Monday, 26 October 2015

Why not insure everyone against losses on the stock exchange?

If you lend to a corporation that specialises in loans to mortgagors, small businesses etc (i.e. make a deposit at a bank) government guarantees you won’t lose out.

But if you lend to a corporation that does anything else, like making cars or computers (i.e. buy bonds in those corporations) then you’re on your own: there are no government guarantees.

What’s the logic there? I smell a rat.

One of the excuses given for taxpayer funded guarantees for those making deposits at banks is that it encourages saving and investment. Indeed the UK’s Vickers commission put just that argument (sections 3.20 – 3.24).

Also it could be argued that the purpose of state guarantees for bank deposits is to ensure that everyone has a secure method of storing and transferring money.  Well unfortunately that argument won’t wash, for the following reasons.

If the sole purpose of state guarantees for bank deposits was achieve the latter “security”,  that could be provided by the state. Indeed, in some countries it already is provided to some extent by the state in the form of state run savings banks (like National Savings in the UK).

In short, the purpose of guarantees or subsidies for bank deposits is quite obviously (as suggested by Vickers) to encourage loans and investments made by banks, AS WELL AS providing everyone with a secure way of lodging and transferring money.

So, back to the original question: why no state guarantees for those investing in the stock exchange (whether as individuals or via pension funds and the like). In particular, why no guarantees for those buying share or bonds on the stock exchange? After all, as Vickers and others so eloquently point out, government guarantees for people who lend encourages lending and investment.

A possible answer to the latter question is that those investing on the stock exchange DELIBERATELY take a risk, whereas those who deposit money in a bank are quite clearly aiming for total safety.

Well that’s just a circular argument: stock exchange investments are risky because they are not backed by the state (i.e. taxpayers).

Not for the first time, the logic behind the conventional wisdom is nonsense.

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