The Price of 12 Votes

And you thought the Paulson plan was expensive.

Members of the House who killed the banking rescue on Monday seem to have accomplished two main things before their revote today: Tanking Republican election prospects, and raising the overall cost of the bill with various political “sweeteners.”

The GOP decline in the polls has continued through the week, as voters are taking their media cues and focusing on the Republican role in the fiasco on the House floor. Speaker Nancy Pelosi couldn’t have planned it better if she had tried to set a trap, and maybe she did. Perhaps the GOP can recover in the next month, but House Republicans with safe seats who voted no on Monday have put their Presidential nominee and vulnerable Senate colleagues in a very deep hole.

[The Price of 12 Votes] AP

As for the higher cost, we don’t primarily mean the Senate pork and mandates for mental health insurance coverage, as bad as those are. The most expensive long-term addition may turn out to be the increase in deposit insurance to $250,000 per account, from the current $100,000. Strangely enough, this is being pitched as a “conservative” idea to attract the votes of Republicans who oppose a “bailout.” John McCain and Barack Obama also both like it. But if the past is any guide, it could end up costing taxpayers far more than Hank Paulson’s plan will.

Proponents claim the increase will reassure Mom and Pop savers that their cash is safe and thus prevent bank runs. Perhaps it will for now, although a run by retail depositors isn’t the cause of our current financial turmoil. More deposit insurance doesn’t address the core problem of distressed loans that is stopping bank lending. There have been some bank runs by wholesale depositors (such as Fannie Mae) wary of putting millions of dollars in bank escrow accounts, but the Federal Deposit Insurance Corp. could handle that by triggering its systemic risk exception for insuring certain deposits.

Instead, the universal expansion to $250,000 will immediately put taxpayers on the hook for far more money if more banks fail. The FDIC had $45 billion in reserves to pay off depositors at the end of the second quarter, or 1.01% of all insured deposits up to $100,000 — less than its statutory obligation of 1.15%. The agency has been planning to charge banks more to fill that gap even before this week’s insurance increase.

However, the FDIC won’t even try to raise premiums to cover the $250,000. Why not? Because the increase is supposed to be “temporary,” running only through the end of 2009. If you believe that, you probably also believe Barack Obama will cut taxes for 95% of Americans. The FDIC now insures some 63% of all deposits, or about $4.5 trillion. The increase to $250,000 will take that to 73%, or about $5.1 trillion, without any comparable increase in FDIC reserves. If a recession combines with the mortgage meltdown to produce more bank failures, look out taxpayers.

The long-term danger is that this increase will merely encourage riskier lending behavior. We’ve seen it before. In the early morning of March 5, 1980, Congress increased deposit insurance to $100,000 from $40,000 at the behest of legendary Representative Fernand St. Germain. That encouraged struggling savings and loans to pay higher rates to grab more deposits and then to take fliers on risky loans. When those risks went bust a decade later, taxpayers had to pay some $150 billion to cover those thrift deposits. That hard lesson is one reason the $100,000 limit hasn’t increased in the interim.

Now, however, the White House and Congress are raising the limit in an effort to pick up 12 House votes. The political bet is that more deposit insurance will please the community bank lobby, which in turn will persuade a dozen Congresspersons to change their vote to “aye.” So the way to persuade Members who claim to oppose a “bailout” is apparently to increase the cost of that bailout. And the same Members denouncing bankers who took reckless risks are delighted about a measure that will encourage bankers to take more such risks. Your Congress at work.

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