How Big Will These Federal Programs Get? No One Knows.
How Big Will These Federal Programs Get? No One Knows.
When was the last time the government delivered both on time and under budget? In the case of public bailouts, it seems every week brings more program expansions. We can only speculate as to how big the Main Street Lending Program (MSLP) and the Paycheck Protection Program (PPP) will be by the time we get out of the Great Lockdown.
Last Thursday, after reviewing 2,200 public comments regarding the MSLP, the Fed decided to lower the minimum loan amount from $1 million to $500,000, allowed lenders to retain a 15 percent rather than 5 percent share for certain loans, and increased eligibility to companies with an annual revenue of up to $5 billion instead of $2.5 billion. The $600 billion facility still has yet to open. But when it does, and if it gets fully funded, it will expand the Fed’s balance sheet by approximately 10 percent.
The PPP could also expand the balance sheet by this amount, considering that the program started at $349 billion and has already grown to $670 billion. The same day as the MSLP release, it was announced that the PPP would expand to work with smaller nonbanks such as those in the farm credit system and community development institutions. The April 27 to May 1 US Small Business Administration Report showed that in the second round of funding there were over 2 million applications approved for $175 billion. This means that there is still a couple hundred billion dollars left which should be exhausted shortly. Given the number of approvals for these forgivable loans, would anyone be surprised if the program were expanded for a third time?
We can only wonder. But as a CNN interview with Larry Kudlow revealed, the top economic advisor to the president said that they might consider getting additional money for the PPP since:
This has been an extremely popular and effective program, no question about it. You know, keeping folks on the payroll is so important….we will be looking at that.
The Fed’s most recent balance sheet update shows that only $19 billion from the PPP Liquidity Facility has been utilized thus far; therefore, we will continue to monitor this amount. Unfortunately, it could reach $600 billion in the months ahead. Both programs are unique because the public will be able to directly participate compared to other programs, in which most cannot, such as various Fed asset purchases, lending, and bond programs.
However, a third program might include Main Street as well. This too has been expanded as of last week: the $500 billion Municipal Lending Facility (MLF). The population requirements were lowered to accept cities with 250,000 residents (formerly 1 million) and counties with 500,000 residents (formerly 2 million). This may spawn more grant programs and other “investments” that could sweep the country and trickle down to members of the public.
Between the maximum capacity of these three programs, the Fed may contribute a $1.7 trillion increase to the money supply. How big the balance sheet will be by the time life returns to normal is anyone’s guess. Also keep in mind that the effect of the banks later pyramiding this money is rarely ever discussed. Nevertheless, all this debt raises another interesting question: How will we pay this money back?
The Wall Street Journal recently posed a similar question to St. Louis Fed president James Bullard. When asked about “the inevitable day of reckoning,” he replied:
We’re borrowing and we’re gonna have to pay that back in the future, so our future tax burden is that much higher. But can we handle it as a nation? I think we can.
Should we take the advice of one of the most respected central bankers in the country? After all, we’ve been told that it was the Fed that brought us out of the last financial crisis. Surely, they can do the same thing again, only this time on a much larger scale…
QT or QE: What Is This?
Leave it to the Federal Reserve to throw a knuckleball when the batter is expecting a fastball. These last few weeks have been just that, with the Fed saying nothing of abandoning their Quantitative Tightening (QT) position while engaging in what appears to be a Quantitative Easing (QE) position.
The general public may be familiar with the term QE, but it’s nothing more than inflationism as public policy, with known detriments as old as money itself. But inflationism or currency debasement doesn’t sound as appealing as Quantitative Easing, and so selling economic destruction as a cure-all is more of a successful branding initiative than anything else.
In the last two weeks, the Fed has almost completely undone a year of balance sheet wind down, conjuring up $400 billion as of last Thursday’s data release.
The problem is that QE or QT is not “economics” per se. There’s no credible theory behind money printing nor are there any guidelines which determine what exactly constitutes these terms.
If the terms QE/QT are broadly given to the direction of the Fed’s balance sheet, then we could say that in the last two weeks, they’ve been doing QE, since the net change to the balance sheet was positive.
