Personal Finance: The alphabet soup of deposit insurance
Many if not most Americans simply assume that their bank deposits and brokerage accounts are backed up by the government. This presumption is supported by the fact that no depositor in a federally insured commercial bank has lost a penny since the inception of bank deposit insurance in 1933.
Similar coverage extends to members of federally insured credit unions and, with some exceptions, to holders of most brokerage accounts. Such has not always been the case. Depressions (“panics” as they were then called) occurred in 1819, 1837, 1873 and 1907 that wiped out banks and depositors’ fortunes. It was only in the shadow of the Great Depression that the idea of government protection of financial accounts gained currency, as it were.
There are limits to coverage, however, of which customers should be aware. To take full advantage and avoid surprises, it helps to understand how the various institutions safeguard your funds and which assets are not protected.
The most familiar depository insurer is undoubtedly the Federal Deposit Insurance Corp., commonly referred to as the FDIC. It is an independent agency of the government that was created to address a national banking crisis arising out of the Great Depression.
Over the four years following the stock market crash of 1929, over 9,000 U.S. banks shut their doors, sapping customers of $7 billion in deposits, or $135 billion in today’s dollars. In response, Congress passed the Emergency Banking Act of 1933 creating the FDIC, modeled on an early plan enacted by the state of Massachusetts. The act was passed over the objection of the American Bankers Association and initially President Franklin D. Roosevelt himself, who feared deposit insurance would encourage risky behavior. (Aside: Risky bank behavior did indeed ensue, but not because of deposit insurance).
The fledgling FDIC provided coverage for deposits of up to $2,500 but soon doubled the limit to $5,000. Increased sporadically over the years, the current limit is $250,000 per customer for each different type of account. For example, a husband and wife are separately insured for $250,000 in a joint checking or savings account at an FDIC member bank. Accounts of different registration types like traditional or Roth IRAs at the same bank are also covered separately for the same amount. Taxable accounts with stated beneficiaries, called payable on death accounts, carry $250,000 coverage per beneficiary up to a total of $1,250,000 in the aggregate.
The FDIC is not taxpayer funded. The primary source of capital for the insurance fund is the collection of premiums charged to member banks. Premium rates range from 9 to 31 basis points (a basis point is 1/100 of one percent) per dollar on deposit, adjusted for risk of the specific institution. In addition, the FDIC can assess additional fees if necessary, and the capital in the fund accrues interest income as well.
Credit union customers enjoy similar coverage thanks to a 1970 law signed by President Richard Nixon that created the National Credit Union Administration. Similar in structure to the FDIC, the agency administers an insurance fund that covers share deposits in federally insured credit unions up to the same $250,000 limit per customer per account type. Note that while about 98% of institutions are covered, there are some small state credit unions that are not. Insured credit unions must prominently display the National Credit Union Administration logo.
The FDIC has stood the test of time. In the wake of the financial crisis from 2008 to 2014, over 500 banks became insolvent, including Washington Mutual, still the largest failure in U.S. history at $307 billion. In 2023, the next three largest collapses occurred with rapid succession. So rapidly in fact that the FDIC was forced to temporarily assume operation of Silicon Valley Bank and Signature bank before a buyer could be found, but all depositors were made whole.
Savings and loan associations once had their own deposit insurance through the Federal Savings and Loan Insurance corporation. In the aftermath of the savings and loan crisis of the 1980s, nearly a third of these associations failed, and their insurance fund was ultimately assumed by the FDIC.
All good for banks and credit unions, but what about brokerage accounts? Enter the Securities Investor Protection Corp. Formed in 1970 in response to a market crash and liquidity crisis, the SIPC offers protection to customers of member firms of up to $500,000 including a cap of $250,000 on cash awaiting investment.
In addition to the stated coverage from the SIPC, most firms purchase substantial additional private insurance from Lloyd’s of London extending coverage into the hundreds of millions of dollars. The value of an account subject to coverage is determined as of the filing date on which a court places the failed firm into liquidation.
Importantly, SIPC coverage does not insure against market value declines. In essence, a client’s portfolio held in a failed institution is lifted out and dropped into another solvent custodial firm. Coverage extends to securities like stocks and bonds, but does not include commodities, futures contracts, non-listed limited partnerships, safe deposit boxes or cryptocurrency holdings other than listed exchange traded funds holding crypto. Since 1971, the SPIC has recovered $142 billion for customers who would otherwise have lost their savings in 330 brokerage liquidation proceedings.
Savers and investors would understandably be hesitant to trust their life savings and retirement assets to an institution that, if it went belly up, could send their assets up in smoke. The fact that most Americans rarely if ever consider the possibility speaks to the success of deposit insurance in safeguarding the U.S. financial system.
Christopher A. Hopkins, CFA, is a co-founder of Apogee Wealth Partners in Chattanooga.
