Saturday, 7 November 2015

Government insures the creditors of banks but not the creditors of other corporations: unjustified discrimination.

Summary.   If you lend money to a corporation which itself specialises in lending money, i.e. if you make a deposit at a bank, most governments protect you. But loans to other corporations are not protected. There is no logic in that pro money lender discrimination.

The most common excuse for that discrimination is that the “protection” encourages saving at banks which in turn encourages investment and economic growth. Unfortunately exactly the same argument applies to non-bank corporations. Thus the logical course of action is to abolish taxpayer funded backing for deposits at commercial banks. Of course everyone is entitled to a totally secure way of lodging and transferring money, but that can be done with accounts where relevant monies are simply lodged at the central bank, and perhaps also put into short term government debt, but nothing else. Indeed those sort of accounts already exist the state run savings banks in several countries.

Ending state protection for conventional depositors would mean the end of privately created money, but that wouldn’t matter.


If you lend to a corporation that specialises in money lending (i.e. make a deposit at a bank) most governments protect you against loss. E.g. in the European Union, deposits up to 100,000 Euros are protected.  That protection extends to term accounts, which in effect are little different to bonds.

In contrast, if you lend to, or buy bonds in a corporation that does NOT SPECIALISE in money lending (e.g. corporations that make cars or computers) then there is no government protection. You’re also on your own with some bonds issued by local government, cities, etc.

That’s clearly an anomaly. So what’s the excuse for that pro-bank and pro-depositor discrimination? Well the most common excuse seems to be that if government insures those who lend to banks, then banks will lend more which allegedly promotes investment and economic growth.

Certainly that “growth” argument is the one put by the UK’s Vickers commission. (See sections 3.20 to 3.24 of their report) And that commission consisted of some economics heavyweights. For example John Vickers himself (chairman of the commission) was formerly chief economist at the Bank of England. And Martin Wolf, chief economics commentator at the Financial Times, was also on the commission.

But there’s a glaring flaw in that “growth” argument, namely that if protecting those who lend to banks results in more investment and growth, the so too would protecting those who lend to other corporations or to cities.  Moreover, defenders of the existing bank system cannot claim that protecting allegedly responsible banks is OK, but protecting any old fly-by-night corporation is not OK: reason is that almost every corporation is MORE RESPONSIBLE than banks! Banks are arguably the world’s biggest criminal organisations if one goes by the size of fines they’ve had to pay recently – over $100billion.

I.e. if the argument is that government should insure only loans to RESPONSIBLE organisations, then insuring loans to banks should be outlawed!

Protection for depositors has been provided for free in the UK for decades, a blatant subsidy of banks and depositors. In contrast in the US, depositor protection in the case of small banks is provided by the self-funding FDIC, while depositors at large banks in the US rely on the too big to fail implicit guarantee of banks provided by Uncle Sam.

But even if depositor protection is done on an FDIC style “self-funding” basis, why is there no equivalent for those who lend to non-bank corporations and cities (NBCCs)?

Of course those who buy NBCC bonds can arrange insurance with privately insurance companies rather than with government, and indeed there’s no reason bank depositors shouldn’t do that. Cars, houses, ships and NBCC bonds are privately insured. Why not term accounts and current / checking accounts at banks?


Another argument that defenders of the existing bank system put is that everyone has a right to a totally safe method of lodging money, thus government backing for bank deposits is justified.

Well that argument confuses two issues: first, the lodging of money in a totally safe manner, and second, lending money – in some cases to quite risky borrowers.

Certainly everyone has a right to a totally safe method of lodging and transferring money. In contrast, borrowers do not have a right to be able to borrow on any sort of subsidised basis.

In fact many governments ALREADY PROVIDE total safety in the form of state run savings banks (e.g. National Savings and Investments in the UK). And as is entirely logical in view of the complete safety offered, depositors’ money in those savings banks is normally invested in a near totally safe manner, i.e. the money is simply lodged at the central bank and/or put into short term government debt and nothing else.

