How many things are out there that the government, essentially the tax payers, are going to have to cover in the event of a disaster? Fannie and Freddie are but two.  The underlying issue is encompassed by “moral hazard”. Essentially, if you have put the downside risk on others, you are prone to take more chances. The common example is the insurance that covers a rental car. Once a driver has it, they tend to take more risks and don’t take the care they would if they had to pay for any damage. If the government will bail them out, why not take on risk?

What deposit insurance does is protect the depositors, not the bank. So depositors don’t have any worries about which bank they deposit money into and aren’t a check and balance with regard to bank safety. What this gives the bank is a steady supply of low cost capital from which they can profit. If risk was taken into account, they would have to pay depositors a much higher rate of interest and they wouldn’t be nearly as profitable. This is essentially a federal subsidy for banks.

Passing on the risk is a major difference between banks today and years ago. There is almost no risk of collapse due to a regional or local event. Even a local bank in New Orleans can weather that storm so to speak, because they didn’t hold the notes on all those homes. The “market” did. The risk was diversified and the bank remains intact. Brilliant is probably a good word for it. 😉