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Constituent Interests and Federal Deposit Insurance

Constituent Interests and Federal Deposit Insurance

From an early date, advocates of deposit insurance pushed for federal legislation. From 1886 through 1933, 150 bills were introduced into either the House or the Senate, proposing to establish federal deposit insurance. 

These proposals differed in their particulars regarding the range of membership (i.e., whether to restrict members to national banks, all Federal Reserve member banks, or all national and qualifying state banks), the form of protection for deposits (mutual bank guarantee or government guarantee), and the charges to participating banks, but they shared common fundamental features. 

All the proposed systems would have established a national system of insurance in which all banks would pay identical premiums and receive identical protection. Such a national system would have extended to the national level the model of deposit insurance adopted at the state level by the eight postbellum insurance systems.

In economic terms, regardless of whether insurance was funded by banks or backed by a government guarantee, such a scheme necessarily involves crosssubsidization of risk across states. 

States with banks that suffered higher risks of failure would gain at the expense of other states’ banks, and in the case of government guarantees, at the expense of the rest of the nation’s taxpayers. From this standpoint, one would expect that the states most likely to favor national insurance would be those with the most vulnerable banking systems.

For these states, the common costs of insurance would be more than reimbursed by the expected bailouts of failed banks by relatively stable banks (and taxpayers) from other states. Compared to state-level deposit insurance, federal deposit insurance was particularly attractive to unit bankers located in the highrisk rural states because it offered greater protection at lower cost. 

But this same fact made federal insurance legislation less likely to succeed. Rural unit banks wielded more power in their states than they wielded in Congress, where banks from states with relatively stable banking systems would oppose crosssubsidization of risky banks. 

One way to test this special-interest, rent-seeking view of support and opposition for federal deposit insurance would be to compare each state’s banking system’s vulnerability with its support for federal legislation creating deposit insurance.

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