As to whether PRIVATE banks should be allowed to run totally safe accounts of that sort (i.e. where money is simply lodged at the central bank and/or put into short term government debt), perhaps they should. I won’t go into that question here. But in the US, that sort of arrangement will soon be in effect. That is, money market mutual funds (MMMFs) in the US will shortly be divided into those which invest just in government debt and which will be allowed to portray their liabilities as genuine money, and in contrast MMMFs which can invest in a broader range of assets, but which as a result will have to let the value of their liabilities float in value, which will mean those liabilities are no longer a form of money: they’re more in the nature of shares.

Bankers manipulate politicians.

Another problem with GOVERNMENT provided insurance for conventional bank accounts is that bankers are experts at manipulating politicians. To illustrate, the UK finance industry spends £90million a year on lobbying. As for the US, as Senator  Dick Durbin said, "And the banks  -- are still the most powerful lobby on Capitol Hill. And they frankly own the place."  In short, bankers will never stop trying to persuade politicians to insure risky deposits and loans at subsidised rate.

Bankers and terrorists.

In fact there’s a similarity between bankers and terrorists, as follows. It’s widely accepted that terrorists do not need to succeed every time. That is, they only need to bring down airliners once in every ten attempts, and they’ve made their point: they get their way.

Same goes for bankers. That is, if politicians currently in power actually know something about banking and economics (no, don’t laugh) and are able to resist bankers’ blandishments, no problem: banks only have to wait two or three years, and there’ll be some politician in power who falls for the nonsense that banks trott out over and over. That’s nonsense of the sort alluded to by Paul Volker when he said "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".

What banks have very cleverly done over the decades and centuries is to combine two activities, namely accepting deposits which are supposedly safe and which make up the vast bulk of the nation’s money supply, and second, money lending. That means that if they make a mess of money lending, the nation’s money supply and money transfer system may be trashed. It is then easy for bankers to persuade politicians to give or lend banks a few billion or trillion of taxpayers’ money at favourable rates.

The solution is to undo that mixing of deposit taking and lending.  Expect howls of protest from bankers whenever that’s proposed, and Volker type sob stories about “economic growth” being hit.

Unused money.

Another argument that defenders of the existing system often put is that if money which is supposed to be totally safe is simply lodged at the central bank, i.e. not used, that will cut aggregate demand.

Well the answer to that is that if that money IS USED, the effect is to raise demand, and assuming demand is already at the maximum level that is feasible without exacerbating inflation too much, then some of that money would have to be withdrawn from the private sector, else inflation would become excessive.  Put another way, if everyone wanted to keep $10,000 dollars under their mattress against a rainy day and scarcely ever used that money, it would be easy and it would cost nothing in real terms to crank up the printing presses and proved everyone with what they wanted.

In short, the REAL COST of providing everyone with rainy day money is zero. Or as Milton Friedman put it, “It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances.”

The end of privately created money.

Assuming debts owed by money lenders (i.e. deposits at banks) are not insured at all, or if they are insured, are insured by PRIVATE insurers rather than by government, then those deposits are not entirely safe because it’s always possible that private insurers fail. 

Thus assuming that what is meant by “money” is a debt owed to the “money owner” or depositor which is totally safe, then those non-insured deposits or bonds do not constitute money.  I.e. “real / genuine” money would only be in the form of debts owed to “money owners” which are backed by government, like the above money in state run savings banks.

Of course if the latter idea were implemented, private banks would try every trick in the trade to PASS OFF their risky liabilities as totally safe money, just as they did in the 1930s before the days of deposit insurance. That trickery would need to be countered with a requirement that private banks made it abundantly clear that those liabilities were NOT government backed, and thus that those liabilities were more in the nature of standard commercial loans than money.

1 comment:

  1. Very clear in theory.
    To make the argument even clearer and much more persuasive, I suggest a systematic, comprehensive QUANTIFIED analysis of all the costs and benefits likely to stem from the ending of subsidies to banks.


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