Updated
Ireland is unhappy with the effect that runs on banks have been having. Their solution? Temporarily guarantee all deposits. The Irish Independent reports, Ireland’s bank guarantee could be model for other countries:
”Certainly this will be looked at by governments elsewhere as a model,” said Paul Niven, head of asset allocation at F&C Investments in London, which oversees $200 billion. ”It’s likely that deposits could be guaranteed, but guaranteeing other parts of the balance sheet in places like the U.S. and the U.K. seems hugely complex.”
In other words, the US and UK are trying to accomplish the same thing: ease the frozen money markets. Instead of buying crap and trying to improve bank balance sheets at taxpayer expense, this plan insures taxpayer deposits at taxpayer expense for a period of two years. There is therefore no driving force to start a bank run. This is not without risks:
The perceived risk of a default by Ireland surged to a record after the government announcement. Credit-default swaps on Ireland’s government bonds rose 30.6 basis points to an all- time high of 63.5, according to CMA Datavision prices. Credit- default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange company fail to adhere to its debt agreements.
I’m not sure that the reaction would be as negative for US Treasuries. Incidentally, the Irish banks got the boost that US lawmakers are desiring:
Irish financial stocks rose after the announcement, with the country’s benchmark ISEQ index gaining as much 6.5 percent. Irish Life & Permanent soared 28 percent to 4.57 euros as of 12:08 p.m., Anglo Irish Bank increased 35 percent and Allied Irish gained 16 percent. Bank of Ireland increased 16 percent.
Mish, a die hard libertarian, seems to have surrendered to the idea that congress is going to do something. He urges you to tell your congressional representative to consider the Irish alternative in How To Stop A Run On The Banks:
The fastest way for the US and other governments to solve this is to raise deposit insurance ceilings. This is a far better option than ballooning the Fed’s balance sheet more.
Furthermore, I would highlight that fully guaranteed deposits would put the US government even more at the top of the capital structure of banks. Existing senior debt is all of a sudden now fully subordinated to a potentially unlimited amount of insured deposit debt.
Read Mish’s article and determine if it is something you can endorse. Congress did respond to the recent input they’ve received.
I’ve spoken to many people who were unclear on the FDIC insurance limits and were rightfully spooked. If you are a business, you can’t afford to have your payroll system in a bank that might disappear, only to drain your payroll account. The Irish plan has immediate benefits for Main Street, and will also help settle Wall Street. The costs are harder to analyze, but it would not require an immediate $700 billion. Compared to the Paulson plan (and the modified version that just failed), this is probably a good deal. I’m not convinced it is better than nothing. Certainly it will be better in the short term — I’m not convinced the Paulson plan even had that going for it. The long term consequences should be considered, but this at least gives people an effective alternative.
Update
In the end, I’m against this plan too. I’ve decided that while increasing the FDIC limits a certain degree is a good idea, there’s some benefit of these bank runs. Ultimately, moral hazard is a bad thing. Banks that need additional deposits can just offer 8% CDs, delaying the inevitable. WaMu offered 5% CDs a little before they collapsed. That offer was one indicator people used to get their money out. That led to the bank run. But, if the money was insured without limit, there’s no reason to be afraid of your own bank offering unsustainable yields. The banks can take huge risks, and either win big or fail. Statistically, more would fail than win big. Those failures would be larger than without the insurance backstop. That would increase the costs to the FDIC. Bank runs and bankruptcy are surprisingly good tools for getting bad banks out of the economy. The illusion of safety would ultimately cost future taxpayers considerably more than doing nothing.
