A few minutes ago Federal Deposit Insurance Commission Chair Sheila Bair told reporters that she would request a temporary increase in deposit insurance to $250,000.  A top Senate Republican staffer just confirmed that Treasury will send up legislative language soon.  Earlier today John McCain and Barack Obama endorsed the idea.  In my opinion, this ensures that the House will reconsider and pass H.R.3997, the "Emergency Economic Stabilization Act of 2008," Thursday afternoon with this modification.

Members of Congress who voted against the bill have reacted to yesterday's market downturn with pledges to reconsider their votes.  They will vote for exactly the bill the voted against yesterday with the addition of the deposit insurance amendment.

Market and governmental gyrations such as this are rare in the U.S.  That's what happens when you try to legislate on such important matters too close to an election.

Any good economist will inquire as to who wins from this proposal and who loses.  The winners, as one of my Wall Street clients just put it, are "the dumb rich" and businesses who can't keep their working capital accounts below $100,000.  The "smart rich" long ago moved their money to safer places.  Most Americans don't have more than $100,000 in their bank accounts, and if they do, it's in a retirement account which is insured up to $250,000 already. 

The losers down the road will be the taxpayers and conservative banks.  The FDIC pays deposit insurance out of a fund paid for with a fee levied on all banks.  The more banks that go under at a loss to depositors, the more the fee will go up on the remaining, less risky, banks to pay depositors claims and to replenish the deposit insurance fund.  Taxpayers will suffer the economic damage done by banks that take on extra risk and fail in response to the increased level of deposit insurance.  For years under Republican presidents and under Democratic presidents, the FDIC has expressed reservations when Congress proposed, as it does almost every year, to increase deposit insurance.  The more deposit insurance, the riskier the bank.  All those concerns about what we economists call "moral hazard," which got us into this financial mess in the first place, have been swept aside in a rush to "do something for Main Street."  So we will increase moral hazard to combat the hangover from excessive and overly risky credit creation -- there's an oxymoron if there ever was one.  That's like trying to cure a hangover with more alcohol.

The key to understanding this conundrum is to realize that your elected representatives in Congress are trying to solve a political problem, how to get reelected on November 4.  They need political cover.  Their president can't provide it, and neither can their leaders, but maybe this deposit insurance increase aimed at "Main Street" can.  Those members of the House who voted down the very same bill yesterday that they will vote for the day after tomorrow with only the addition of $250,000 of deposit insurance will have a lot of explaining to do.

The only saving grace in this that I can see other than doing whatever it takes to get credit markets functioning again is that the short run cost in deposit insurance outlays may not be as big as I fear after the "Emergency Economic Stabilization Act of 2008" becomes law in the next few days.