However, if the terms are more narrowly defined to only mean the change in US Treasury holdings and Mortgage-Backed Security holdings, then we could say that the Fed is still engaging in QT, since they are still rolling off these securities. The net balance sheet increase has only been due to lending programs that temporarily help banks out of this current crisis.
Yet the magnitude and length of time must also be considered.
On Monday CNBC announced that First Citizens Bank will purchase “around $72 billion of Silicon Valley Bank assets at a discount of $16.5 billion.” The role of the Fed and FDIC is instrumental to this bank merger, with the final cost of the bailout still not known.
The [FDIC] regulator added that the estimated cost of SVB’s failure to its Deposit Insurance Fund (DIF) will be around $20 billion, with the exact cost determined once the receivership is terminated.
By simply making available new funding programs for banks and FDIC, it appears the threat of bank runs has subsided, for now. And if we’re really lucky, the Fed’s lending schemes are nearing the end, stopping at only a few hundred billion and not several trillions of dollars.
Again, “if” the money the Fed loaned is paid back promptly, and “if” the banking crisis subsides, the balance sheet should resume its downward trajectory. Then history would consider this as still part of the QT phase. Conversely, if this lending program is only just the start of much longer and larger programs to come, history will show QE began two weeks ago.
Regardless of whether this is QT or QE, we remain in uncharted waters with nothing but a promise of a bigger storm ahead. Should these lending schemes be hailed a success, then it stands to reason that when the next bank fails, the Fed will go back to the same playbook, again and again…
As for what tomorrow brings, no one knows. But Minneapolis Federal Reserve Bank Neel Kashkari continues to have no shortage of foresight for the problems he helps create, as told to CBS over the weekend:
He said that banks holding commercial real estate assets could also see losses in the future.
And in his own words saying:
But right now it's unclear how much of an imprint these banking stresses are going to have on the economy.
Noting that it was too early to determine the impact on inflation.
Clearly the Fed remains on standby, ready and willing to create money to prop up failed banks, at the same time staying committed to reducing its holdings of US government and mortgage debt. And so, the Fed really is the lender of last resort, functioning only in terms of “need” for the big banks. So long as no bank asks for money from the Fed, the Fed won’t give them any. But the minute a bank needs the Fed, the Fed will be there like any other insurance company… with an infinite amount of cash on hand, prepared to inflate dollars at little cost to them, but at a big cost to society.
Ginning Up a Fake China Threat
Critics of the increasingly bipartisan consensus of conflict with China face a difficult task. For the (fake) China threat is not a single concrete thing that can be pointed to or otherwise signified. Rather, as a manufactured thought climate produced by a series of interlocking incentive structures, like Kafka’s Castle it looms inscrutable but no less ominous.
Upon close inspection, however, the inner workings of the (fake) China threat reveal nothing new about the anatomy of the state.
First, it serves as a legitimating device, a new reason for the continually climbing defense budgets, new toys for generals and admirals, overseas bases, the meddling by comfortably ensconced state department officials in the affairs of other states, and the existence of an intrusive national security apparatus. Stoking the fear, representatives of the state spin conflicts they seek as looming threats to everyday Americans in order to justify their continued position of power over them, with a well-funded network of think tanks and the corporate press helping prescribe the acceptable limits of public discourse in order to marginalize dissent.
Second, the (fake) China threat serves as a convenient scapegoat for the end results of the bad policies Washington itself pursued. America deindustrialized? China’s fault. Millions of Americans hooked on drugs? China’s fault. The Saudis and Iranians don’t want the Americans around anymore? China’s fault.
There is one element of truth to the (fake) China threat, however. That is, the existence of an independent China (or Russia) is a threat to Washington’s accustomed privilege of being able to do more or less whatever it wants wherever it wants.
But the existence of an independent China is already a fact.
Refusal on the part of Washington to accept it will cause more than theoretical problems.
