Supplemental Insurance for Banks: A Myth?

Don't many banks and funds have supplemental insurance to protect themselves? Tons of it. Insurers have written $62 trillion worth of credit-default swaps. Banks have private deposit insurance. But you have to understand: These seeming guarantees have been part of the problem, because they have given speculators a false sense of security. Insurers wrote them when they believed the system was risk-free. CDSs became speculative vehicles, and the liabilities at this point are way too big to cover. Additionally, many of the deals are complex and nearly opaque as to who owes what to whom.

Insurance is always available when there is nothing to fear, but it goes away when big trouble looms. A subsidiary of Warren Buffett's Berkshire Hathaway company just announced (9/10) that it will stop offering supplemental deposit insurance to the 1500 banks it was covering. As you can see, it offered the insurance to make money, not to protect banks. Now that banks need protection, there is no more insurance.

Still, one can hardly blame an insurance company for getting out of the business. Insurance is supposed to provide a way for prudent people voluntarily to socialize their risks. But when profligacy puts everyone at risk, insurance is impossible. In a depression, insurance companies stop insuring because they fail. Washington Mutual bank, reportedly in trouble, is 7.5 times as big as the biggest bank that's ever failed in the U.S. Buffet is just acting ahead of the disaster. The government never acts ahead of disaster, so when the FDIC stops providing insurance, it will be because it has no choice.