Their inaction made deposit insurance losses even worse. Deposit insurance mispricing caused a substantial misallocation of credit in the 1980s that prolonged the recovery from the last recession. Deposit insurance must be priced to reflect the riskiness of individual banks, but the FDIC cannot properly set risk-sensitive premiums because accurate prices can be established only in private, competitive markets. Banking has become a captive of government regulatory micromanagement that cannot keep up with rapid changes in a financial world driven increasingly by electronic technology. Government regulation has become counterproductive and harmful to good banks and thrifts as well as to America's international competitiveness.
Regulation now shapes banking strategy, which occasionally creates dangerous herd effects.
Let private markets set risk-sensitive deposit insurance premiums, based on leading indicators of banking risk, thus discouraging unwise banking practices. These guarantors have the strongest incentive to minimize losses and should therefore control the risks that they have assumed. Numerous safeguards protect taxpayers against another deposit insurance bailout. Every guarantor must be guaranteed with regard to its cross-guarantee obligations. Risk dispersion rules require a minimum number of guarantors for any one bank or thrift and limit both the aggregate risk assumed by a guarantor and the amount of risk that any one guarantor can assume for any one bank or thrift.