Obama, McCain in accord on FDIC limit of $250,000

In rare agreement, presidential candidates Barack Obama and John McCain yesterday endorsed an increase in bank deposit insurance limits, but legal and academic specialists said the idea may do little to solve the fast-moving financial crisis and could cause new problems over time.

Obama, the Democratic nominee, and McCain, the Republican, both advocated increasing from $100,000 to $250,000 the amount of deposits that would be insured by the Federal Deposit Insurance Corp. in the event of a bank failure, the first increase in 28 years. The proposed increase originated with House Republicans during negotiations over the $700 billion bailout, but was not included in the bill that went down to defeat in the House Monday. Later yesterday, FDIC Chairman Sheila Bair announced support for the idea.

Because a majority of House Republicans voted against the bill, including the insurance increase might bring enough of them back aboard to get it through the chamber.

"It's almost like throwing a bone to Main Street, as it's being described," said Ann Graham, professor at Texas Tech University School of Law and a former regional counsel of the FDIC. "Frankly, it's a little bit misleading . . . It's almost a [public relations] tactic as opposed to a substantive change."

Graham said the increase could provide some benefit to small business owners who need to maintain payroll accounts of more than $100,000 in a single institution. But she said the FDIC since 2006 already insures Individual Retirement Account deposits up to $250,000. And depositors can also set up revocable trusts, known as payable-on-death accounts, that are insured for up to $500,000 from which they can make withdrawals or change heirs at will.

By increasing the amount of deposits to be insured, Graham said, the FDIC is redefining the small investor it was designed to protect when it the agency was created in 1933 during the Great Depression. It would also be easier for banks to attract larger amounts from depositors, who would not need to worry what the banks were doing with those funds because the larger deposits would be insured.

"From a political point of view, there's a lot of appeal, but from an economic point of view, other than calming the moment, it's not very good," said George G. Kaufman, professor of finance and banking at Loyola University Chicago.

Kaufman said inclusion of the increased insurance limit may help attract enough new votes to win passage, "but it will generate a huge moral hazard problem," referring to the unintended consequences that occur when parties are insulated from risk. "It might help deal with the panic today, but it sets the stage for crises down the road."

"Virtually every mortal is fully covered by the $100,000 limit, and it's not that hard to get all your deposits covered under the existing regulations," said John L. Douglas, former general counsel of the FDIC and now in private law practice in Atlanta. "You can split them among several banks, and indeed, one of the virtues of having a $100,000 limit is that people pay more attention to their banks."

Under current rules, deposits up to $100,000 per person per institution are insured by a fund drawn from assessments on banks. "It has nothing to do with the root cause of the larger problem," Douglas said.

The FDIC, which insures deposits of almost 8,500 banks and savings associations, now has about $45 billion in its insurance fund and will propose raising premiums in the upcoming weeks to ensure that the fund remains strong, said David Barr, spokesman for the FDIC.

Barr said the amount of uninsured deposits varies in each bank failure. When Silver State Bank in Nevada failed last month, only about $20 million of $1.7 billion was in deposits greater than the account limits and thus was uninsured, he said. When the giant IndyMac Bank of California failed in July, about $540 million out of $19 billion in deposits were uninsured, he said.

"No depositor has ever lost a penny of insured deposits and never will," Barr said.