Whether a multitude of bank failures caused the Great Depression or the other way around is still subject to debate, as is the “chicken or egg” puzzle. In any case, the U.S. government stepped in and formed the Federal Deposit Insurance Corporation (FDIC) in 1933 to make sure that in the unlikely event that a bank does fail, depositors still have access to their hard-earned cash that they had entrusted to that bank for safekeeping.

What is the FDIC?

The Federal Deposit Insurance Corporation (FDIC) is a government agency charged with “preserving and promoting consumer confidence” in banks and other financial institutions.

The FDIC insures deposits in banks and thrift institutions for at least $250,000. Insured deposits include savings accounts, money market accounts and certificates of deposit (CDs).

The FDIC does not cover money invested in stocks, bonds, mutual funds, life insurance policies, annuities or municipal securities, even if those investments were bought from an FDIC-insured bank.

The FDIC is managed by a five-person Board of Directors, all of whom were appointed by the President and confirmed by the Senate. No more than three members of this board can be from the same political party. The agency is headquartered in Washington, DC, and employs more than 7,000 people.

FDIC insurance only covers loss due to a bank failure and won’t kick in if there’s a fire, fraud or theft. Most individual banks carry their own private hazard and casualty coverage against those types of losses.

How recovery works

In the unlikely event of a bank failure, account holders get their funds back just about immediately as long as the amount is under the FDIC-insured amount. If their accounts exceed that amount, they will probably have to wait until the FDIC sells the bank’s assets to get any more money. That’s why it is a good idea to limit the amount of your deposits to the insured amount. But you can always spread your accounts around, even in the same bank, so they all have enough coverage.

When a bank fails, regulators announce the closure on a Friday. For the most part, they’ve already lined up another bank that is willing to buy the failed bank’s business minus their problem loans and troubled assets.

Those same regulators hand over the management of the failed bank to the FDIC, which then works through the weekend to make sure of a seamless and orderly transition come Monday. During the transition customers can still use the ATMs, checks and debit cards, just as if nothing has happened. The bank then reopens under the new ownership on that Monday. Access to accounts continues just like before under the new ownership, although the name of the bank may change.

Where does the FDIC get the money?

Two immediate questions arise: Where does the FDIC get their money, and will they run out during tough financial times? Rest assured, because they are an arm of the government, they have nearly unlimited amounts of cash to draw on with just a phone call.

Banks pay premiums to have their deposits insured and that money goes into the Deposit Insurance Fund (DIF). If that account is depleted, the FDIC has a $30-billion line of credit with the Department of the Treasury. To fully seal the deal, and to make sure there will always be money to pay out customers after banks fail, the U.S. government has assured the FDIC that it will provide financial backing no matter what happens.

The FDIC can also borrow from the Treasury, in the form of short-term loans, which it did during the savings and loan crisis of 1991.

All you need to do is make sure your deposits are FDIC-insured.

Do your homework

To ensure your deposit accounts are covered by FDIC insurance, you’ll need to do two things. First, verify that your bank is a “Member FDIC.” Virtually all banks are required to carry FDIC insurance, but some state-chartered banks may be grandfathered out of the requirement.

Next, make sure your deposits don’t exceed the limits of FDIC coverage. The basic limit is $250,000 per depositor, per bank. If you are in the happy situation of needing more coverage than that, it’s possible to get additional coverage you have several accounts with different legal ownerships at the same bank. Some banks may still participate in the Transaction Account Guarantee (TAG) program, but that provision is currently set to expire December 31, 2010.

Here are some tips to follow:

• Ask the branch manager if the institution has FDIC insurance
• Look for the FDIC logo on the door or window
• Look for the FDIC logo on the website
• Call 1-877-ASK(275)-FDIC(3342) and ask if your financial institution is insured
• Make sure the amount of your account is within the FDIC limits – Visit the Electronic Deposit Insurance Estimator to help you determine this
• Remember only deposit accounts like personal checking, business checking, personal savings, business savings accounts, online savings accounts, certificates of deposit and money market accounts are covered

Accounts at credit unions are insured by the National Credit Union Association (NCUA).

While it’s unlikely you’ll ever need it, FDIC insurance provides peace of mind that your deposits are safe. According to the FDIC website, since the FDIC’s founding in 1933, no depositor has lost a penny from the failure of a member bank.

(by Heather Larson)