One of the biggest casualties of the financial crisis is confidence in the nation's banks, which has been eroding in a way not seen since the Great Depression as a result of the rapid-fire failure of IndyMac, Washington Mutual, Wachovia and other top institutions.
The banks were brought down in part by panicky withdrawals by small businesses and retirees with uninsured deposits over $100,000 in a disconcerting echo of the earlier era. Worries about the trend prompted congressional leaders to consider adding a provision to the bailout bill to lift the insured deposit ceiling to $250,000.
"There is one thing the government can do that would do a lot to restore confidence: raise the antiquated $100,000 limit," said John Rutledge, a former Reagan economic adviser. "It is not controversial. Congress won't melt down while talking about it. And it won't cost the taxpayers a dime."
Depositors pulled an estimated $16.7 billion out of Washington Mutual Inc. accounts in the days before it was taken over by the Federal Deposit Insurance Corp. last week, while similar 11th-hour bank runs were reported at IndyMac Bank and Wachovia Corp.
Although the FDIC so far has covered deposits over $100,000 in all the banks it has closed this year, people with accounts over the limit heard reports about the banks' ailing health and pulled their money out because of worries they would lose their business income or retirement savings. History shows that even minor runs on a bank like that can be self-fulfilling - helping to cause the bank's failure.
"I have been arguing for weeks that we should increase the limit to $1 million so people won't have to run around town dividing their IRA, 401(k) and life savings accounts among banks," said Mr. Rutledge. "That is especially important now that the number of banks has been reduced by the recent casualties."
Sheila Bair, FDIC chairman, is well aware of the problem and is urging Congress to temporarily raise the insurance ceiling to assuage the worries of bank customers.
"Unfortunately, there is an increasing crisis of confidence that is feeding unnecessary fear in the marketplace," she said. "To address this crisis of confidence, I do believe that it would be helpful for the FDIC to have the temporary ability to raise deposit insurance limits. This would provide the dual benefits of providing additional liquidity to banks for lending as well as provide some additional reassurance to depositors above the current limits."
The FDIC would recoup the cost of the additional insurance through increased insurance assessments on banks, she said. Panic withdrawals have not been as much of a problem among people with deposits under $100,000 — the vast majority of consumers — suggesting they for the most part feel safe because they realize their deposits are insured.
John Makin, economist at the American Enterprise Institute, also advocated raising the deposit insurance limit to ease the crisis of confidence, which he said "rivals the financial and economic challenges of the Great Depression."
"The insurance ceiling, now at $100,000, is grossly inadequate, especially for the small businesses that must maintain such depository accounts for the normal conduct of business, including the meeting of payrolls," he said. "The risks attached to expanding depository insurance to cover all deposits are far outweighed by the risks of having a number of the nation's small businesses unable to meet payroll because of losses on uninsured deposits over $100,000."
Mr. Makin noted that an even bigger loss of confidence threatened money market accounts, which are uninsured deposits at investment firms that until this month most consumers believed were as safe as bank deposits. The massive default on debts by Lehman Brothers on Sept. 15, however, led to the first losses on such funds and the closure of several amid an estimated $250 billion of withdrawals by panicked investors.
When the Reserve Primary Fund became the first to "break the buck" on Sept. 17, that caused a "panic run" out of money funds into Treasury securities that pushed the yields on Treasury bills virtually to zero, far below the 5 percent inflation rate, Mr. Makin said.
"Investors were willing to pay the Treasury to store cash for the first time since the Great Depression," he said, calling it "a sure sign of panic over the safety of the U.S. banking system."
The rush out of money market funds within days forced the Treasury to institute an unprecedented program to temporarily insure the funds, drawing on Depression-era authorities to use its $72 billion exchange stabilization fund for backing.
Rolfe Winkler, an accountant who writes a blog on the financial crisis and has been encouraging people to withdraw their money from banks, said he has little confidence in the government to prevent another implosion like the Great Depression, when families lost their life savings as banks failed en masse.
"FDIC insurance is comforting, sure. But if I think my bank is going out of business, I'll have my money now, thank you very much," he said. "If everyone decides to do this simultaneously, the worldwide financial system literally ceases to function. You lose access to whatever money you've saved in the bank."
He acknowledged that the results of following his advice could be disastrous. "Companies everywhere fail to make payroll. Economic activity doesn't just slow down - it stops," he said. "That's why everyone in Washington is panicking."