I did address it. You reduce these problems by regulating the risk insured banks are allowed to take and by making sure they pay adequate insurance payments.
That’s why the FDIC exists, and its existence or necessity is not, in and of itself, an argument against fractional-reserve banking. Practically every economic activity humans have ever invented has fairly required government regulation/insurance in some form or other.
But doesn’t the FDIC only makes sense if the bank can’t make high risk investments? I ask because I think Glass-Steagall should be reinstated. Investment banks and management companies should be a completely different company, unable to be owned by a “proper” bank. Otherwise, you put a pretty hefty risk on the safety net.
No.
The government actually forbids fractional-reserve status for stores of other commodities - grain, for example.
A grain elevator owner cannot take 100 units of grain from 10 customers, and then write on little slips of paper “come to me whenever you want and get 50 units of grain”, and hand them out to 1,000 customers.
That is called fraud in any other industry other than banking. Only banking is allowed to do that, because the government allows it.
Fractional banking is a fraud, unless the depositors willingly enter into an arrangement whereby they know there is (1) risk of loss of all of their assets or (2) there is a predetermined liquidation preference that they agree to, in case of a run.
As one poster remarked above, it is a means for the public to socialize their losses.
Nicely put.
I would challenge that there is no “added efficiency” created by allowing this form of fraud to continue.
“Catastrophic shocks” could only be
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War
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Distortions created by arbitrary use of force (e.g. extracting wealth from the citizenry to build X, or Y, or Z when such things are not needed)
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Collapse of confidence due to fractional-reserve banking and fiat currency
Who calls it a fraud in any other industry? It doesn’t meet the dictionary definition because there’s no deception involved. Anyone can educate themselves on what happens inside a bank. People might not bother learning, but there is still no deception.
I also doubt the law calls it fraud, unless you’ve got a specific cite saying otherwise. This from the Virginia code outlines that grain banking is against the law, but the f-word doesn’t show up. Just because it’s regulated out of existence doesn’t make it fraud. I’m not allowed into the business of thermonuclear arms dealer, but not because of fraud.
Do you apply this definition to any other form of debt?
Is every accounts payable for every business “fraud” in your estimation unless it meets your criteria? Because again, I doubt the law uses the same terminology. Some contracts which both parties would otherwise voluntarily agree to are verboten for reasons entirely removed from any notion of deception.
This isn’t just about a single run, though. I’m sure you realize this but it’s not enough to look at an incident in isolation. It’s about the banking system as a whole, including the regulatory apparatus. We’ve got to look at the whole picture, and the results can be counter-intuitive. Canada, for instance, has extremely strong banks. They also have very few banks. It’s a very consolidated sector. We might think that would cause more systemic risk, but at least on first glance, it gives the appearance that the extra rents they receive from the lack of competition allows them to be much more cautious with their positions.
I’m no expert on regulation and I’m not married to this explanation, but at least some seemingly sensible banking reforms in the US would quite possibly lead to a similar consolidation. It’s just that there are podunk banks in every Congressional district, so there’s no way that such a thing would ever pass. Of course, the big US firms compete internationally so this might not match other examples, but at the very least, we have to acknowledge that there are systems out there that seem to deliver the very stability that people claim to want. The consequence would be a bigger industry shakeup than is politically possible. It’s not necessarily “fractional-reserve banking” that’s the problem, but the entire market and regulatory structure.
Well if you choose to blame it on the failures of regulators that’s an ideological choice for you. The simple fact is that the banks experience runs because they don’t have the funds to cover all deposits. Fractional reserves create the instability. You’re blaming government for not fixing a problem government created in the first place.
Banking is a way of making money out of nothing, but where else is money supposed to come from? Gold?
We could hire people to bury barrels full of money in the ground, and then pay them to dig it up again, and it would be the same level of stupidity.
All those diggers could be doing something useful instead, like building houses, or making iPads.
The problem with relying on commercial bankers alone is the constant boom/bust cycle it produces. Which is why we need more aggressive fiscal policies to prevent the pointless recessions/depressions that commercial banking alone creates.
Deposit insurance doesn’t cover a bank’s shareholders. If a bank fails, the depositors are paid off, and the shareholders lose their equity.
Moreover, there isn’t really any sense in which deposit insurance socializes losses, because the government never takes a loss. Banks pay for deposit insurance, which in turn means that depositors pay for it, by receiving marginally less interest on their money. Bank failures are paid for out of the fund created the banks’ insurance premiums. The FDIC receives no appropriated (i.e., taxpayer) funding.
