An excellent op-ed piece by Jim Grant, author of Jim Grant’s Interest Rate Observer, in the Washington Post. Grant looks back at the past and finds that bankers use to be personally liable for a bank failure. The government didn’t step in and bail out the banks in the olden days. From 1848 to 1913, the banks had no central bank or Federal Reserve to backstop their ruinous behavior.
The substitution of collective responsibility for individual responsibility is the fatal story line of modern American finance. Bank shareholders used to bear the cost of failure, even as they enjoyed the fruits of success. If the bank in which shareholders invested went broke, a court-appointed receiver dunned them for money with which to compensate the depositors, among other creditors. This system was in place for 75 years, until the Federal Deposit Insurance Corp. pushed it aside in the early 1930s. One can imagine just how welcome was a receiver’s demand for a check from a shareholder who by then ardently wished that he or she had never heard of the bank in which it was his or her misfortune to invest.
Many might say that this system wouldn’t work very well. After all, didn’t the US suffer from numerous banking panics in 1800s. Grant addresses those concerns as well.
a pair of academics who gave the “double liability system” serious study (Jonathan R. Macey, now of Yale Law School and its School of Management, and Geoffrey P. Miller, now of the New York University School of Law), the system worked reasonably well. “The sums recovered from shareholders under the double-liability system,” they wrote in a 1992 Wake Forest Law Review essay, “significantly benefited depositors and other bank creditors, and undoubtedly did much to enhance public confidence in the banking system despite the fact that almost all bank deposits were uninsured.”
This type of system is being used in Brazil right now with great success. Grant notes how Brazil use to be subject to bouts of hyperinflation on a regular basis. Now if a Brazilian bank fails, “their net worths are frozen for the duration of often-lengthy court proceedings. If worse comes to worse, the responsible and accountable parties can lose their all.”
The US has created a system whereby the bankers enjoy the profits on the way up while the taxpayer pays the losses on the way down. You can’t have capitalist gains and socialized losses. Of course, this is exactly what the bankers want. I have a few articles discussing how the Federal Reserve was created for this very purpose. The Federal Reserve is one of the most anti-capitalist structures in the world. A small cartel of bankers who sit behind closed doors and attempt to manipulate the market. They tell us they know what is better for us than we know what is in our best interests. The reality is the Fed allows banks to make tons of money and avoid any losses when things head south. Anyone who argues the Fed was created to maximize job creation while controlling inflation has been drinking too much of this (excuse my French):
What bothers me the most is the complete disconnect between risk and reward with the banks. As a small business owner, I will be worried about feeding my family if my business goes kaput. So, if my business does really well, it stands that I should do well financially. I shouldered the risk. Bankers, on the other hand, get a home in the Hamptons if things go well. If failure ensues, the bankers get a home in the Hamptons. This applies to the corporate world in general. CEOs receive massive compensation packages without any downside for failure. Of course, this applies double with bankers since they hold the potential to bring the entire economy to its knees if enough of them screw up.
Even worse, we are finding that having the government backstop the banks doesn’t work. Europe’s action to bail out Greece was really a backstop to the banks. By buying Greek bonds, the European Central Bank (ECB) is ensuring the banks that loaned money to Greece don’t suffer any losses. Of course, this isn’t working. Fears now exist that the currency, the Euro, might fail. This will come home to America some day as well. Mark my words. This means that you and I will pay the ultimate price for the bankers failure without even receiving an invite to a picnic at the banker’s mansion.