Bank Busts Lead to Sweetheart Deals
Amidst the wreckage of bank failure grow lucrative deals. Shares of New York Community Bank Inc. surged with the announcement that the FDIC had made NYCB a “sweetheart deal” as the deposit insurer “priced the assets to move quickly,” wrote Wedbush analyst David Chiaverini in his upgrade of the stock, as reported in Bloomberg. “In exchange for the $2.7 billion discount on acquired loans [assets], plus the interest income earned on the loans and securities, NYCB will give up only $300 million in equity appreciation rights to the FDIC,” added the Wedbush analyst.
Plus, the takeover didn't include Signature's $4 billion in crypto-related deposits, included all of Signature's branches, and some of its loan portfolio, reports Business Insider. Emphasis was added because Signature didn’t have to take any bad loans.
"With New York Community's addition of certain deposits and assets of Signature's Bridge Bank, NYCB's balance sheet could be improved with less reliance on higher-cost wholesale funding. NYCB's loan-to-deposit ratio should decline from a high 119% in Q4 with the assumption of Signature deposits, while $12.9B in loans were bought for $2.7B, which equates to a 79% haircut," Bloomberg Intelligence analyst Herman Chan commented.
The FDIC killed two birds with one stone with the move, moving cherry-picked assets and deposits from a failed bank (Signature) to one that was overleveraged (119% loan-to-deposits) and possibly headed for trouble (NYCB).
Of course, sweetheart deals are nothing new. Post the 2008 crash, Rialto (a division of homebuilder Lennar) bought a 40 percent share of $1.2 billion in loans from failed banks for 40 cents on the dollar, with the FDIC carrying a loan for $1 billion of the deal at zero interest for seven years.
This was called a partnership, however, when a government entity carries its partner’s share at zero percent interest for seven years that term doesn’t seem to apply. The RE Action Committee explained at the time:
Lennar (Rialto) acquired indirectly 40% managing member interests in the limited liability companies created to hold the loans for approximately $243 million (net of working capital and transaction costs), including up to $5 million to be contributed by the Rialto management team. The FDIC is retaining the remaining 60% equity interest and is providing $627 million of non-recourse financing at 0% interest for 7 years. The transactions include approximately 5,500 distressed residential and commercial real estate loans from 22 failed bank receiverships.
Attorney Bryan Knight, in 2011, called the Private-Public Investment Programs (“PPIP’s”), such as Lennar/Rialto “ the biggest waste of government spending and most damaging program to the American public.”
Rialto was given a $600 Million interest free non recourse loan by the Federal Government to purchase assets of failed banks. Therefore, Rialto has no risk in collecting on assets because no interest is accruing and Rialto is not liable to pay back the loan since the loan is a non-recourse. This gives Rialto even more incentive to refuse loan workouts and to collect asset management fees. It is not rocket science, a bank that has risk of taking a loss is more likely to work with a borrower. Here Rialto has no risk.
How the FDIC hands out favors is described perfectly by Patrick Newman in his book Cronyism writing:
Cronyism [is] when the government passes policies to benefit special-interest politicians, bureaucrats, businesses, and other groups at the expense of the public.
The rewards of cronyism take the form of monetary gains, particularly increased incomes and profits for individuals and businesses, or psychic gains from greater power and authority.
The case of Silicon Valley Bank is especially egregious cronyism. Joseph Wang, the CIO at Monetary Macro who previously was a senior trader on the Fed’s open markets desk told Roger Hirst on Real Vision:
So, the bailout of Silicon Valley Bank was, in a sense, the bailout of millionaires and billionaires who weren't the clientele of Silicon Valley Bank. Those are guys who mismanaged your cash badly and wanted to bail out. Now, if you were going by the rule of law, you'd say that yeah, you guys. You can take it, and these are the rules. But these guys were also politically connected and very loud in social media and in the press. And so, they have influence and they can, I guess, encourage the government to bend the rules in their favor.
Winston Churchill and later Rahm Emmanuel famously said “Never let a crisis go to waste.” Cronyism never does.
Artificial Intelligence Enhances Consumer Sovereignty
Despite the fears that Artificial Intelligence will disempower consumers, companies find it easier to keep up with ever changing preferences of consumers by applying AI technology. Companies apply AI to the infinite areas of business operations, production, pricing, customer experiences, and manufacturing processes. Firms are racing one another to integrate AI applications into their business practices to meet consumer needs.
