Anatomy of the Bank Run

It was a scene familiar to any nostalgia buff: all-night lines waiting for the banks (first in Ohio, then in Maryland) to open; pompous but mendacious assurances by the bankers that all is well and that the people should go home; a stubborn insistence by depositors to get their money out; and the consequent closing of the banks by government, while at the same time the banks were permitted to stay in existence and collect the debts due them by their borrowers.

In other words, instead of government protecting private property and enforcing voluntary contracts, it deliberately violated the property of the depositors by barring them from retrieving their own money from the banks.

All this was, of course, a replay of the early 1930s: the last era of massive runs on banks. On the surface the weakness was the fact that the failed banks were insured by private or state deposit insurance agencies, whereas the banks that easily withstood the storm were insured by the federal government (FDIC for commercial banks; FSLIC for savings and loan banks).

But why? What is the magic elixir possessed by the federal government that neither private firms nor states can muster? The defenders of the private insurance agencies noted that they were technically in better financial shape than FSLIC or FDIC, since they had greater reserves per deposit dollar insured. How is it that private firms, so far superior to government in all other operations, should be so defective in this one area? Is there something unique about money that requires federal control?

The answer to this puzzle lies in the anguished statements of the savings and loan banks in Ohio and in Maryland, after the first of their number went under because of spectacularly unsound loans. "What a pity," they in effect complained, "that the failure of this one unsound bank should drag the sound banks down with them!"

But in what sense is a bank "sound" when one whisper of doom, one faltering of public confidence, should quickly bring the bank down? In what other industry does a mere rumor or hint of doubt swiftly bring down a mighty and seemingly solid firm? What is there about banking that public confidence should play such a decisive and overwhelmingly important role?

The answer lies in the nature of our banking system, in the fact that both commercial banks and thrift banks (mutual-savings and savings-and-loan) have been systematically engaging in fractional-reserve banking: that is, they have far less cash on hand than there are demand claims to cash outstanding. For commercial banks, the reserve fraction is now about 10 percent; for the thrifts it is far less.

This means that the depositor who thinks he has $10,000 in a bank is misled; in a proportionate sense, there is only, say, $1,000 or less there. And yet, both the checking depositor and the savings depositor think that they can withdraw their money at any time on demand. Obviously, such a system, which is considered fraud when practiced by other businesses, rests on a confidence trick: that is, it can only work so long as the bulk of depositors do not catch on to the scare and try to get their money out. The confidence is essential, and also misguided. That is why once the public catches on, and bank runs begin, they are irresistible and cannot be stopped.

We now see why private enterprise works so badly in the deposit insurance business. For private enterprise only works in a business that is legitimate and useful, where needs are being fulfilled. It is impossible to "insure" a firm, even less so an industry, that is inherently insolvent. Fractional reserve banks, being inherently insolvent, are uninsurable.

What, then, is the magic potion of the federal government? Why does everyone trust the FDIC and FSLIC even though their reserve ratios are lower than private agencies, and though they too have only a very small fraction of total insured deposits in cash to stem any bank run? The answer is really quite simple: because everyone realizes, and realizes correctly, that only the federal government--and not the states or private firms--can print legal tender dollars. Everyone knows that, in case of a bank run, the U.S. Treasury would simply order the Fed to print enough cash to bail out any depositors who want it. The Fed has the unlimited power to print dollars, and it is this unlimited power to inflate that stands behind the current fractional reserve banking system.

Yes, the FDIC and FSLIC "work," but only because the unlimited monopoly power to print money can "work" to bail out any firm or person on earth. For it was precisely bank runs, as severe as they were that, before 1933, kept the banking system under check, and prevented any substantial amount of inflation.

But now bank runs--at least for the overwhelming majority of banks under federal deposit insurance--are over, and we have been paying and will continue to pay the horrendous price of saving the banks: chronic and unlimited inflation.

Putting an end to inflation requires not only the abolition of the Fed but also the abolition of the FDIC and FSLIC. At long last, banks would be treated like any firm in any other industry. In short, if they can't meet their contractual obligations they will be required to go under and liquidate. It would be instructive to see how many banks would survive if the massive governmental props were finally taken away.

