Question

Describe the ways in which the government provides a safety net for banks. How has that safety net evolved over time?

Answer 1

Solution: The government provides a safety net for banks in three ways. The government has set up the FDIC to insure bank deposits upto $100,000 per account holder in a bank, they act as a lender of last resort of lending money to the banks, and they have a policy for banks deemed too big to fail by the government. These too big to fail banks are banks that would seriously hurt the banking industry or the economy if they failed. These safety nets have evolved overtime in a few different ways. The FDIC increased their insurance to cover $250,000 instead of $100,000 in order to prevent bank runs. In order for a bank to be eligible to use lender of last resort, they must be solvent but illiquid. The government will make exceptions to these requirements as they did in 2008. The final evolution is with the too-big-to-fail banks, in 2009 the government helped merge Wachovia with Wells Fargo in order to combine the weaker bank with a strong bank and help stop a bank run.