The reality is that consumers do, in many ways, steer the production and prices of economic goods and service offerings. The consumer is sovereign in a market economy; unfortunately, some still think otherwise. Why? Because artificial intelligence is mediating streams of knowledge between buyer and seller, exposing consumers to changing market conditions, prices, and circumstances. There is an antimarket camp; this camp is not keen on the fact that consumers steer the direction of pricing and production. The result is that AI integration into business practices is strikingly on the consumer's side.
As far as businesses entities are concerned, unsurprisingly, a 2023 customer poll found that "the majority of consumers (73 percent) believe there is potential for impact on customer experience, particularly in digital settings," according to Businesswire. With firms increasing their uses of AI in operations, finance, sales, and production, it becomes apparent that the simplest input into AIaas will likely tilt toward maximizing consumer demand. Techcrunch said in a recent article, "Every organization has their gold-standard employee, and AI learning can analyze employees' traits and behaviors in customer interactions, raising the bar for all." Another tool to used to maximize human productivity within a company! On the bright side, “AI can learn from top performers and share what makes them so great,” The author added, "Every employee can be a top performer.” Ludwig von Mises said, "the consumer is sovereign and cannot be replaced in a marketplace economy." Similarly, a recent Forbes article projected positive AI trends in 2023 and beyond; the author listed ten trends to look for in the use of AI in 2023, except one of the most important, unsurprisingly, the betterment of consumer sovereignty. Consumer sovereignty is not coercive in the exchange relationship between buyer and seller. Instead, it happens “only by serving the consumers, since again, the sale is voluntary on the part of both producers and consumers,” according to Murray Rothbard.
Along with AI technologies, human touch, and interaction are required and expected in many buyer and seller transactions. However, AI will assist business owners in a big way, providing enhanced customer experiences via the use of AI-powered websites, apps, manufacturing, et cetera., and other services that consumers demand. Despite all mounting evidence showing that AI-enabled applications can address customer uneasiness in a market economy because AI is a consumer-centric tool that maximizes consumers' market information, the antimarket camp does not believe that the consumer is sovereign. We must understand that AI is a maximizing tool with generative output data. In other words, AI will allow consumers and producers to spontaneously adjust their actions in market cooperation. Artificial intelligence adapts to consumer preferences and learns the top choices within data input units over time. AI learns via natural learning systems, which virtually enlarges its storage that adjusts to preferences and parameters of pricing and production, especially in reducing cost and adopting price changes.
Therefore, the economics of information – perfect or imperfect information – does not hold in the epoch of AI—spontaneous information dispersed with the aid of AI technology between buyer and seller reigns supreme. However, the spontaneous flow of information aided by AI goes against the precepts of mainline economics that support the economy of information and the so-called equilibrium. AI is an institution of the extended order in a market economy; it drastically changes the perfection or imperfection of information, spontaneity, or stagnate forms of knowledge of market conditions. AI enables consumers' sovereignty by enabling firms to reach and satisfy customers in different places, times, and circumstances giving sellers and buyers more or less information and vice versa, precisely as F.A. Hayek and Mises have preached for so long.
More Supervision and Regulation to Prevent Bank Runs?
Was That the Dip?
A few days from now marks the one-year anniversary of the article: Will You Buy the Dip? It was there I told everyone I know that eventually the Federal Reserve will conclude its Quantitative Tightening (QT), and a new round of Quantitative Easing (QE) would emerge. This was both inherent and inevitable due to the inflationary nature of central banks. So the idea was to buy the stock market once the Fed resumed the QE process.
The question is: Did last Sunday’s announcement of the Bank Term Funding Program usher in a new easy money era, i.e., was this the dip / pivot / stock market buy signal?
Consider the last two years of the Fed’s balance sheet. Between March and May of 2022, the Fed’s assets topped out at just under $9 trillion. Since then the Fed began its slow descent into QT, where last month it reduced its balance sheet, composed mostly of US Treasuries (UST) and Mortgage-Backed Securities (MBS), by around $80 billion a month. During this entire round of QT the broad stock market made no new highs and has instead slowly declined.