Unless the laws are changed, you have a contract which they can enforce, but so can you.

Just hope there is no small print that gives them options that would be unacceptable to you, like an adjustable rate.

Inflation is to your advantage, so long as you have the income to make payments, and that is why we have it for the same inflation that works for you works for the government when they are paying off their loans.

Inflation also puts you in a higher bracket, so they get more of your money. Adjustments the IRS makes are behind the curve, so you can’t stay even.

This is the enviable situation to be in, loads of assets bought with fixed-rate credit.

The only problem is, that when money fails, governments go after other assets as well.

Under the Weimar Republic, landlords gave away the keys to property to tenants as property taxes soared to untenable levels, anyone with any kind of property that could be seized or taxed could lose it - including real estate.

It is difficult to predict how this will play out.

It is impossible to "insure" a firm, even less so an industry, that is inherently insolvent. Fractional reserve banks, being inherently insolvent, are uninsurable.

Perhaps not impossible, but nearly impracticable. A workable insurance scheme would require premiums that'd be incredibly expensive and in constant fluctuation.

Loan-sharking, pawnbroking, even "try-me" loans - these all reflect the risk in their "premiums". If the same were required of banks, the mask of respectability would be stripped from the industry.

If private corporations insured banks, they'd need a rating system like what auto insurers have for drivers. And just as for drivers, the insurance premiums would vary according to their risk rating.

Banks would then need to pass on the insurance costs to their customers. Some banks would be able to pay depositors, while others would have to charge them. Depositors and borrowers would then be able to judge which banks were good risks and which were shaky.

Again, such a system would bring transparency to the entire banking facade - which is precisely why it will never be allowed to happen. What we have instead is a system of subsidized franchises of the same business, none of which are in competition with one another, and none of which need fear anything but having its franchise charter revoked.

A very good article. Thank you for posting it!

Just hope there is no small print that gives them options that would be unacceptable to you, like an adjustable rate.

That, or inflation adjusted dollars. I'd read somewhere, a while back, that some newer contracts had tricky wording inserted regarding future repayment. Not sure if it's true, though.

Well said. Ultimately, with the Banksters, it's "heads I win, tails you lose." They'll re-write the rules if and when it gets down to it. You know, I remember well in 2008 the traders who really saw what was coming shorted the heck out of Lehman Brothers and Goldman Sachs. Hank Paulson, a Goldman Sachs insider, as Treasury Secretary let the shorts kill Lehman, but when it came to his baby Goldman Sachs, he suspended trading and screwed the shorts. He literally re-wrote the rules when the smart traders were about to win to save his insider cronies.

That's already happened. We know they're not gonna let the other side win.

And the sides really are now "Main Street" versus "Wall Street." Wall Street will do whatever is necessary to prevent Main Street from winning, at least if it means their being wiped out.

Frankly, I really don't know how to play it. Part of me says to get another house right away while sale prices are still low and interest rates are ridiculously low. But the other part of me says no, invest in an Airstream Trailer with a Ford 350 and hit the road. They'd have to find me first before they confiscate my stuff.

Hmmmm . . .

Me too, I don’t know what the best course of action is. We see the old system crumbling around us, the sheeple see the stock market going up and think, “WOW! The economy is fixed!”, when in fact, it’s hot money from the fed pumping up stock prices in the first bout of inflation.

Another way the little people got screwed was with this whole MF Global theft and Corzine skated. People had ownership certificates for bullion with serial numbers - that is a warehouse receipt. This property was stolen.

During the Weimar collapse, even real estate was not safe. All property was subject to excess taxation and/or outright confiscation.
During Weimar, property owners gave the keys to tenants so as not to be robbed of their entire fortunes via confiscatory taxation.

I’ve been directing people to a great book I read on the Weimar collapse, “When Money Dies”. Check my back posts where I posted a link that you could download it for free.

Never mind, found the old link.

You can click on the book below to get it from Amazon:

You are in luck... it appears that you can still read it or download it for free online here and only here:

When Money Dies: The Nightmare of the Weimar Collapse

This book was out of print for a while, but now is being reissued. If you are interested, I suggest you grab the free e-book above while it lasts, as it will likely soon disappear since the book has gone back into print.

