Can the FDIC really protect you?

We've all seen the little FDIC signs at the bank. They are there to make you feel secure. They tell you any deposit up to $100,000 is insured by the Federal Deposit Insurance Corporation. You don't have anywhere near $100,000, so you breath a sign of relief. You don't have anything to worry about .... do you?

During the Great Depression, people lost money when banks closed. The banks had to close because customers got scared and made a run on the bank in an attempt to get their money out. Banks don't have to have cash on-hand for every dollar that is deposited in the bank. You deposit your money, and the bank turns around and lends out up to about 90% of those deposits so it can earn interest on those funds from people who need to borrow the money. The bank is only required to hold on to about 10% of those deposits. That 10% is what is referred to as a "reserve ratio".

So, when the people made a mad, fearful dash to get their money back from the bank, the bank could only give back what they had on hand. Once that reserve fund was gone, the bank was out of assets and had to close. At the end of the day, if you didn't have those two dollar bills left like George Bailey and his friends at the Bailey Building & Loan Association, your bank was wiped out. Those customers who didn't get their deposits out were out of luck, because their deposits weren't insured.

But you're different. As you stand in line at the local bank and trust, you look at the little black-and-gold plastic FDIC sign and feel comfortable, because you know the FDIC will be there "like a good neighbor". The question for today's blog is how big would a crisis have to be before even the mighty FDIC couldn't save you? It might not have to be all that big.

Last week, there was a good old-fashioned run on the bank at IndyMac when over $1 billion in deposits were withdrawn by worried customers. IndyMac was shut down by the government and all accounts were insured only for the first $100,000 per account. Any money over that (estimated at about $1 billion at IndyMac) was left unprotected and uninsured. Since the FDIC has to insure the deposit amounts of $100,000 and less, it appears they may have to come up with between $4 and $8 billion to insure those deposits.

So ... how much money does the FDIC have in its reserve fund? It appears to be around $52.843 billion [check out the details here]. That sounds like a lot of money, but it is only about 1.19% of the estimated $52.214 trillion the FDIC is insuring.

Remember, as a bank, IndyMac had to keep a reserve ratio that is almost 10 times higher than the FDIC's -- and they ran out of money when people started withdrawing their deposits. If the estimates on IndyMac are correct, the FDIC will have to draw out between 7.57% and 15.14% from its Deposit Insurance Fund (DIF) for IndyMac's customers.

Consider the consequences of hundreds of banks failing. If one bank can draw down the DIF by as much as 15%, it would only take seven more failures of the size of IndyMac for the FDIC to be insolvent.

Does the little plastic sign still make you feel all warm inside?