The Fed’s balance sheet has also become quite interesting as of late:
Incredible! It took one year for the Fed to reduce the balance sheet by $600 billion, and in just one-week, from March 8-15, the balance sheet increased by $300 billion!
This is what I was referring to, some event or crisis occurring that would be used as an excuse to get the Fed to return to the market… but human action is complex, and nothing seems to go according to plan. The increase in the balance sheet is not a result of the Fed buying-up more US debt or mortgage securities. As far as the public is aware, the Fed is still committed to QT via rolling off its existing UST and MBS holdings.
The balance sheet increase actually came from the loans the Fed granted for troubled bank relief. Details in the Fed’s notes reveal the elements comprising the $8.689 trillion balance.
Loans amounted to $318 billion, whereas a week prior, it was only $15 billion. The current $318 billion consists of Primary credit ($152 billion) and Other credit extensions ($142 billion). The new Bank Term Funding Program only accounted for $11.9 billion.
On one hand the Fed is reducing ownership of securities owned (loans to government), but on the other hand it’s creating money to loan to banks. It would be great to know how large this temporary one-year program will get, but we’re not privy to this information. However, with no limits on how much the Fed could create, it could amount to trillions of dollars.
Like the World Bank and IMF which grant loans to bankrupt nations, only to make them worse off by ending up in more debt, the Fed appears to be engaging in a similar scheme. By lending to bankrupt institutions, the hope is that within a year from now these failed banks will be better off than they are today, paying back the Fed in full plus interest.
The new funding program may very well push the Fed’s balance sheet to new all-time highs, and if it were to expand by a few trillion dollars more, one could expect to see this reflected in asset prices. But having no idea as to how big these bank loans will get, coupled with the Fed’s continual shredding of UST and MBS holdings, I still lack conviction that the Fed is serious about pumping the stock market back to new highs at the moment. Good luck in your trades.
How Does a Bank Collapse in 48 Hours?
“How does a bank collapse in 48 hours?” Asks the CNN headline. Especially a bank that reported a profit of $3.4 billion just last year. Murray Rothbard answered the question years ago in What Has Government Done To Our Money?, “No other business can be plunged into bankruptcy overnight simply because its customers decide to repossess their own property. No other business creates fictitious new money, which will evaporate when truly gauged.”
If you watched the Fed Chair Jerome Powell testify before the Senate and the House this month you heard over and over that banks are well capitalized. The non-sequitur inspiring the Shakespearean quote “Methinks you protest too much.”
The very next day after the hearings, shares of SVB Financial Group, parent of Silicon Valley Bank, fell 60 percent (the bleeding continued in after hours trading) after a Wall Street Journal article revealed, the bank “had sold large portions of its securities portfolio and would raise fresh capital, highlighting a broader problem for U.S. lenders who have seen rising interest rates hammer the values of their bond holdings.”
A day later Silicon Valley Bank depositors ran for the exits attempting to pull $42 billion out on Thursday, leaving the firm with a negative cash balance of almost $1 billion, regulators said. joining shareholders the same day the WSJ article appeared. The FDIC promptly closed the bank Friday morning saying: "Silicon Valley Bank, Santa Clara, California, was closed today by the California Department of Financial Protection and Innovation, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. To protect insured depositors, the FDIC created the Deposit Insurance National Bank of Santa Clara (DINB). At the time of closing, the FDIC as receiver immediately transferred to the DINB all insured deposits of Silicon Valley Bank."
Almost Daily Grant’s wrote “Total deposits stood at $175.4 billion, with $151.6 billion of those uninsured. Those with deposits in excess of the FDIC’s $250,000 insurance threshold will receive a receivership certificate for their funds, with payments to follow as the regulator sells down remaining assets.” (emphasis added)
Roku, Roblox, and Blockfi are among the companies that had millions on deposit at SVB, uninsured. “The company’s deposits with SVB are largely uninsured,” Roku said. “At this time, the company does not know to what extent the company will be able to recover its cash on deposit at SVB.”
