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Anatomy of the Bank Run
Mises Institute ^ | March 25, 2013 | Murray N. Rothbard

Posted on 03/25/2013 4:50:44 PM PDT by BfloGuy

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?

Rothbard, Murray N.

$20.00 $12.00

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.


TOPICS: Business/Economy; Constitution/Conservatism; Government; News/Current Events; US: Maryland; US: Ohio
KEYWORDS: bankrun; corrupt; counterfeit; fdic; fed; fslic; maryland; nuttery; ohio; tinfoilhatsociety
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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.

Deposit insurance is a fraud, too. When you lend your money to a bank [and that's what you are doing], there is a risk involved. The government has tried really, really hard since FDR to convince us that saving money in a bank is a riskless endeavor.

They tried the same thing in Cyprus, too. But since Cyprus can't print money, it must skim part of the bail-out from the depositors. It's really as it should be. Otherwise, the taxpayers of other countries must foot the bill.

In the US, of course, we'd all pay for the bailout through dollars that buy less.

1 posted on 03/25/2013 4:50:44 PM PDT by BfloGuy
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To: BfloGuy
In the US, of course, we'd all pay for the bailout through dollars that buy less.

And we're fixin' to get a lot more "less."

2 posted on 03/25/2013 4:58:34 PM PDT by ez (Laws only apply to little people. Criminals, politicians, and newsies are exempt.)
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To: BfloGuy

Have The Russians Already Quietly Withdrawn All Their Cash From Cyprus?
http://www.zerohedge.com/news/2013-03-25/have-russians-already-quietly-withdrawn-all-their-cash-cyprus

The “Wealth Tax” Contagion Is Rapidly Spreading: Switzerland, Cyprus And Now ....(Lichtenstein!)
http://www.zerohedge.com/news/2013-03-25/wealth-tax-contagion-rapidly-spreading-switzerland-cyprus-and-now


3 posted on 03/25/2013 5:08:36 PM PDT by Jack Hydrazine (I’m not a Republican, I’m a conservative! Pubbies haven't been conservative since before T.R.)
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To: BfloGuy

I hate banks. I’ve always hated banks. I will always hate banks.


4 posted on 03/25/2013 5:10:07 PM PDT by jeffc (The U.S. media are our enemy)
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To: jeffc
"I hate banks. I’ve always hated banks. I will always hate banks."

It's not like the old days is it Butch?

5 posted on 03/25/2013 5:15:31 PM PDT by Liberty Valance (Keep a simple manner for a happy life :o)
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To: jeffc

good thought...


6 posted on 03/25/2013 5:17:26 PM PDT by ptsal (E)
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To: jeffc

It’s not the banks,it’s the bankers.The bankers in Cyprus will need to keep an eye out for eastern European guys with umbrellas.I would suggest that they hire someone to start their cars for them too.


7 posted on 03/25/2013 5:19:18 PM PDT by Farmer Dean (stop worrying about what they want to do to you,start thinking about what you want to do to them)
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To: BfloGuy

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.


This is correct up to a certain point.

Eventually there will come a time when no other nation wants our dollar and at that point, even though the fed prints enough money to pay off bank depositors, it will do the depositor no good because no one will want his money either.

So tell me, when you go to purchase food or oil to heat your house, which is worse...to have no money at all or to have a pickup truck load of green paper that no one wants?

In either case, the financial system is ruined and barter is the only way out.

That is my theory.

You are welcome to proceed on the basis of yours.


8 posted on 03/25/2013 5:20:30 PM PDT by old curmudgeon
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To: BfloGuy
I was working for a bank the day it was seized and sold by the FDIC.

It was a small bank owned by a small family, employed nearly 300 people and was closed for no good reason. Every employee laid off and indentured for the next 90 days.

Armed U.S. Marshals, State Police, etc. showed up on a Friday afternoon the 3rd week of January, 2010.

The armament was not to deter the run, but to detain and retain the employees.

The ones not escorted out of the buildings wound up being indentured servants of the FDIC until 4/30/10.

After all was said and done, the bank turned a $30 million profit in 2009, but was collapsed and sold off piecemeal over the next year or so.

I was given a 20-minute warning, told my boss I didn't want to be a part of that and left. He called me back 20 minutes later and asked me to return. Worst decision I ever made was to go back in there. Of course, if I had not, I would to this day be hunted and haunted.

Worst 90 days of my life, all for no good reason.

9 posted on 03/25/2013 5:22:06 PM PDT by elkfersupper ( Member of the Original Defiant Class)
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To: old curmudgeon

Our money is worth no more today than confederate money was worth in 1865.

The only thing making it worth anything is that it is accepted. When it stops being accepted it will be worth nothing, same as the Confederate dollar.


10 posted on 03/25/2013 5:30:46 PM PDT by Venturer
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To: BfloGuy

Why do Keynesians operate under the assumption that people are stupid?

