Sunday, 29 November 2015
Why do governments rescue banks but not widget makers?
When a widget maker fails, government doesn’t rescue of those who funded the widget maker, and quite right. Bankruptcy of widget makers indicates resources should probably be allocated to something else. But if a bank fails, government rescues those who funded the bank, i.e. relevant depositors. Bank failures probably indicate that too much borrowing and lending is taking place, i.e. that there’s too much debt. Deposit insurance thus helps ensure that that misallocation of resources continues.
Governments only have a motive for the above nonsense where two of the basic activities of banks can be combined, namely first lending, and second, accepting deposits which are supposed to be totally safe. Banks force governments to assist the first activity by forcing them to underwrite or insure the second.
The alternative and better option is to separate lending from deposit accepting. Under that arrangement, only deposits made at the central bank or put into government debt are insured by government. Plus under that “separation” arrangement lending is funded (as in any normal corporation) by shareholders, bondholders and the like (who can lose their money). There again, there is no need for state organised insurance.