A Belief in Bank Solvency is More Fantastical Than a Belief in God

“Bank runs, once they start, are difficult to contain, and they take down both weak and strong institutions indiscriminately. In the early 1930s the U.S. had to close thousands of solvent banks because they were unable to withstand the massive withdrawals of a frightened public. We learned the hard way that central bank lending was not enough to fend off a full-scale banking panic; thus, in 1934, the FDIC was born.”
Sheila Bair: Former chair of the FDIC, and former member of the Basel Committee.

No, no, no… Fractional reserve banks are never solvent. The only thing that keeps banks solvent is a fantastical belief among depositors that their money is safe. A belief that is grades more ridiculous than a belief in God. I don’t know whether there is a God or not or, at least, it is impossible for me to completely disprove the existence of God. But I know for a fact that banks lend out far more money than they take in deposits.

What happened in the 1930s was a complete breakdown in this fantastical belief. Which meant all banks, weak or strong, were insolvent.

Is it not baffling how so many people with positions of respect and experience in finance can so completely misunderstand the banking system..?

  4 comments for “A Belief in Bank Solvency is More Fantastical Than a Belief in God

  1. Paul Marks
    Jul 9, 2012 at 2:06 pm

    We must be careful to state what is actually meant by “fractional reserve” banking. In ordinary language lending out a “fraction” of real savings means (for example) lending out nine tenths of them (90%) and, indeed, if “deposites” (an incredibly misleading term) were not lent out then interest could not be paid. But by the very complex interactions of various banks (very complex – and DELIBERATLY so) this “fraction” can go up to a hundred tenths (1000%) of real savings (of actual cash) or more. Still a “fraction” in formal mathematics – but not a “fraction” in ordinary language. This is what is meant by “credit expansion” or a “credit bubble” and it is at the heart of “boom- bust” events. And, far from government intervention restricting the size of such credit-money bubbles (such an expansion of bank credit “broad money” beyond the “monetary base”), government (and Central Bank) intervention EXPANDS the credit bubble – indeed govenment policy DEPENDS UPON bubble finance.

    To put governments in charge of such matters is like putting a fox in charge of a hen house.

  2. Paul Marks
    Jul 9, 2012 at 2:14 pm

    No matter how reckless (or over “educated”) bankers are – credit-money (bank credit) bubbles would never have got to more than a “fraction” (in ordinary language) of their present size without repeated government (Central Bank) intervention, over a long period of time.

    That is why calls (which one hears every day) for the Bank of England (or the Federal Reserve system or….) to “do something” to control “irresponsible bankers” are so absurd.

    The whole basis of the policy of modern governments is “cheap money” – (lower interest for loans than would be the case if bankers had to rely on real savings – on the REAL SACRIFICE OF CONSUMPTION by savers) .

    That is what modern “monetary policy” is all about – and was so even before Keynes.

    The credit bubbles of bankers inevitablly end in tears (although sometimes not the tears of the bankers who created them – which is one reason people get so angry). But government intervention is all about making those credit-money bubbles (and the boom-bust events they create) BIGGER, not smaller.

    • Jul 10, 2012 at 8:03 am

      Agreed, also one of the reasons the Gold Standard was abandoned was because it placed a significant restriction on Government spending.

  3. Richard Carey
    Jul 12, 2012 at 12:27 pm

    Makes me think of something Garet Garret wrote (he’s talking about Keynes’s magnum opus.)

    “The moment of the book was most fortunate. For the planned society they were talking about the Socialists were desperately in need of a scientific formula. Government at the same time was in need of a rationalization for deficit spending. The idea of welfare government that had been rising both here and in Great Britain — here under the sign of the New Deal — was in trouble. It had no answer for those who kept asking, “Where will the money come from?” It was true that government had got control of money as a social instrument and that the restraining tyranny of gold had been overthrown, but the fetish of solvency survived and threatened to frustrate great social intentions.

    Just at this historic crisis of experimental politics, with the Socialists lost in a wilderness lying somewhere between Utopia and totalitarianism, and with governments adrift on a sea of managed currency, afraid to go on and unable to turn back, the appearance of the Keynes theory was like an answer to prayer. Its feat was twofold. To the Socialist planners it offered a set of algebraic tools, which, if used according to the manual of instructions, were guaranteed to produce full employment, economic equilibrium, and a redistribution of wealth with justice, all three at once and with a kind of slide-rule precision — provided only that society really wanted to be saved. And the same theory by virtue of its logical implications delivered welfare government from the threat of insolvency. That word — insolvency — was to have no longer any meaning for a sovereign government. The balanced budget was a capitalist bogey. Deficit spending was not what it seemed. It was in fact investment; and the use of it was to fill an investment void — a void created by the chronic and incorrigible propensity of people to save too much.”

    http://mises.org/daily/5589/

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