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The Federal Deposit Insurance Corporation: With Banks Failing or In Peril, It's Especially Important Now to Understand and Reform this Crucial Institution


Friday, Aug. 15, 2008

Last month, the failure of the IndyMac bank in Southern California, which left many depositors holding the bag, made national headlines. Amid stories like this, and in light of continuing jitters over the health of the American financial sector, understanding how the Federal Deposit Insurance Corporation (FDIC) insurance program works is obviously important for anyone who has money in a bank. Below, I will describe some of the misunderstood aspects of this federal governmental insurance regime, and question whether some simple changes wouldn't improve the system substantially. By necessity, I will leave out some of the complexity of the FDIC rules. Accordingly, readers should certainly investigate how the rules apply to their own situations carefully, notwithstanding any general observations I make in this column.

Why the FDIC’s Basic “$100,000 Per Depositor” Rule of Thumb Is Inaccurate: Sole Accounts Versus Joint Accounts

For starters, the oft-repeated mantra that the FDIC insures accounts at covered banks up to "$100,000 per person per institution" is simply wrong. In fact, an individual can protect far more than $100,000 at each bank if she knows the rules and is careful about taking advantage of them.

The key is that the FDIC insures different categories of accounts -- which are defined in terms of types of ownership -- differently and separately. The simplest kind of account is sole ownership. If only one person has his name on one or more bank accounts in a bank, then the FDIC will insure all of those accounts up to $100,000 total. Thus, Depositor A can have one account with $100,000 in it, or instead have four accounts with $25,000 in each, and either way, all of Depositor A's money is covered. If his solely-owned accounts had totaled more than $100,000, however, then any money above the $100,000 limit would be uninsured.

How, then, can Depositor A protect more than $100,000? One obvious, if cumbersome, way is to open accounts at more than one covered bank. If Depositor A has a solely-owned account in Bank #1 with $100,000, and a solely-owned account in Bank #2 with another $100,000, then both accounts are fully insured. This feature has prompted many middle and upper-middle class Americans to run around dividing their savings into multiple institutions, watching carefully to see when they reach the insurance limit at each bank.

But there are other, less well known, ways for a person to protect more than $100,000. As noted above, the crucial point is that the FDIC insures accounts held in different forms of ownership differently. Joint accounts are a different type of ownership from solely-owned accounts. In a joint account, more than one person has his name and signature card on the account, and each owner has the power to access the funds therein. Importantly, any money held by a person in joint accounts is insured by the FDIC separately and in addition to any money held by that same person in that same bank in solely-owned accounts.

To see how this works, consider the following example: Depositor A has $100,000 in Bank #1 in an account with only his name on it. In addition, he and his wife, Depositor B, have a joint account, with both their names on it, in that same bank, containing $200,000. All of that money is fully FDIC-insured. Here’s why: Because the FDIC insures the jointly-titled account separately from the account with only Depositor A's name on it, Depositor A can enjoy insurance for $100,000 in his solely-titled account, and another $100,000 for his half-interest in the $200,000 jointly-held account. Depositor B, in addition, is insured for her half-interest in the $200,000 jointly-held account.

Moreover, Depositor B could have a solely-titled account of her own for another $100,000, and all $400,000 of the couple's money in that one bank would be insured, which in effect works out to $200,000 of insurance per married person, twice the $100,000 per person refrain that is often heard. (Note also that the FDIC generally cares only about the way the accounts are titled, not who does or does not, in fact, own the monies placed in the account under community property and other bodies of property law.)

Why Trust Accounts and Other Types of Accounts Complicate Matters Even Further

Indeed, there are yet other types of ownership that would enable Depositors A and B to insure more money still in a single bank. Accounts that are payable on the death of the account owner to a beneficiary, or more formal trust accounts, and certain Individual Retirement Accounts, are all insured in addition to the solely- and jointly-titled accounts described above.