Didn’t it take a loss in the savings-and-loan crisis?
As opposed to whom else?
Since we all know what it is and what its terms are, whom does it defraud?
This is only true if all such systems are unstable. Yet in the very post you responded to, I pointed out a fractional-reserve system that has been stable.
And no, it’s not a simple fact that banks experience runs because they lack the funds. That’s a necessary but not a sufficient condition. There are stable systems that lack the funds to pay off all depositors simultaneously, but which don’t suffer the kinds of runs that the US has experienced lately. So what’s up with those? It’s worth investigating why some fractional-reserve system are wobbly, and others aren’t.
No, I’m not.
I’m open to the possibility that a free banking system like Scotland had in the 18th century, or Canada had in the 19th century, would work better than our present system. This kind of structure worked significantly better than the faux-free system the US was using in the 19th century. Such a change is not politically possible, but I’m willing to entertain the notion. That’s hardly a sign of ideological inflexibility.
Given a large enough crisis, there’s the possibility that a tsunami of failures would wipe out that fund.
There’s not really any doubt what the government would do in that case.
So, you’re just using the bank as a place to store your money.
You can do that now; rent a safe-deposit box.
That’s true absent deposit insurance, though, too, and deposit insurance arguably reduces the likelihood of such a cascade. I.e., it reduces the possibility of having to socialize losses.
True. However, I would contend (somewhat mischievously, to be sure) that the S&L industry as originally designed represented an attempt to socialize gains by ensuring access to inexpensive home loans, and that the sharp changes in the regulatory environment of that sector (from restrictions that made them unable to compete to throwing open the doors to criminals) made it a unique case – perhaps more a matter of paying the piper than socializing losses.
The government. Collectively the Treasury and the Fed have created approximately 17 trillion dollars worth of money and other assets (bonds) which are the basis of our financial system. The money protects the economy, prevents runs on banks, boosts employment, and makes the economy run more efficiently.
But that’s a hair’s breadth away from the current, perfectly legal agricultural commodity futures market, where lots of people contract to provide various things at certain locations and times without any intention of actually doing so. And also lots of people contract to pick up said things at said locations and times without having any intention of actually doing so. And the whole system actually works very well like that.
(And as noted, even your grain elevator example is not “fraud” if everyone involved knows what is going on. It may be illegal for other reasons, but fraud ain’t it.)
Fractional reserve banking is another word for “banking”.
If banks were required to keep 100% of deposits on hand, they wouldn’t be banks, they’d be safe-deposit boxes. And if you wanted a loan, you wouldn’t go to a bank. You’d have to go to a venture capitalist.
And if you were required to keep 100% of all deposits on hand, how could anyone get a loan from anyone? When people get a loan, we write down “I owe Bob 27 drachmas”. Then I take the money from Bob and spend it on food and clothing for my starving family. I don’t have the money anymore, I spent it. If Bob comes to me tomorrow and demands his money, I won’t be able to pay him because I don’t have it, that’s the reason I borrowed it in the first place because I needed money today that I didn’t have. If I were required to keep 100% of the funds I borrowed from Bob on deposit, then why would I have borrowed it, since I couldn’t spend it?
Any time a store extends credit, or someone borrows money, we have a simple form of fractional reserve banking. Any time we allow businesses to list “accounts receivable” as assets we are allowing a form of fractional reserve banking.
Indeed, extending credit, fractional reserve banking, IOUs, credit card purchases and so on are just ways of creating paper money. Which explains why gold bugs also hate banking, since if we use gold and silver coins as money there is no use for a bank as we know it, merely safe deposit boxes like they have at Gringott’s.
Of course I don’t understand how gold bugs could endorse a gold standard currency, since as everyone knows paper money backed by gold magically turns into fiat currency every time a government gets into trouble. When a war starts the first thing the government does is stop redemption of paper money for precious metals. So paper money backed by gold is a fraud, even if the issuer of the paper has 100% of the gold on hand represented by the paper. The only trustworthy money is actual precious metal, not a paper representation of that precious metal, be it a gold certificate or a bank statement that so-and-so has X grams of gold on deposit.
And it is curious that under today’s fiat currency system you can go into any pawn shop and exchange your fiat currency for real gold or real silver, whereas in the old days when we were supposedly on the gold standard that was illegal. A fiat currency means a free market for precious metals, a precious metal standard means the government tightly controls every single aspect of the precious metal market. So being for the gold standard is another way of demanding that the government socialize the gold industry.
Fractional reserve banking was not willed into existence by government, you know.