FEBRUARY 1, 2016
AT WHOSE EXPENSE ?
Would we loan to our neighbor or to our relative the entire amount of our income whenever we may receive it week after week, month after month, year after year?
No?
Even if our neighbor or our relative promised to let us have any amount of our money back whenever we asked for it?
Probably not, one may quickly respond.
Yet this is the deal we willingly make with our banks every time we deposit money in our bank accounts. Quite simply we have more trust in our banks and their executives than we have in our neighbors and our relatives. In this instance proximity and blood relationship seems less reliable than the advertising slogans of the bankers. However, some banks fail with each passing year. Why do we have no worries about our bank deposits?
If more of us knew or thought about how banks work, we might be more concerned. When making deposits at a bank we are actually loaning the banks our money. We are trusting them to use our money wisely and to earn enough income from our money to pay us back and to pay us interest on our balances if we have opened an account that earns interest income.
Banks operate under a fractional reserve system requiring only a small percentage of total deposits be held in cash for any withdrawals that bank depositors may need.
The rest of our deposits are available to be loaned out to other businesses, individuals, or governments. It is amusing to realize that the banks loan much of our money to our neighbors in the form of home mortgages and in the form of consumer debt — credit card debt, car loans and student loans for example. These new debtors are the same people to whom we are unwilling to loan money directly. We are trusting the banks to manage that credit risk for us. More importantly the banks loan huge sums to one another, to hedge funds, to mutual funds, to insurance companies, to pension plans, to financial institutions serving other investors, and to large and small corporations of every stripe imaginable.
If things go bad, why worry?
In these United States after more than three-quarters of a century we have been lulled into this belief:
If our bank fails, the Federal Deposit Insurance Corporation (FDIC) will save us and pay us every dollar we have on deposit at that failed bank. The FDIC is an agency of US Government. We believe that the federal government will back the FDIC no matter how great any particular financial crisis may be.
Are we justified in holding this belief? Currently the outstanding debt of the federal government stands just shy of $19 Trillion - that is trillions of dollars — not billions or millions. May we really rely on the resources of the federal government to shore up the obligations of the FDIC in the face of another major financial crisis?
We all use banks. That is without doubt.
When another financial crisis comes what repairs will be needed?
At whose expense will those repairs be made?
Stay tuned as the world economy unfolds in 2016.
