Moral Hazard and Bank Policy
By Arnold Kling
These issues are discussed by Russ Roberts and Gary Stern. There are two issues that they keep circling around. One is the effect on capital structure of policies and practices that routinely protect creditors and counterparties. The other is what I think of as the time inconsistency problem. That is, even if policy makers say that they will not bail out creditors, when the crunch comes, they always find a need to do so “this time.” And creditors know that.
Charles Calomiris sees deposit insurance as the original sin of regulation-induced moral hazard.
financial economists and economic historians regard deposit insurance (and other safety-net policies) as the primary source of the unprecedented financial instability that has arisen worldwide over the past thirty years
Actually, I think that most financial economists and economic historians favor deposit insurance, but Calomiris cites a number who share his view. In any case, he does not recommend abolishing deposit insurance. Instead, he talks about better ways to regulate banks, given that we have deposit insurance. He has more to say on the topic here.