Of course you can always buy a bookshelf copy from Amazon as it's cheap enough.

Thanks, Bon Mots. I'll check it out.

Rushdoony has a book from the 70s called "Larceny in the Heart." His basic argument is that it's immoral for a Christian to play the "I can beat this inflation thing" game. He says it's a fundamentally immoral thing and that a good man would have nothing to do with it, at least that's how I understand it. He backs it up with lots of Scripture. You can get it cheap on Amazon for kindle.

Never take religious advice from economists, nor financial advice from spiritual advisors... just my take.

Here is one more to read that is excellent, but a bit more academic:

This Time Is Different

This book was written by Harvard Economics Professor Rogoff and is well researched - it goes back some 800 years to crises just like the one we face now and how they always do the same thing... just like they are doing now.

A good 'heads-up' on how this will play out.

Unfortunately, there is not enough gold (and silver, combined) in the world today to back a major currency.

You were on a roll till that statement.

Any amount of gold will serve to back a currency. If the dollar were defined as 1/4 of 1 grain of gold (1/1920 of a troy ounce) and dollar-holders could redeem their dollars at will for that amount; it would suffice to back the currency.

As long as banks are required to part with their gold reserves upon demand of the depositor, they will be careful not to over-extend themselves. Increasing redemption of gold serves as a signal to a bank that customers are losing confidence and the situation should be corrected: loans called in, interest rates on deposits increased, etc..

Redemption is the key to a successful gold standard. The amount of backing must be defined, but the quantity doesn't matter.

Seriously, 1/4 of a grain of gold? That is just nonsensical as a means to back a currency. You might as well base it on fairy dust, which probably has a better conversion ratio with the dollar.

You obviously did not read my comment very carefully. The amount of gold backing the currency DOES NOT MATTER.

Why do you consider my suggestion so ridiculous? Please expound. I await your explanation eagerly,.

You answered your own question:

“The amount of gold backing the currency DOES NOT MATTER.”

Priceless is the same as worthless.

Gold only has value to those that value gold. Because there is so little of it in the world, it is no different than baseball trading cards: of great value to those who collect it and trade it, but of no value to those who don’t.

Try this experiment. Go to a grocery store and fill that cart up. Then offer gold as payment to the cashier. Since they have no way of converting it, ask the manager to do so. He will have no way of converting it either.

“Sorry, Mac. Cash, credit, debit or check only.”

“But don’t you *understand*??? This is GOLD!”

“Sorry, Mac. Cash, credit, debit or check only.”

When money is worthless, as it has been in so many countries and is now in quite a few, gold does become desirable.

I am amazed at those who say it has no worth because you can’t eat it when our country required that the currency be coin for many many years.

Since Biblical times, gold has been sought after.

What was the California gold rush all about?

My point is that there is just far too little of it in the world, much less the US, to matter.

In physical ownership, there is only about $250 billion in gold in the US, assuming $1600/ounce. Our daily retail is over $2 trillion.

Ironically, if the US government owned all this gold, it would back about 12.5% of daily retail. Paper money is so rare that there is only enough to back 5% of daily retail.

So, if something went wrong with our virtual money right now, like what is happening in Cyprus, our paper money would be worth more than gold. Assuming, of course, the government had decided to nationalize all gold, again.

Gold only has value to those that value gold.

That's true, of course. But you miss the point of a properly gold-backed currency. It limits the amount of paper dollars that can be printed.

That's the point.

In practical terms, at least right now, no it doesn’t.

First, distinguish between the hyperinflated virtual dollar that exists only on computer, and the 20 times deflated paper dollar. The government literally cannot print more paper money than it is doing right now. For it to do so, it would have to open at least 18 more high security printing offices, spend billions on the printing presses, which almost have to be built from scratch, and spend more billions on the right kind of ink, paper, and printing plates.

A minimum of ten years, my guess, for them to do this.

The flip side is that the USG could announce tomorrow that the dollar was again backed by gold. With one microgram of gold being worth a dollar (.000047 of a dollar at current prices). And that the public ownership of gold is again forbidden. And that the transfer of gold will only be with banks and foreign governments.

On top of which, based on its current supplies of gold, the USG has $50 trillion in the bank.

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