Not the Free Market #3: FDIC

The FDIC (Federal Deposit Insurance Corporation) is the government agency that insures deposits at almost all banks. It's clearly not a free market institution since it's a government agency, and there is an explicit guarantee that the FDIC will pull money out of the general fund even if the FDIC fund runs out.

The FDIC is designed to protect banks, although it does this by protecting depositors. Banks don't actually have all your money. They lend it out to others, and only keep enough on hand to deal with normal day-to-day deposits and withdrawals. In a bank run, too many people come asking for their money at once, and these funds are drained. At this point the bank fails, and the remaining assets are liquidated and distributed to the depositors, however they would typically only get a fraction of the money they had deposited.

This precarious nature of fractional reserve banking puts a natural, free-market check on how much of your money the bank will be willing to lend out. In order to get around this check, the banking industry proposed the FDIC. Now, people can always count on the government to bail them out, so they no longer have to worry about the solvency of their banks. This allows the banks to lend out much more money, and ultimately make much more money. This results in yet another distortion to the normal market process.