Mandel: Expand FDIC Coverage, Now

BusinessWeek's chief economist argues that an increase in bank-deposit insurance is the fastest and clearest way for Congress to calm things down

By Michael Mandel

When you build a wall, you need to start with the bricks on the bottom. In the same way, when fighting a financial crisis, the government needs to start with the basics: reassuring bank depositors that their money is safe.

That's why Congress should stop fighting over the Paulson plan, at least for the moment, and quickly—instantaneously—pass an expansion of deposit insurance. That expansion should guarantee deposits up to $1 million and allow banks to offer deposit insurance above that for a small fee. What's more, Congress should augment the deposit insurance fund, which was $45 billion at the end of the second quarter, with another $100 billion or so.

Such a plan should win favor with both Republicans and Democrats. It builds on a very popular existing program rather than creating a new one. What's more, both Barack Obama and John McCain came out on Tuesday, Sept. 30, in favor of increasing the deposit limit to $250,000, up from its current $100,000. FDIC Chairwoman Sheila Bair has also called for higher insurance limits.

Beefing up deposit insurance will reassure average Americans that their money is safe, no matter what happens. It will prevent runs on commercial banks and keep the banking system as a bulwark of stability in troubled times.

Opposition Disappears

Ironically, Wall Street firms used to be the main opponent of raising deposit insurance limits. They would argue—backed up by big lobbying dollars—that such a move would give commercial banks an unfair advantage against investment banks and stock brokers. But now Lehman and Bear Stearns are gone, Merrill has been bought up by Bank of America (BAC), and Goldman Sachs (GS) and Morgan Stanley (MS) have transformed themselves into commercial banks. There is no organized opposition to a perfectly reasonable change.

Expanding deposit insurance would solve the immediate problem. It would attract more funds to the banks, which would then have more money to lend. And it would calm down the note of hysteria that hit last week.

After that's done, Congress can turn to the question of what else needs to happen to firm up the markets. It may be that the banks still need an injection of capital, or that the housing market still needs some support. But with the base of the financial system solid, at least there will be time to think.

Mandel is chief economist for BusinessWeek.