Overseas this weekend, leaders of roughly 180 tech companies sent a letter calling on UK Chancellor Jeremy Hunt to intervene. “The loss of deposits has the potential to cripple the sector and set the ecosystem back 20 years,” they said in the letter seen by Bloomberg. “Many businesses will be sent into involuntary liquidation overnight.”
While SVB was a lender to the venture capital industry and tech sector, the investments that did the bank in were bonds backed by the full faith and credit of the U.S. government. However, the value of those bonds has plunged as interest rates have increased dramatically.
Banks are able to use a little accounting trickery pokery as it concerns bonds designated “available-for-sale,” as opposed to “held-to-maturity.” The available-for-sale label allows banks to “exclude the paper losses on those holdings from its earnings and regulatory capital, although the losses [do] count in equity.” Held-to-maturity allows banks “under the accounting rules to exclude paper losses on those holdings from both its earnings and equity.”
This problem is not particular to the bank serving techland.
The Federal Deposit Insurance Corp. reported that U.S. banks’ unrealized losses on available-for-sale and held-to-maturity securities totaled $690 billion as of Sept. 30, up 47% from a quarter earlier, reported the WSJ.
Bank analyst Christopher Whalen wondered in a tweet, “Is it possible that nobody has asked Chair Powell about the deteriorating solvency of US banks due to QE? Where do you think that -$600 billion number will be at the end of Q1 '23” (emphasis added)
MarketMaven’s Stephanie Pomboy weighed in on the same subject with this tweet, “I'm puzzling to understand how THIS isn't the only thing people are talking about today????????? Someone tell me about the rabbits. and fast!”
But again on Capitol Hill and at the Eccles Building no one was uttering a discouraging word. However, FDIC Chairman Martin Gruenberg said in a December 1, 2022 speech, “The combination of a high level of longer-term asset maturities and a moderate decline in deposits underscores the risk that these unrealized losses could become actual losses should banks need to sell investments to meet liquidity needs.”
Now Gruenberg’s prophecy is coming to fruition. Silicon Valley said it decided to bite the bullet and sell holdings and raise fresh capital “because we expect continued higher interest rates, pressured public and private markets, and elevated cash burn levels from our clients as they invest in their businesses.” The fresh capital could not be had at any price.
Rothbard reminds us, “The bank creates new money out of thin air, and does not, like everyone else, have to acquire money by producing and selling its services. In short, the bank is already and at all times bankrupt; but it's bankruptcy is only revealed when customers get suspicious and precipitate ‘bank runs.’”
So the banks are well capitalized Mr. Powell? Bank depositors and ex-depositors will decide that. Silicon Valley Bank is the first this cycle to fail, but likely not the last.
How Reporters Manipulate You
An article in the New York Times last night by reporters Jonathan Swan and Maggie Haberman is an excellent example of one of the common ways “hard news” reporters can put their thumbs on the scale and push a preferred agenda.
On Monday Florida governor, and likely presidential candidate, Ron DeSantis said on Fox News that “becoming further entangled in a territorial dispute between Ukraine and Russia” is not a vital interest of the United States.
The people who work at and manage the New York Times clearly disagree with this opinion. That’s clear to anyone who has consumed their war coverage and seen the way they frame the conflict.
However, the paper wants its reporting to continue to appear nonpolitical as can be seen in this disclaimer halfway down the article.
So how do they dissuade readers of DeSantis’s point without appearing to rebuke it? They launder their opinions through experts and notable people with the same view.
In this article, they focus on some of DeSantis’s fellow Republicans who happen to agree with the New York Times on this particular issue.
The article presents reactions from seven Republicans who strongly denounce the DeSantis statement. They rake the Florida governor’s name through the mud with their comments. They call him weak and say that he’s so wrong it’s a risk to national security.
The article also quotes a Wall Street Journal columnist who criticizes GOP noninterventionists for wanting to “surrender” to Putin.
The article has one single quote from someone who agrees with DeSantis, but only because he wants the U.S. to focus more on combating China. Pure noninterventionism is given no voice, only a dissenting interventionist.
