Banking Demystified

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Banking Demystified

by Doug French by Doug French

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Those under the delusion that it was an orgy of deregulation and lack of government oversight in financial markets that has led to the current crash and rash of bank failures and bailouts will be overjoyed to learn that the Federal Deposit Insurance Corporation (FDIC) is doubling its operating budget for 2009 to $2.24 billion and will increase its workforce by 30 percent to 6,269.

The pace of bank busts is quickening, with nearly half of this year’s 25 failures coming in the current quarter. There were only three failures in 2007 as the real estate boom still had fainting signs of life left in it and there were no failures from June 2004 through February 2007 when the boom was in full swing. This boom was driven by huge increases in the money supply created by the Federal Reserve which led to massive mal-investment in: row after row of single family tract homes that were scooped up by panting speculators who financed their punts with cheap no-money down loans, strip malls and suburban office buildings, skyscrapers and casinos the world around.

To the government regulatory world, the banking system was sound while the boom unfolded, but as Murray Rothbard pointed out in his article "The Myth of Free Banking in Scotland" which is included as an appendix in the new addition of The Mystery of Banking, "a dearth of bank failure should rather be treated with suspicion, as witness the drop of bank failures in the United States since the advent of the FDIC."

As Rothbard points out, the banks may be doing fine when there are no failures, but society is getting the worst of it. "Bank failures are a healthy weapon by which the market keeps bank credit expansion in check; an absence of failure might well mean that that check is doing poorly and that inflation of money and credit is all the more rampant," Rothbard wrote. "In any case, a lower rate of bank failure can scarcely be accepted as any sort of evidence for the superiority of a banking system."

With real estate collateral values plunging, credit losses are soaring, decimating the capital ratios of banks all over the world. Large banks that are viewed as "systemically important" such as Citicorp are bailed out. Others are kept alive via capital injections from the government’s Troubled Assets Relief Program (TARP). But many of the small fry are (and will be) seized by regulators and liquidated. Thus, of the 1,400 new FDIC positions, two-thirds will be working on the "closed bank" side with the other third working on the "open bank" side, according to FDIC spokesman David Barr.

The folks at the FDIC evidently think 2009 will be a banner year for bank failures. And they should. Thus, roughly 400 of the new hires will be doctors doing check-ups on existing banks, while 1,000 will be working in the morgue doing autopsies and disposing of dead banks.

Mr. Barr points out that most of these new positions will be temporary, but H.L. Mencken reminds us "all bureaucracies will bear close watching, and none more so than that which comes into power in a wave of popular enthusiasm, and with the avowed purpose of saving the country from ruin."

All of this regulating won’t make for sound banking. That’s impossible with fiat money, fractional reserves and central banking as Rothbard explains. To put banking back on sound footing, the dollar must be defined by weight in gold, the Fed must be liquidated, banks must have gold equal to 100 percent of demand deposits, the U.S. Mint should be abolished, and the FDIC, instead of bulking up, should be abolished, "so that no government guarantee can stand behind bank inflation, or prevent the healthy gale of bank runs assuring that banks remain sound and noninflationary."

Meanwhile, the FDIC Board also announced that the FDIC’s Deposit Insurance Fund decreased by $10.6 billion, or 23.5 percent in the third quarter and currently stands at $34.6 billion. That sounds like a lot of money, but it’s less than one percent of the $4.3 trillion in deposits that the FDIC is insuring. But FDIC chair Shelia Bair has no fear: "While we will likely continue to see more bank failures, it is important for the American public to know that the FDIC stands ready to meet our sacred commitment to depositors. It is a golden promise that has been kept for 75 years and one that will not be broken.”

Did she say "golden" promise? Not hardly. "From a money, centuries ago, based solidly on gold as the currency, and where banks were required to redeem their notes and deposits immediately in specie," Rothbard wrote, "we now have a world of fiat paper moneys cut off from gold and issued by government-privileged Central Banks."

The FDIC’s golden promise is no substitute for the real thing.

Doug French [send him mail] is executive vice president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

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