Dismantling the FDIC Would Undermine a Fragile Banking System

Reports of sweeping reform of the banking agencies are encouraging, because the current regulatory structure—rooted in the Civil War and Great Depression eras—cries out for modernization. But they are also concerning, because the financial system that bolsters our economy is fragile.

The new administration will bring with it a new attitude toward bank regulation. Its urge to act boldly shouldn’t crowd out the need to act wisely. A sledgehammer approach to reforming regulatory agencies is less effective than a more surgical approach. Any action, whether bold or cautious, may be delayed by the need for congressional action.

Here are two contrasting examples: the Federal Deposit Insurance Corporation and the Federal Home Loan Banks.

Banks primarily fund themselves with customer deposits. Bank deposits play a critical role in the nation’s payment system, in household savings, and in the implementation of monetary policy. For 90 years, the stability of the banking system has been grounded in the robust system of deposit insurance administered by the FDIC.

Each bank proudly displays the iconic FDIC badge stating, “Backed by the full faith and credit of the United States government.” The premium for this insurance on deposits is paid for directly by banks and indirectly by depositors. Congress has underwritten this guarantee by statute.

This form of deposit insurance has served the nation well since its establishment in 1933 by the Banking Act. While we have experienced banking crises since then, there have been no full-scale bank runs or panics during that period. It has been a model for other countries.

Dismantling the FDIC as has been reported would lay bare the fragility of the banking system. Each individual depositor would be left to monitor the financial condition of their bank. Determining the safety and soundness of a bank is both art and science. It’s not a task suited for the average bank customer.

Unwinding the FDIC is a distinctly bad idea even in the unlikely event the next Congress were to go along with it. Equally unwise is moving the FDIC to the Treasury Department, where it would be more vulnerable to political manipulation.

In contrast, banks also fund themselves by tapping into an obscure 92-year-old federal government enterprise known inappropriately as Federal Home Loan Banks. Their singular function has evolved into enabling their member banks and insurance companies to borrow funds at rates that mimic the rates paid by the US government.

As originally conceived in the 1930s, this government enterprise was supposed to stimulate the then dormant housing market. That was the bargain: access to cheap taxpayer-supported funds in exchange for housing assistance.

The bargain has been broken.

Today, these taxpayer-supported firms play no role in stimulating housing. Most of their member banks and insurance companies have long since exited the housing market entirely. Yet they remain in business, subsidized by the taxpayers, providing negligible public good.

For over two years, the FHLBs have vigorously opposed any efforts at reform even though as one regulator charged, they are a form of “corporate welfare.” The Congressional Budget Office and others have pegged their annual taxpayer subsidy at nearly $11 billion. The FHLBs have grown in assets to $1.3 trillion, all the while providing little to no public good.

Dismantling the 11 FHLBs would cause no public harm to the nation’s financial ecosystem. Rather, their demise would unclutter the system by encouraging the member banks to pay market rates on deposit accounts. This would be a boon for consumers.

As for the buyers of FHLB debt, mostly money market mutual funds, removing subsidized FHLB debt from their menu would eliminate an unnecessary distortion from the money market. The funds would simply replace FHLB debt with the next best (hopefully non-taxpayer subsidized) alternative instrument.

For purposes of the next administration and the Department of Government Efficiency initiative, the difference between the FDIC and FHLBs is not just that one serves the public interest and the other does not. It’s also that the FDIC could only be dismantled with congressional approval, while all it would take to dismantle the FHLBs is the executive decision to do so.

Congress has ordained by statute that bank deposits are backed by the “full faith and credit of the United States.” No such statutory guarantee stands behind FHLB debt. No regulation of the government guarantees FHLB debt. FHLB debt is backed only by an implicit assumption in the marketplace.

If the Secretary of the Treasury were to announce that going forward, the government wouldn’t guarantee implicitly or explicitly the debt of FHLBs, debt issuances by each of the 11 FHLBs would carry a higher risk premium if they were marketable at all. The value proposition for members borrowing at taxpayer-subsidized rates from their FHLB would vanish.

Approximately 60% of FHLB assets are highly secured advances while approximately 34% of their assets are very safe investments (such as government and agency securities). Unwinding the FHLBs would be an entirely orderly process.

According to President-elect Donald Trump’s statement announcing the Department of Government Efficiency, the commission’s report isn’t due until July 4, 2026. The evidence regarding the FHLBs has already been compiled, so an administration serious about financial regulatory reform needn’t wait that long. Let the reform begin.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

William M. Isaac was chairman of the FDIC and is chairman of Secura/Isaac, LLC.

Cornelius Hurley teaches financial services law at Boston University and was an independent director of the FHLB of Boston.

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