There have been many times in our country’s past when panic has struck at the heart of our financial system. The system thrives on trust and when participants lose faith, chaos can ensue. As many people know, banks do not keep all of their deposits on hand. Instead, they keep a fraction and loan the rest out; hence the name: fractional reserve banking. If every customer showed up at your local bank to withdraw their funds at the same time there would be no way to satisfy every request.
One of the most severe banking panics in US history happened during the early 1930s. While there isn’t one thing that caused the Great Depression, the banking panics that started in Louisville, KY in 1930 are seen as the straw that broke the camel’s back. These bank runs eventually spread all over the country and most governors had enacted bank holidays in their states. (The phrase “bank holiday” is a bit misleading. It just means there is no money, we’re closed.) When FDR became president in March of 1933, providing relief to the banking sector was at the top of his to-do list.
The breadth and extent of The Banking Act of 1933 was eclipsed only by the need for it in the first place. Both the economic paralysis at the time and the enormous bill were unprecedented. Never before had the federal government attempted to regulate the economy in such significant way. The biggest “game-changer” in the legislation was the creation of the Federal Deposit Insurance Corporation, better known as FDIC. FDIC insurance is enjoyed by depositors at US commercial banks and savings institutions. At its inception, deposits were insured up to $2,500 and bank runs were basically a thing of the past. It wouldn’t be until the Savings and Loan Crisis of the 1980’s and 90’s where we would see small localized panics. And the institutions affected by it were not insured by FDIC.
Today deposits are insured up to $250,000 per depositor, per bank. This amount was more than doubled during the last financial crisis in 2008 when the faith of the average economic participant was tested yet again. It’s no coincidence that government decided to increase the amount during the panic in hopes of preserving the number one ingredient in a sound banking system: trust.