Best of the Week
Most Popular
1. Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
2.Tech Stocks Bubble Valuations 2000 vs 2021 - 25th Sep 21
3.Stock Market FOMO Going into Crash Season - 8th Oct 21
4.Stock Market FOMO Hits September Brick Wall - Evergrande China's Lehman's Moment - 22nd Sep 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
7.AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
8.Why Silver Price Could Crash by 20%! - 5th Oct 21
9.Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
10.Global Stock Markets Topped 60 Days Before the US Stocks Peaked - 23rd Sep 21
Last 7 days
CATHY WOOD ARK GARBAGE ARK Funds Heading for 90% STOCK CRASH! - 22nd Jan 22
Gold Is the Belle of the Ball. Will Its Dance Turn Bearish? - 22nd Jan 22
Best Neighborhoods to Buy Real Estate in San Diego - 22nd Jan 22
Stock Market January PANIC AI Tech Stocks Buying Opp - Trend Forecast 2022 - 21st Jan 21
How to Get Rich in the MetaVerse - 20th Jan 21
Should you Buy Payment Disruptor Stocks in 2022? - 20th Jan 21
2022 the Year of Smart devices, Electric Vehicles, and AI Startups - 20th Jan 21
Oil Markets More Animated by Geopolitics, Supply, and Demand - 20th Jan 21
WARNING - AI STOCK MARKET CRASH / BEAR SWITCH TRIGGERED! - 19th Jan 22
Fake It Till You Make It: Will Silver’s Motto Work on Gold? - 19th Jan 22
Crude Oil Smashing Stocks - 19th Jan 22
US Stagflation: The Global Risk of 2022 - 19th Jan 22
Stock Market Trend Forecast Early 2022 - Tech Growth Value Stocks Rotation - 18th Jan 22
Stock Market Sentiment Speaks: Are We Setting Up For A 'Mini-Crash'? - 18th Jan 22
Mobile Sports Betting is on a rise: Here’s why - 18th Jan 22
Exponential AI Stocks Mega-trend - 17th Jan 22
THE NEXT BITCOIN - 17th Jan 22
Gold Price Predictions for 2022 - 17th Jan 22
How Do Debt Relief Services Work To Reduce The Amount You Owe? - 17th Jan 22
RIVIAN IPO Illustrates We are in the Mother of all Stock Market Bubbles - 16th Jan 22
All Market Eyes on Copper - 16th Jan 22
The US Dollar Had a Slip-Up, but Gold Turned a Blind Eye to It - 16th Jan 22
A Stock Market Top for the Ages - 16th Jan 22
FREETRADE - Stock Investing Platform, the Good, Bad and Ugly Review, Free Shares, Cancelled Orders - 15th Jan 22
WD 14tb My Book External Drive Unboxing, Testing and Benchmark Performance Amazon Buy Review - 15th Jan 22
Toyland Ferris Wheel Birthday Fun at Gulliver's Rother Valley UK Theme Park 2022 - 15th Jan 22
What You Should Know About a TailoredPay High Risk Merchant Account - 15th Jan 22
Best Metaverse Tech Stocks Investing for 2022 and Beyond - 14th Jan 22
Gold Price Lagging Inflation - 14th Jan 22
Get Your Startup Idea Up And Running With These 7 Tips - 14th Jan 22
What Happens When Your Flight Gets Cancelled in the UK? - 14th Jan 22
How to Profit from 2022’s Biggest Trend Reversal - 11th Jan 22
Stock Market Sentiment Speaks: Are We Ready To Drop To 4400SPX? - 11th Jan 22
What's the Role of an Affiliate Marketer? - 11th Jan 22
Essential Things To Know Before You Set Up A Limited Liability Company - 11th Jan 22
NVIDIA THE KING OF THE METAVERSE! - 10th Jan 22
Fiscal and Monetary Cliffs Have Arrived - 10th Jan 22
The Meteoric Rise of Investing in Trading Cards - 10th Jan 22
IBM The REAL Quantum Metaverse STOCK! - 9th Jan 22
WARNING Failing NVME2 M2 SSD Drives Can Prevent Systems From Booting - Corsair MP600 - 9th Jan 22
The Fed’s inflated cake and a ‘quant’ of history - 9th Jan 22
NVME M2 SSD FAILURE WARNING Signs - Corsair MP600 1tb Drive - 9th Jan 22
Meadowhall Sheffield Christmas Lights 2021 Shopping - Before the Switch on - 9th Jan 22
How Does Insurance Work In Europe? Find Out Here - 9th Jan 22
MATTERPORT (MTTR) - DIGITIZING THE REAL WORLD - METAVERSE INVESTING 2022 - 7th Jan 22
Effect of Deflation On The Gold Price - 7th Jan 22
Stock Market 2022 Requires Different Strategies For Traders/Investors - 7th Jan 22
Old Man Winter Will Stimulate Natural Gas and Heating Oil Demand - 7th Jan 22
Is The Lazy Stock Market Bull Strategy Worth Considering? - 7th Jan 22
METAVERSE - NEW LIFE FOR SONY AGEING GAMING GIANT? - 6th Jan 2022
What Elliott Waves Show for Asia Pacific Stock and Financial Markets 2022 - 6th Jan 2022
Why You Should Register Your Company - 6th Jan 2022
4 Ways to Invest in Silver for 2022 - 6th Jan 2022
UNITY (U) - Metaverse Stock Analysis Investing for 2022 and Beyond - 5th Jan 2022
Stock Market Staving Off Risk-Off - 5th Jan 2022
Gold and Silver Still Hungover After New Year’s Eve - 5th Jan 2022
S&P 500 In an Uncharted Territory, But Is Sky the Limit? - 5th Jan 2022

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Insuring Bank Deposits, Ensures Insolvency

Politics / Market Regulation Jul 24, 2013 - 04:56 PM GMT

By: MISES

Politics

Frank Hollenbeck writes: The US government is trying to implement the 21st century version of the Glass-Steagall Act of 1933. The proposed bill would separate traditional banks (which are backed by the FDIC) from riskier financial institutions that include companies focused on investment banking, private equity and more. This is to give the impression that governments are taking actions against the financial sector whose actions nearly brought the entire world economy to its knees back in 2008. The implicit assumption is: if this legislation is passed, the banking sector will never again be a source of financial panics. Nothing could be further from the truth.


