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Excerpt: Since the Great Depression in the U.S. has developed institutions to control financial crises. Most important has been deposit insurance, and it has worked well. Bands have been able to attract deposits during the Savings and Loan crisis in the 1980s and the stock market crash in 1987.
But insurance provides incentives for risk-taking. Because depositors know they'll get their money back, they have little incentive to evaluate banks. As a result banks raise money at low rates regardless of their risk; they get the upside, and the insurer takes most of the downside. The Savings and Load crisis in the 1980s showed both the advantages and disadvantages of this insurance. The S and L's took too much risk, and many collapsed, but there was limited impact on the rest of economy...
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