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Deposit "Insurance"

We have not yet examined another important change wrought in the U.S. financial system by the New Deal. In 1933, it proclaimed assurance against the rash of bank failures that had plagued the country during the Depression. By the advent of Franklin Roosevelt, the fractional-reserve banking system had collapsed, revealing its inherent insolvency; the time was ripe for a total and genuine reform, for a cleansing of the American monetary system by putting an end, at long last, to the mendacities and the seductive evils of fractional-reserve banking. Instead, the Roosevelt Administration unsurprisingly went in the opposite direction: plunging into massive fraud upon the American public by claiming to rescue the nation from unsound banking through the new Federal Deposit Insurance Corporation (FDIC). The FDIC, the Administration proclaimed, had now “insured” all bank depositors against losses, thereby propping up the banking system by a massive bailout guaranteed in advance. But, of course, it's all done with smoke and mirrors. For one thing, the FDIC only has in its assets a tiny fraction (1 or 2 percent) of the deposits it claims to “insure.” The validity of such governmental “insurance” may be quickly gauged by noting the late 1980s catastrophe of the savings and loan industry. The deposits of those fractional-reserve banks had supposedly nestled securely in the “insurance” provided by another federal agency, the now-defunct, once-lauded Federal Savings and Loan Insurance Corporation.

One crucial problem of deposit “insurance” is the fraudulent application of the honorific term “insurance” to schemes such as deposit guarantees. Genuine insurance gained its benevolent connotations in the public mind from the fact that, when applied properly, it works very well. Insurance properly applies to risks of future calamity that are not readily subject to the control of the individual beneficiary, and where the incidence can be predicted accurately in advance. “Insurable risks'' are those where we can predict an incidence of calamities in large numbers, but not in individual cases: that is, we know nothing of the individual case except that he or it is a member of a certain class. Thus, we may be able to predict accurately how many people aged 65 will die within the next year. In that case, individuals aged 65 can pool annual premiums, with the pool of premiums being granted as benefits to the survivors of the unlucky deceased.

The more, however, that may be known about the individual cases, the more these cases need to be segregated into separate classes. Thus, if men and women aged 65 have different average death rates, or those with different health conditions have varying death rates, they must be divided into separate classes. For if they are not, and say, the healthy and the diseased are forced into paying the same premiums in the name of egalitarianism, then what we have is no longer genuine life insurance but rather a coerced redistribution of income and wealth.

Similarly, to be “insurable” the calamity has to be outside the control of the individual beneficiary; otherwise, we encounter the fatal flaw of “moral hazard,” which again takes the plan out of genuine insurance. Thus, if there is fire insurance in a certain city, based on the average incidence of fire in different kinds of buildings, but the insured are allowed to set the fires to collect the insurance without discovery or penalty, then again genuine insurance has given way to a redistributive racket. Similarly, in medicine, specific diseases such as appendicitis may be predictable in large classes and therefore genuinely insurable, but simply going to the doctor for a checkup or for vague ills is not insurable, since this action is totally under the control of the insured, and therefore cannot be predicted by insurance firms.

There are many reasons why business firms on the market can in no way be “insured,” and why the very concept applied to a firm is absurd and fraudulent. The very essence of the “risks” or uncertainty faced by the business entrepreneur is the precise opposite of the measurable risk that can be alleviated by insurance. Insurable risks, such as death, fire (if not set by the insured), accident, or appendicitis, are homogeneous, replicable, random, events that can therefore be grouped into homogeneous classes which can be predicted in large numbers. But actions and events on the market, while often similar, are inherently unique, heterogeneous, and are not random but influencing each other, and are therefore inherently uninsurable and not subject to grouping into homogeneous classes measurable in advance. Every event in human action on the market is unique and unmeasurable. The entrepreneur is precisely the person who faces and bears the inherently uninsurable risks of the marketplace.42

But if no business firm can ever be “insured,” how much more is this true of a fractional-reserve bank! For the very essence of fractional-reserve banking is that the bank is inherently insolvent, and that its insolvency will be revealed as soon as the deluded public realizes what is going on, and insists on repossessing the money which it mistakenly thinks is being safeguarded in its trusted neighborhood bank. If no business firm can be insured, then an industry consisting of hundreds of insolvent firms is surely the last institution about which anyone can mention “insurance” with a straight face. “Deposit insurance” is simply a fraudulent racket, and a cruel one at that, since it may plunder the life savings and the money stock of the entire public.

  • 42. This crucial difference was precisely the most important insight of the classic work by Frank H. Knight, Risk, Uncertainty and Profit, 3rd ed. (London: London School of Economics, [1921] 1940).