Comments (Sometime around 1829, a man named Joshua Forman wrote: “Banks constitute a system, being peculiarly sensitive to one another’s operations, and not a mere aggregate of free agents.”
In the simplest terms, Forman was saying one bad apple really can spoil the whole bunch.
We certainly saw this during the financial crisis, when even the banks themselves didn't know which of their competitors was solvent, and so all overnight lending and inter-bank credit dried up.
The effect was so drastic that American companies were literally a few days from not being able to make payroll, as payroll depends on credit.
You may also recall that during these dark days, the Fed stepped in and basically guaranteed every transaction and every asset that banks owned. The FDIC also raised its guarantees to include any deposit up to $250,000.
The point of these actions was to instill some confidence that inter-bank loans would be honored — and to keep individual account holders from pulling their money out and completely crashing the banking system.
It worked (at least, well enough to prevent a total economic collapse).
There are those who still argue the Fed should have never stepped in, that the U.S. government should never have backed the “too big to fail” concept; that, like Lehman Brothers, banks should have been allowed to fail.
Unfortunately, they would have taken a lot of regular Americans' bank accounts with them...
I wonder how the “let them fail” crowd would have felt if the U.S. had adopted the latest policy the EU proposed toward Cyprus — that even those depositors below the 100,000 euro deposit insurance threshold would lose some of their money.
Say what you want about government intervention. But what about the FDIC deposit insurance? Is the government overstepping its bounds here?
Or is this one of those “fine — unless it happens to me” things?
Deposit Insurance: Confidence or Crutch?
Nearly 200 hundred years ago, Joshua Forman was asked by then New York State Governor Martin Van Buren to reform the state's banking system. In 1829 he proposed a deposit insurance fund that would be funded by the banks themselves. The idea was to avoid “chain-reaction panics” in the banking system, as the New York Times puts it.
Opponents in the New York State Assembly said such an insurance fund would reduce “public scrutiny and watchfulness” of the banks.
Voters like the idea of deposit insurance. The Federal Deposit Insurance Corporation was created in 1933 as a response to the bank runs from the Great Depression.
Even after the financial crisis, not many Americans worry about the health of their bank, because even if the bank fails, the FDIC will bail them out. We could even include bondholders here, as U.S. government bailout have largely ensured that even bondholders (who are investors, not depositors) don't take losses.
It makes perfect sense to say deposit insurance and the army of regulators that's supposed to watch bank investments have reduced the “public scrutiny and watchfulness” of the banks.
Do you read Bank of America's financial statements?
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If you want to ride a motorcycle without a helmet, you are stupid. But should there be laws against it? Isn't this a matter of personal freedom?
Well, no. Not really. Because motorcycle insurance premiums will be higher if the insurance companies have to pay out to cover the profoundly stupid. And EMTs and hospitals will have to waste time on the idiots instead of tending to the non-stupid injured or sick.
There is often legitimate reason to legislate against stupidity.
But how far should we take the nanny state mentality?
Could we not say the very concept of deposit insurance gives the illusion of safety that leads to events like the S&L crisis from the 1980s and the financial crisis of 2008?
Now, I'll confess I am trying to whack the hornet's nest here. Because it strikes me that there is a lot of hypocrisy surrounding the “too big to fail” concept — like demanding government spending cuts, except for defense and Medicare/Medicaid.
The New York Times reports:
In 2009, in the financial crisis, the F.D.I.C. fund was underwater. Net assets — $53 billion before the crash — fell to a negative $21 billion. The agency crawled back into the black by ordering banks to pay premiums in advance and by leveling a special assessment. In 2010, the Dodd-Frank law raised premiums, especially for bigger banks and for banks classified as riskier. No taxpayer money was used.
No, deposit insurance isn't really a problem — at least, not from a financial perspective. It is funded by the banks.
But that doesn't mean individuals should shirk their responsibility to look after their money.
Banks in Cyprus are on the verge of failure. With something like $65 billion in deposits in a country with $25 billion in GDP, there's no way short of capital controls the banks can withstand the bank runs that are coming.
And given the stance the EU has taken, I wouldn't consider my money safe in any European bank — especially not in Spain, Italy, Ireland, or any other country that's had or is having banking problems.
This may actually be good news for U.S. banks, as I expect money leaving Europe would head for the stability of U.S. banks. (And yes, that means I am still bullish on Bank of America (NYSE: BAC).)
The European Union has signaled a new era for bailouts and central banks backstops. You should take steps to diversify your assets into different institutions and accounts. You should have cash on hand, and you should also own gold and silver that you store yourself, so you can get at it if you need to.
I don't expect the United States to follow Europe's lead. But you never know...
Here are some other ideas about how you can protect your wealth.
Until next time,
http://www.wealthdaily.com/articles/is-it-time-to-end-deposit-insurance/4111