The Legacy of Deposit Insurance: The Growth, Spread, and Cost of Insuring Financial Intermediaries
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 analysis of an insurance-free post Great Depression financial system in order to assess the burden imposed by this legacy of the New Deal.