Two words: Moral Hazard
First, we shall let Rothbard explain how the mega-banks use the FDIC to prevent their Ponzi scheme from collapsing at tax payer expense.
From Anatomy of the Bank Run by Murray N. Rothbard
The answer lies in the nature of our banking system, in the fact that both commercial banks and thrift banks (mutual-savings and savings-and-loan) have been systematically engaging in fractional-reserve banking: that is, they have far less cash on hand than there are demand claims to cash outstanding. For commercial banks, the reserve fraction is now about 10 percent; for the thrifts it is far less.
This means that the depositor who thinks he has $10,000 in a bank is misled; in a proportionate sense, there is only, say, $1,000 or less there. And yet, both the checking depositor and the savings depositor think that they can withdraw their money at any time on demand. Obviously, such a system, which is considered fraud when practiced by other businesses, rests on a confidence trick: that is, it can only work so long as the bulk of depositors do not catch on to the scare and try to get their money out. The confidence is essential, and also misguided. That is why once the public catches on, and bank runs begin, they are irresistible and cannot be stopped.
We now see why private enterprise works so badly in the deposit insurance business. For private enterprise only works in a business that is legitimate and useful, where needs are being fulfilled. It is impossible to “insure” a firm, even less so an industry, that is inherently insolvent. Fractional reserve banks, being inherently insolvent, are uninsurable.
What, then, is the magic potion of the federal government? Why does everyone trust the FDIC and FSLIC even though their reserve ratios are lower than private agencies, and though they too have only a very small fraction of total insured deposits in cash to stem any bank run? The answer is really quite simple: because everyone realizes, and realizes correctly, that only the federal government – and not the states or private firms – can print legal tender dollars. Everyone knows that, in case of a bank run, the U.S. Treasury would simply order the Fed to print enough cash to bail out any depositors who want it. The Fed has the unlimited power to print dollars, and it is this unlimited power to inflate that stands behind the current fractional reserve banking system.
Next, we shall paraphrase this most recent report from Zero Hedge on the activities of the major banks:
Bank of America has shifted anywhere up to the total of $53 trillion of the total derivatives it held as of June 30 to its retail bank. The reason for the transfer? Bank customers who were uneasy with the fact that suddenly the collateral backstoping the operating entity handling their counterparty risk was downgraded to just above junk, demanded that said counterparty risk be mitigated by the bank’s $1 trillon in deposits.
In other words, as Bloomberg first reported when it broke this story, anywhere up to the full $53 trillion (we don’t know for sure how much so we assume the worst case) is now fully and effectively backstopped explicitly by the bank’s $1.041 trillion deposits. Pardon’s we meant the people’s deposits: the same deposits which caused the bank’s website to be inoperative for several days in a row after it was rumored that there was an electronic run on the bank. Why? Just so Bank of America can appear solvent, to whatever remaining clients it has, so they decide not to take their business to another derivative counterparty. And who is exposed to this latest idiocy? Why you.
In other words, while previously there had been a firewall between the bank’s depository entity and the one that gambles, on either a flow or prop basis, with the above mentioned multi-trillion number, that firewall is now gone and all the money has been comminlged, explaining the FDIC’s fear [because the FDIC has to insure all the deposits in the event of a default]. And of course, in order to thank depositors for being explicit guarantors of the bank’s derivative business, it is now forcing them to pay a $5/month fee.
Somehow we really doubt the 12/31 update will show a “total deposits” number over $1 trillion. Or anywhere remotely close.
Laslty, nobody should make the mistake that BofA is alone in this move: every other bank that has major derivative exposure and has a depository base has certainly been forced to do precisely the same by its bigger accounts, who have no desire of being exposed to surging counterparty risk and would much rather split it with America’s depositors.