Look.

If I know that next Thursday the government is going to confiscate 10% of my saving’s deposit, I’m going to start taking as much money I can out of the bank.

And the economist are always shocked that people behave this way.


11 posted on 03/25/2013 6:33:12 PM PDT by PanzerKardinal (Some things are so idiotic only an intellectual would believe it.)
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To: PanzerKardinal

A question for you.

How do you know that the bank will not take 10% out of your account next Thursday?


12 posted on 03/25/2013 6:40:16 PM PDT by old curmudgeon
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To: Farmer Dean

I think it’s a bit more serious than umbrellas, and there is no reason in the world that Russian oligarchs need to have “plausible deniability”.

In other words, they would send some real brutal muscle to Cyprus, with orders to squeeze these bankers until they kick down at least that oligarchs money. All of it. Like a really nasty loan shark, they wouldn’t care *where* the bankers got the money, just as long as they got it.


13 posted on 03/25/2013 6:58:13 PM PDT by yefragetuwrabrumuy (Best WoT news at rantburg.com)
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To: BfloGuy

One of their last sentences is intriguing, but unfinished:

“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.”

The the question becomes, “and then what happens?”

I think I have an answer for that, based on how Weimar Germany (with advice from the US), got out from its horrible hyperinflation of its fiat currency, the Papiermark.

The first thing they did was to create a new, gold backed, “bank and government currency”, that did not circulate, but because it was very stable, did not inflate either. It was called the Rentenmark, as normalized the German economy, while erasing “bubble debts” and taking possession of forfeited assets.

It got the Papiermark back under control, at least enough so that when a third currency, a circulating currency, also gold backed, the Reichsmark, was introduced, it was also very stable. So stable that it even survived World War II.

Unfortunately, there is not enough gold (and silver, combined) in the world today to back a major currency. But this problem can be alleviated by including other non-renewable commodities: aluminum, copper, iron, other metals and mined chemicals, and even processed steel.

The US most certainly could create a “bank and government”, non-circulating currency, that officially would be “specie backed”, but unofficially would be “specie plus”.


14 posted on 03/25/2013 7:14:04 PM PDT by yefragetuwrabrumuy (Best WoT news at rantburg.com)
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To: yefragetuwrabrumuy

The guy who got stuck with a ricin pellet from the end of an umbrella probably thought it was pretty serious,but you’re right it’s going to be a bloodbath this time.


15 posted on 03/25/2013 7:20:29 PM PDT by Farmer Dean (stop worrying about what they want to do to you,start thinking about what you want to do to them)
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To: Farmer Dean

“It’s not the banks,it’s the bankers.The bankers in Cyprus will need to keep an eye out for eastern European guys with umbrellas.I would suggest that they hire someone to start their cars for them too.”

Actually, I’d be in favor of some Cypriot “banksters” being “offed” by the Ruskies.
Maybe the fear that they can be “disposed of,” will put some fear into all of them.


16 posted on 03/25/2013 7:31:26 PM PDT by vette6387
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To: BfloGuy; Abundy; Albion Wilde; AlwaysFree; AnnaSASsyFR; bayliving; BFM; cindy-true-supporter; ...

Maryland Savings and Loan “Freak State” PING!


17 posted on 03/25/2013 7:56:58 PM PDT by Tolerance Sucks Rocks (Drag Me From Hell!)
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To: elkfersupper

Back in those days every Friday was edgy. No one knew if they were next on the list. Crazy Days.


18 posted on 03/25/2013 8:22:15 PM PDT by Orange1998
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To: jeffc

I intend to rout you out and by the Eternal God I will rout you out. If the people only understood the rank injustice of our money and banking system, there would be a revolution before morning.” —Andrew Jackson,


19 posted on 03/25/2013 8:36:07 PM PDT by TomasUSMC ( FIGHT LIKE WW2, FINISH LIKE WW2. FIGHT LIKE NAM, FINISH LIKE NAM)
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To: old curmudgeon
Dollars are tax scrip. They're good for paying US tax bills. And since the US economy is so huge, there's a lot of demand for them. But that's about it. The dollar will finally die the day Los Federales say they'll no longer accept their own dollars in payment for debts. That's possible, I think.

Here's a question that's been bothering me. I bought a residence in 2009 for essentially nothing down and a 30 year fixed mortgage at under 5%. What happens when inflation takes off - I think it already has begun - and then the bank is left with me paying off the loan for what increasingly looks like Monopoly Money. Will the Spirit of Cyprus play out here as a unilateral re-writing of the loan agreement to keep payments up with inflation? It's hard to imagine that the banks will stand by as I begin to pay them confetti. Am I wrong?

20 posted on 03/25/2013 8:44:55 PM PDT by Gluteus Maximus
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