First, the housing bubble would still have existed without investment banking. The liar loans and no-money-down loans were all commercial banking activities. If these mortgage loans had never existed, investment banks could not have repackaged and sold then to mutual and pension funds, and insurance companies. By setting rates too low for too long, the central bank created an environment for bubbles. Glass-Steagall would have been a bump in the road. If a child goes into a candy store and “pigs out”, do you blame the child (the bankers), or the parents (the central bank) for putting him in the candy store in the first place?

Second, the US experienced several severe financial crises during the 19th century: the panics of 1819, 1837, 1857, 1873, 1893 among others. At the time, most investment banking activities did not even exist. The banking sector’s ability to create money out of thin air allowed the excessive credit growth, unjustified by the resources liberated by real savings, which spurred economic activity during the boom phase of the business cycle. This growth could not have occurred without fractional reserve banking. End that, and you end most boom and bust cycles.

The Glass-Steagall act was completely repealed in 1999 with the Gramm-Leach-Bliley act, allowing commercial banks to easily enter investment banking activities. In other words, fractional reserve banking and deposit insurance allowed banks to take on risky gambles, and now they were being allowed to engage in even riskier gambles. The recent legislation such as Dodd-Frank, the Vickers report in the UK and the liikanen report in Continental Europe all try to limit commercial bank activity into investment banking. The essential idea behind some of these new rules is each gamble would be assigned a risk weighting. A commercial bank could then only take on so many bets before being required to split off these risky activities into a separate entity.

No one, of course, is asking the critical question: why are banks allowed to take these risky gambles with deposits in the first place? They shouldn’t be.

Deposit insurance is one of the two factors which allows banks to take such risky gambles. Created in 1933, it is a perfect example of government policy that ultimately will be determined to have done more harm than good. It was supposed to reduce risks, but has done just the opposite. When governments provide flood insurance the private sector would never consider, people then build homes in areas prone to suffer from severe flooding.

Prior to deposit insurance, people were careful about where they deposited their money to pay rent or food bills. If a bank ran into trouble by undertaking poor lending practices, people would quickly try to pull their money out of the bank. Bank runs were a good thing because runs served to force banks to be extremely careful about their lending practices. The threat of a bank run maintained sound incentives.

Deposit insurance is a perfect example of Frederick Bastiat’s parable of the broken window: what is seen, and what is not seen. For about 70 years, bank runs have been eliminated; giving depositors what some would say is the illusion of protection. That is what is seen. What is not seen is, without insurance, banks would have been taking much less risks with deposits, and governments would have been less able to finance spending through bank purchases of their bonds.

Europe, today, is a perfect example of the disastrous effects of deposit insurance. Had it not existed, the 2008 crisis might have never occurred, or been much milder or occurred much earlier, and the debt situation of governments worldwide would be completely different. It is surprising how many free market economists defend deposit insurance although it is a product that the free market, prior to 1933, never considered worth undertaking.

Why was Ireland forced to bail out its banks? Why don’t governments treat banks like any other business? If Nokia was unable to sell phones competitively, it should go bankrupt. The government should not be bailing out private businesses. Again, it is the fault of deposit insurance. Although a bank may no longer exist, the government is still liable for the banks’ liabilities, its deposits, because of deposit insurance.

Today, many Italian or Spanish banks have used deposits to buy large percentages of their government’s debt. If either Spain or Italy is closed out of the financial markets, which is getting more and more likely, the value of their debt will drop significantly as Greek debt did back in 2010. These banks will go bankrupt instantly, and the Italian or Spanish governments will be on the hook for the deposits that served as funds to purchase their bonds since these deposits are insured!

These governments will then have to print their way out of the problem. However, this would go against the ECB’s mandate and would probably face a German veto. A breakup of the Euro would then be inevitable. An official rate would then be set between Euros and liras or pesetas. This rate, however, would have nothing to do with the market rate. Depositors holding less than 100,000 euros would get their money back in liras or pesetas. However, this new currency would not be able to buy much. Deposit insurance guarantees the nominal value of deposits, not its real value: hence, the illusion of protection.

The economic consequences of the hyperinflation inevitable in Spain or Italy will have worldwide repercussion. None of this would have happened without fractional reserve banking. Deposit insurance would then have been unnecessary.

We need to end this constant race between banks and regulators. We already have more compliance officers than loan officers. All this new banking legislation will probably make the situation even worse. Banks will always be able to use new technologies and new financial instruments to stay one step ahead of the regulators. We continue to put bandages on a system that is rotten to the core. Banking in its current form is not capitalism. It is fraud and crony capitalism, kept afloat by ever-more desperate government interventions. It should be dismantled.

Comment on this article.

Frank Hollenbeck, PhD, teaches at the International University of Geneva. See Frank Hollenbeck's article archives.

You can subscribe to future articles by Frank Hollenbeck via this RSS feed..

© 2013 Copyright Frank Hollenbeck - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in