Consider, for example, formal trust accounts. If Depositors A and B have three children, X, Y, and Z, they could set up a trust account owned by the "AB family trust" in which the money would be under the control of A and B so long as they are alive, but would then pass to X, Y and Z upon A and B's death. And the FDIC statutes and regulations provide that federal insurance of such an account would extend to $100,000 per trust creator per beneficiary. In this illustration, that would mean up to $600,000 of insured funds in that one trust account ($100,000 times two because there are two trust creators -- A and B -- times three because there are three trust beneficiaries, X, Y and Z.)

Moreover, that $600,000 of insured funds would be on top of the $400,000 that A and B could insure in their hypothetical solely- and jointly-owned accounts discussed earlier, for a total of $1 million of covered deposits, just in Bank #1 alone!

Given These Complex Rules, FDIC Insurance May Prove to Be a Trap for the Unsavvy

These complicated rules are not easily discernable from the FDIC's very mediocre website and the even more mediocre written pamphlets available at banks. I had to look at the Congressional statutes and federal regulations (which the FDIC site does enable you to link to, if you are diligent) themselves in order to confirm my tentative understandings as discerned from the FDIC website’s characterizations of the rules. Even financial journalists frequently misread and/or misunderstand the rules; I have seen very intelligent and thoughtful personal finance columnists in major national newspapers misdescribe the scheme in recent weeks. And bank employees seem even less well-informed; conversations I've had with bank managers over the last month or so have yielded completely conflicting -- and almost always technically inaccurate -- answers.

But the fact that even many "experts" don't easily or fully understand the FDIC system is less a reflection on them than it is an indictment of the current insurance program itself. If an insurance regime -- especially one offered by the federal government -- is to accomplish its goals of promoting peace of mind and stability and fairness, then surely its rules must be transparent and relatively easy to understand. Government-provided insurance should not be an "insiders' game," where some resourceful folks cleverly protect millions of dollars in just a few institutions while other, less sophisticated, middle class Americans waste time shuttling money from bank to bank and running the risk of getting burned if they happen to let their account balances in any one bank exceed $100K.

Ultimately, too, all this wasteful money-moving that the current system encourages doesn't seem to have solved the problem of providing security for Americans’ savings. Some estimates suggest up to one third of all the money deposited in FDIC-insured banks across the country is uninsured because it falls outside the insurance rules. And my (admittedly underinformed) sense is that a lot of those uninsured deposits are not held by “fat cats” who have millions in each bank. (Fat cats generally don't put their millions in banks; the return on investment is too low.) Instead, I fear that much of the uninsured deposit money belongs to folks like many of those hurt by IndyBank's collapse -- middle and upper-middle class Americans who might have their life savings of $400,000-$500,000 unwisely accumulated in too few types of accounts at too few banks.

The FDIC’s Rules Need to Be Modernized and Simplified

. An important, related question is this one: Why we haven't revised the $100,000 baseline number to reflect modern economic reality? The numerical cap (which, as noted, is not really a cap for the savvy) has not been updated since 1980 (even though it was updated four times between 1966 and 1980), and surely $100,000 means something very different in today's economy than it did almost 30 years ago. In the late 1970s, perhaps it made some sense to think that people who had more than $100K in any bank were likely to be quite rich -- persons who could insure themselves by diversifying their portfolios. But that is certainly not so today.

Let’s assume that we don't want to publicly insure the super rich, and if we don't want the FDIC to incur more liability that that to which it is currently exposed (because FDIC resources are finite). A better system would still be possible: It would simply pick a modernly realistic number, say a million or two million bucks, and then guarantee that a person can have that much of his money -- and no more – insured across all the FDIC-insured institutions in which he has accounts, regardless of how much of it is in any one bank, and without undue emphasis on way that title is held.

Vikram David Amar is a professor of law at the University of California, Davis School of Law. He is a 1988 graduate of the Yale Law School, and a former clerk to Justice Harry Blackmun. He is a co-author, along with William Cohen and Jonathan Varat, of a major constitutional law casebook, and a co-author of several volumes of the Wright & Miller treatise on federal practice and procedure. Before teaching, Professor Amar spent a few years at the firm of Gibson, Dunn & Crutcher.

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