Sean M. Hoskins
Analyst in Financial Economics
In September 2008, the ongoing financial turmoil became a financial panic—large financial institutions were failing, the stock market was falling, and credit markets were freezing. The federal government responded with a series of lending and guarantee programs to contain the panic and to mitigate the damage to the broader economy. Among the many policy responses, the Federal Deposit Insurance Corporation (FDIC) established the Transaction Account Guarantee (TAG) program on October 14, 2008.
The FDIC’s initial TAG program provided unlimited deposit insurance for noninterest-bearing transaction accounts (NIBTAs). A NIBTA is an account in which interest is neither accrued nor paid and the depositor is permitted to make withdrawals at will. NIBTAs are frequently used by businesses, local governments, and other entities as a cash management tool, often for payroll transactions. In spite of a loss of confidence in other parts of the financial system, the insured banking sector saw few bank runs during the financial crisis. The establishment of TAG in addition to the existing deposit insurance may have helped bolster depositors’ confidence in banks as reliable counterparties and prevented them from suddenly withdrawing their deposits.
The second TAG program, which was established by the Dodd-Frank Wall Street Reform and Consumer Protection Act (P.L. 111-203; the Dodd-Frank Act), was a temporary extension of the original program with some changes. This TAG program is set to expire on December 31, 2012. If the program expires, the $1.4 trillion currently insured by TAG in NIBTAs would no longer have unlimited deposit insurance but would have the $250,000 standard maximum deposit insurance amount. Changes to the FDIC’s authority made by the Dodd-Frank Act make it unlikely that the FDIC could act to extend the program under its own authority. An extension may require congressional action.
Opinions are divided on the merits of extending the program. Underlying the divergent policy views are contrasting opinions about the state of the economic recovery and the role of the government in guaranteeing bank liabilities and in determining the size of the traditional banking system.
If the TAG program expires, depositors could keep their deposits in the traditional banking system, or they may decide to transfer some or all of their deposits to nonbank investment options. TAG deposits that remain in the banking system may migrate to the largest or most interconnected banks if large depositors view these as safer, or TAG deposits could move away from the largest banks in response to changes made by the Dodd-Frank Act. TAG deposits that go to nonbanks may flow to money market funds, which are often cited as one of the most popular short-term investment options. A decrease in deposits could affect the liquidity position of a given bank—the ability of the bank to meet its liabilities—but the overall liquidity of the banking system has increased since 2008.
If the TAG program is extended, the resulting risk exposure could put additional strain on the FDIC’s Deposit Insurance Fund. In addition, a TAG extension could increase moral hazard by neutralizing market mechanisms that penalize the banking system for taking on additional risk. A TAG extension could take multiple forms, ranging from a permanent extension to a temporary, voluntary extension with a short phase-out period.
Date of Report: October 24, 2012
Number of Pages: 15
Order Number: R42787
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