Cost of FDIC Insurance and Counterfactual Deposit Losses
(in 1982-84 billions dollars)

Estimated Cost of
Bank Failures
(Average Annual Cost/
Present Discounted Value)
Under the FDIC


Recovery Rates



Loss Rates of 1921-28


Bank Failure Rates

0 0 2 percent





0.1 percent





0.2 percent



1.32/24 1.38/25

0.283 percent


1.08/24 1.86/34 1.94/36


Figure 1
Real Value of Deposit Insurance per Account


Figure 2
Percentage of Bank Deposits Insured by the FDIC

Changes in the nominal coverage are indicated by the vertical lines


Figure 3
FDIC Insurance Fund as a Percentage of Insured Deposits
1934 - 1994


Figure 4
Insurance of Accounts in FDIC Banks


Figure 5
FDIC Effective Assessment Rate
1934 - 1994


Figure 6
Membership in the FSLIC