Friday, 20 May 2016

A flaw in deposit insurance.

If you lend direct to corporations A,B,C… there’s no government run insurance for you. But if you lend to a bank, i.e. make a deposit at a bank, and the bank lends to A,B,C… then you’re automatically insured.

That makes no sense because there is no inherent merit in lending to A,B,C… via some third party like a bank as compared to lending direct. That’s not to say there is anything WRONG with “indirect lending”, whether done via a bank, a mutual fund or whatever. The point is that, to repeat, there is no special merit in indirect lending.

Ergo if government should EITHER abandon deposit insurance, OR offer insurance for all those with bonds in non-bank corporations. After all, the main argument for deposit insurance seems to be that that form of insurance increases bank deposits which in turn increases bank loans and thus allegedly boosts economic growth. And that argument applies in exactly the same way to bonds in a non-bank corporation or firm.

Moreover, the big attraction of being insured by GOVERNMENT rather than by some private sector insurer is that governments can grab almost limitless amounts of money off taxpayers to bail out the depositors of failed banks. That right to grab taxpayers’ money is not a free market phenomenon.

Thus the answer to the question “Should government insure ALL  lenders” is “probably not”.

Moreover, politicians have a long record of being complete suckers when confronted by bankers: that is, bankers only have to produce sob stories about economic growth being hit if the deposit insurance premium is too high, and politicians fall for it every time. Or as Paul Volker put it, “You know, just about whatever anyone proposes, no matter what it is, the banks will come out and claim that it will restrict credit and harm the economy…It’s all bullshit.”

And just to illustrate the size of the above “sucker” problem, UK banks and their depositors enjoyed the luxury of deposit insurance between WWII and a few years ago all at no charge at all: i.e. the insurance was provided by UK taxpayers for free!

As to what people would do if lending entities DIDN’T accept deposits, that’s easy: totally safe deposits could be made at entities where relevant monies are kept in a totally safe fashion, like the various state run savings banks (e.g. National Savings and Investments in the UK). And as to how LENDING entities would be funded, they’d be funded just by equity.

And that split of the bank industry into two halves, lending and deposit taking has been advocated for decades, e.g. by Irving Fisher in the 1930s and Milton Friedman in the 1960s.

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