In paragraph 23, Haberman and Swan do admit one important detail that the readers who made it that far would be forgiven for getting completely backward. The opinions of those highlighted in this piece are unpopular with the GOP base compared to the skepticism of U.S. intervention in Eastern Europe voiced by Donald Trump and Ron DeSantis.
Readers will come away from this article thinking that DeSantis said something on TV that most people, including leaders and prominent members of his own party, think was stupid.
That is the exact kind of point you’d expect from the paper’s Editorial Board. But here it’s presented by reporters writing in the “hard news” section of the supposed paper of record.
Larry Summers Apologizes for his Rothbardian Insight and George Selgin Exhales
Larry Summers affirms the Rothbardian critique of fractional-reserve banking on Twitter...
SVB committed one of the most elementary errors in banking: borrowing money in the short term and investing in the long term. When interest rates went up, the assets lost their value and put the institution in a problematic situation. https://t.co/HxsgqpZOuL— Lawrence H. Summers (@LHSummers) March 14, 2023
...but then takes it back...
Responding to some of the comments here: Of course banks borrow short and lend long, but properly managed and supervised banks limit duration mismatch between liabilities and assets so their capital position is not gravely compromised by rising long-term interest rates.— Lawrence H. Summers (@LHSummers) March 14, 2023
...and free banker George Selgin breathes a sigh of relief at "Prof. Summers" retraction.
I'm glad to see, upon reading on, that Prof. Summers explains himself in the comments. Still, I was taken aback upon first seeing this tweet by him attributing SVB's troubles to its having done what all banks always do! https://t.co/EAAYc4ZrOS— George Selgin (@GeorgeSelgin) March 14, 2023
The Banking System is Built on Deception
There's nothing like a bank failure to get people thinking about the banking system. And though it appears the Fed has bought the nation's banks some time, the pair of bank runs on Friday and Sunday again exposed the fragility of the nation's banks.
But fragility isn't the only problem. As Rothbard hammered home decades ago, our banking system relies on a deceptive scheme, authorized and supported by the government, called fractional reserve banking.
To quickly review how fractional reserve banking works, say you deposit some of your dollars into your bank account. If the bank's reserve ratio is 5%, it then loans 95% of those dollars to other people who spend them on goods and services. The sellers of those goods and services then deposit the dollars in their own bank accounts.
Again, 95% of the dollars get loaned out and deposited in yet more bank accounts. However, all of these dollars still appear in every one of these accounts. Eventually, we'll arrive at a situation where most of the dollars you see in your bank account also show up in the accounts of many other people, appearing to them as their own dollars.
This gives the illusion that there is more money in the economy. But all that's really happened is that the bank has created new claims on the same amount of dollars. Specifically, a property claim on money stored has been transformed into a sort of callable loan that simultaneously appears available to a number of other bank customers.
Advocates of free banking argue that, on the free market, some bank customers would choose to invest in these types of collectivized callable loans. I agree. But these would certainly trade at a discount compared to cash because of the underlying risk of default.
But in today's banking system, these collectivized callable loans trade at par with cash. That indicates that enough bank customers are ignorant about the nature of their bank accounts. And banks benefit tremendously from this ignorance. They get to loan money into existence without account holders behaving any differently.
The banking deception relies mainly on concealment with a touch of duplicity. Watch banking commercials or read webpages about opening a checking account. You'll find common selling points like ease of access, security, connection to the digital financial system, a large ATM network, and the ability to send money to friends and family. All of these are also features of 100% reserve warehouse-style banking. The fractional reserve process is largely concealed from the customer, while the language used can mislead about the nature of bank accounts.
For instance, when a bank says, "your money is secure," they mean that there are measures in place to ensure only you can access your account and alert you when there is a suspicious login. What they do not mean, but what a lot of people surely understand them to mean, is that your money will not suddenly disappear from your account as it has at these banks that failed.
But that is exactly what can happen with these collectivized callable loans. It's why the funds in bank accounts are not the perfect money substitute that most people are misled into thinking they are.
Fractional reserve banking presents multiple people with what they believe to be a property claim over the same dollar. Beyond being risky and unstable, modern banks systemically rely on ignorance, deception, and government privilege. Until that changes, we remain teetering on the edge of the next crisis.
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