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Q&A on the S&L Mess

The Free Market

Tags Money and BanksMoney and Banking

04/01/1989Murray N. Rothbard

The Free Market 7, no. 4 (April 1989)


Q. When is a tax not a tax?

A. When it's a "fee." It was only a question of time before we would discover what form of creative semantics President Bush would use to wiggle out of his "read my lips" pledge (bolstered by the Darman "walks like a duck" corollary) never ever to raise taxes. Unfortunately, it took only a couple of weeks to discover the answer. No, it wasn't "revenue enhancement" or "equity" or "closing of loopholes" this time; it was the good old chestnut, the "fee."

When Secretary of the Treasury Brady came up with the ill-fated "fee" proposal for all bank depositors to bail out the failed, insolvent S&L industry, President Bush likened it to the user fee the federal government charges for people to enter Yellowstone Park. But the federal government—unfortunately—owns Yellowstone and, as its owner, may arguably charge a fee for its use without it being labeled a "tax" (although even here problems can be raised since the government does not have the same philosophical or economic status as would a private owner). But on what basis can a "fee" be levied on someone's use of his own money to deposit in an allegedly private savings and loan bank? To whom, and for what?

No, in the heartwarming firestorm of protest that arose, from the general public, and from all politicians and political observers, it was clear that to everyone except the Bush Administration, that the proposed levy on savers looked, talked, and waddled very much like a tax-duck.


Q. When is insurance not insurance?

A. When you are trying to "insure" an industry that is already bankrupt. Sometimes, the tax that is supposedly not a tax is called, not a "fee" but an "insurance premium." When the barrage of public protest virtually sank the "fee" on savers, the Bush Administration began to backpedal and to shift its proposal to a levy on other banks that are not yet officially insolvent, this new tax on banks to be termed a higher "insurance premium."

But there are far more problems here than creative semantics. The very concept of "insurance" is fallacious. To "insure" a fractional-reserve banking system, whether it be the deposits of commercial banks, or of savings and loan banks, is absurd and impossible.It is very much like "insuring" the Titanic after it hit the iceberg.

"Insurance" is only an appropriate term and a feasible concept when there are certain near-measurable risks that can be pooled over large numbers of cases: fire, accident, disease, etc. But an entrepreneurial firm or industry cannot be "insured," since the entrepreneur is undertaking the sort of risks that precisely cannot be measured or pooled, and hence cannot be insured against.

All the more is this true for an industry that is inherently and philosophically bankrupt anyway: fractional-reserve banking. Fractional-reserve S&L banking is pyramided dangerously on top of the fractional-reserve commercial banking system. The S&Ls use their deposits in commercial banks as their own reserves. Fractional-reserve banks are philosophically bankrupt because they are engaged in a gigantic con-game: pretending that your deposits are there to be redeemed at any time you wish, while actually lending them out to earn interest.

It is because fractional-reserves are a giant can that these banks rely almost totally on public "confidence," and that is why President Bush rushed to assure S&L depositors that their money is safe and that they should not be worried.

The entire industry rests on gulling the public, and making them think that their money is safe and that everything is OK; fractional-reserve banking is the only industry in the country that can and will collapse as soon as that "confidence" falls apart. Once the public realizes that the whole industry is a scam, the jig is up, and it goes crashing down; in short, the whole operation is done with mirrors, and falls apart once the public finds out the score.

The whole point of"insurance," then, is not to insure, but to swindle the public into placing their confidence where it does not belong. A few years ago, private deposit insurance fell apart in Ohio and Maryland because one or two big banks failed, and the public started to take their money out (which was not there) because their confidence was shaken. And now that one-third of the S&L industry is officially bankrupt—and yet allowed to continue operations—and the Federal Savings and Loan Insurance Corporation (FSLIC) is officially bankrupt as well, the tottering banking system is left with the Federal Deposit Insurance Corporation (FDIC). The FDIC, which "insures" commercial banks, is still officially solvent. It is only in better shape than its sister FSLIC, however, because everyone perceives that behind the FDIC stands the unlimited power of the Federal Reserve to print money.


