Janet Yellen Addresses Tough Reality of Americans' Money Amid Bank Panic

Treasury Secretary Janet Yellen said Thursday some Americans' uninsured deposits would not be protected by the federal government, after the collapse of several midsize banks with high levels of uninsured cash over the past week sent the financial industry spiraling into a panic.

During a Senate Finance Committee hearing, Yellen was grilled by Oklahoma GOP Senator James Lankford over the Biden administration's handling of the banking crisis, which saw the federal government offer a multibillion-dollar bailout to Silicon Valley Bank (SVB) after a bank run left it without enough cash to back up hundreds of millions of dollars of its clients' deposits. Most of those deposits were not insured.

To address the crisis, U.S. bank regulators announced a plan last weekend to fully insure all deposits at SVB as well as the crypto-friendly Signature Bank. This would cover all deposits above the Federal Deposit Insurance Corp.'s insured limit of $250,000. Federal officials said the plan would be paid for by a special fee levied on all FDIC institutions.

While all banks would be required to pay for the plan, Yellen said under questioning Thursday that it would not apply to every bank. She said the federal government would extend the privilege only to troubled banks whose failure would have a profound impact on the U.S. financial system.

Uninsured deposits, Yellen said, would be covered only if a "failure to protect uninsured depositors would create systemic risk and significant economic and financial consequences," which would be decided by a supermajority of the FDIC's board members, Yellen, and the President.

Reached for comment, a U.S. Treasury Department spokesman referred Newsweek to Yellen's Thursday testimony, saying it spoke for itself.

Bank failures are a common occurrence in the United States. Since 2001, some 563 banks across the country have failed, including a high of 157 at the height of the Great Recession in 2010, according to FDIC data.

While assets of those closed banks were regularly absorbed by other banks, some accounts were left to be reimbursed by the FDIC after the banks' owners failed to identify a buyer. Any accounts that were uninsured came with no guarantee that the money would be replaced.

When First Arizona Savings Bank shut down in 2010, for example, the FDIC estimated that about $1.8 million of the bank's $198.8 million in deposits were uninsured, according to local news reports. That left account holders holding uninsured deposits with little recourse for getting their money back.

However, the FDIC has historically stepped in to back uninsured deposits at large banks that, as Yellen said, pose a "systemic" risk to the U.S. financial system. When the nation's seventh-largest bank, Continental Illinois, failed in 1984, the FDIC made sure all deposits at the bank were insured, even if they were above the FDIC's $250,000 threshold.

"That was controversial because up until that point in the prior few years, smaller banks had been failing, and when they failed, only [insured] depositors were protected—uninsured depositors lost money, other creditors lost money," FDIC official Arthur Murton recounted in a recent podcast for the agency.

"Continental Illinois comes along, seventh-largest bank, everyone is protected. So that disparate treatment is obvious to people and creates a double standard, and that's where the term 'too big to fail' entered the lexicon," he said.

A series of "rolling recessions" across the country later prompted the FDIC to intervene in problems at regional banks that were involved in key industries like energy and agriculture, leading to a decline in FDIC funds that prompted reforms to the FDIC that are in effect today.

That's essentially what Yellen said Thursday: that the FDIC's policy on uninsured deposits that was established at that time will continue to be enforced moving forward—even as uncertainties about the U.S. banking system mount.

In further questioning, Lankford asked Yellen whether that policy's implication would be that small banks would become less appealing to depositors with accounts exceeding the FDIC's $250,000 insurance threshold. While companies could, in theory, have multiple accounts at a bank that are below $250,000, others might not. Nonprofits or companies with large payrolls might have accounts well above that amount.

For various reasons, those companies could choose to keep their money at a smaller institution, like a credit union or a community bank, whose collapse might not have a profound impact on the national economy. Lankford asked whether such special treatment by federal regulators could be construed as a declaration that the federal government would only step in to insure larger institutions rather than smaller ones.

Amid the sharp increase in bank mergers over the past decade, Lankford expressed concern that the trend could only accelerate under current policy, causing the U.S. banking system to become less resilient.

"I'm concerned you're...encouraging anyone who has a large deposit at a community bank to [hear], 'We're not going to make you whole, but if you go to one of our preferred banks, we will make you whole,'" Lankford told Yellen.

Yellen replied, "That's certainly not something that we're encouraging."

Newsweek has reached out to Lankford's office for comment.

Update 03/16/23 6:38 p.m. ET: This article was updated to reflect accurate language.