Q. Why did deregulation fail in the case of the S&Ls? Doesn't this violate the rule that free enterprise always works better than regulation?

A. The S&L industry is no free-market industry. It was virtually created, cartelized, and subsidized by the federal government. Formerly the small "building and loan" industry in the 1920s, the thrifts were totally transformed into the government-created and cartelized S&L industry by legislation of the early New Deal. The industry was organized under Federal Home Loan Banks and governed by a Federal Home Loan Board, which cartelized the industry, poured in reserves, and inflated the nation's money supply by generating subsidized cheap credit and mortgages to the nation's housing and real-estate industry.

FSLIC was the Federal Home Board's form of "insurance" subsidy to the industry. Furthermore, the S&Ls persuaded the Federal Reserve to cartelize the industry still further by impos"i ing low maximum interest rates that they would have to pay\ their gulled and hapless' depositors. Since the average person, from the 1930s through the 1970s, had few other outlets for their savings than the S&Ls, their savings were coercively channeled into low-interest deposits, guaranteeing the S&Ls a hefty profit as they loaned out the money for higher-interest mortgages. In this way, the exploited depositors were left out in the cold to see their assets decimated by continuing inflation.

The dam burst in the late 1970s, however, with the invention of the money-market mutual fund, which allowed the fleeced S&L depositors to take out their money in droves and put it into the market-interest funds. The thrifts began to go bankrupt, and they were forced to clamor for elimination of the cartelized low rates to depositors, otherwise they would have gone under from money-market fund competition. But then, in order to compete with the high-yield funds, the S&Ls had to get out of low-yield mortgages, and go into swinging, speculative, and high-risk assets.

The federal government obliged by "deregulating" the assets and loans of the S&Ls. But, of course, this was phony deregulation, since the FSLIC continued to guarantee the S&Ls' liabilities: their deposits. An industry that finds its assets unregulated while its liabilities are guaranteed by the federal government may be, in the short-run, at least, in a happy/ position; but it can in no sense be called an example of a free-enterprise industry. As a result of nearly a decade of wild speculative loans, official S&L bankruptcy has now piled up, to the tune of at least $100 billion.


Q. How will the federal government get the funds to bail out the S&Ls and FSLIC, and, down the road, the FDIC?

A. There are three ways the federal government can bail out the S&Ls: increasing taxes, borrowing, or printing money and handing it over. It has already floated the lead balloon of raising "fees" on the depositing public, which is not only an outrageous tax on the public to bail out their own exploiters, but is also a massive tax on savings, which will decrease our relatively low amount of savings still further. On borrowing, it faces the much ballyhooed Gramm"Rudman obstacle, so the government is borrowing to bailout the S&Ls by floating special bonds that would not count in the federal budget. An example of creative accounting: if you want to balance a budget, spend money and don't count it in the budget!


Q. So why doesn't the Fed simply print the money and give it to the S&Ls?

A. It could easily do so, and the perception of the Fed's unlimited power to print provides the crucial support for the entire system. But there is a grave problem. Suppose that the ultimate bailout were $200 billion. After much hullaballoo and anyone else in order to acquire an ironclad guarantee against loss.

The depositors must be allowed to go under along with the S&Ls. The momentary pain will be more than offset by the salutary lessons these depositors will have learned: don't trust the government, and don't trust fractional"reserve banking. One hopes that the depositors in fractional-reserve commercial banks will profit from this example and get their money out posthaste.

All the commentators prate that the government "has to" borrow or tax the funds to payoff the S&L depositors. There is no "has to" about it; we live in a world of free will and free choice.

Eventually, the only way to avoid similar messes is to scrap the current inflationist and cartelized system and move to a regime of truly sound money. That means a dollar defined as, and redeemable in, a specified weight of gold coin, and a banking system that keeps its cash or gold reserves 100% of its demand liabilities.


Murray N. Rothbard

Murray N. Rothbard made major contributions to economics, history, political philosophy, and legal theory. He combined Austrian economics with a fervent commitment to individual liberty.

Cite This Article

Rothbard, Murray N. "Q&A on the S&L Mess." The Free Market 7, no. 4 (April 1989): 1–3.