Apropos of Nothing: Merrie Olde England

I have London on my mind this weekend. Niece #3 heads there this evening for her semester abroad experience. So I thought I’d read up to see what she’ll land in come Sunday morning.

PM David Cameron seems to be competing with French president Nicolas Sarkozy as to which European leader gets the bigger rock star welcome in Libya.


Does the term ‘mission accomplished’ and all it came to represent mean nothing to these men?

–Unlike many conservative pols on this side of the pond, Cameron is “emphatically in favour of gay marriage.”


–Unemployment in the UK is at 7.9%. I’m not clear yet on the specifics, but there seems to be evidence of a national jobs effort in the UK. Unlike in the US, where there seems to be evidence of more political gridlock.


–I’m hoping my niece doesn’t run into these creepy dudes. Hopefully they will remain out of sight until next summer.


–The exchange rate is moving slightly in my niece’s favo(u)r. A month ago, one pound sterling was worth about $1.65. Now it’s about $1.58. Not a lot, but better than the other way around.

Bank Deposits Should Be At Risk

Suppose you own a store and want to protect your inventory from shoplifters.  You probably pay to install video cameras, and may even hire a security guard to wander around.  Suppose you are a celebrity, and want to protect yourself from adoring and perhaps not so adoring fans.  You probably pay to hire a bodyguard to travel around with you.  Suppose you own a cache of diamonds and want to protect it from theft.  You probably either pay to have a safe installed in your house, or you pay for a safe deposit box in someone else’s safe.

The common thread here is that, if you want to protect something, you generally have to pay to get someone else to protect it.  Oddly, however, when we want to protect our money, what do we do?  We deposit it in a bank and, rather than pay them to protect it, we expect them to pay us for the privilege of protecting it.  This makes no sense whatsoever.

The truth is that the only reason that banks are able to pay interest on deposits with them is because, far from protecting our money, they are putting it at risk.  That is precisely what interest represents…a premium received as payment for taking the risk that one may not get back one’s money.  And that is precisely the service that banks perform when they take deposits.  They do not protect your money.  They help you earn more money by putting what you already have at risk.

The federal government has obscured this fact, and through its federal guarantees on bank deposits led people to believe that they should be able to earn money with their money without ever taking any risk.  FDIC offers up the possibility of a free lunch.  This is a nonsensical view of reality.

There are some real economic benefits to FDIC insurance, but they derive mainly from tricking people into taking risks with their money, through the promise of a free lunch, that they wouldn’t otherwise take.  If you really wanted to protect your money, you should rent a safe deposit box at a bank.  This is a service that banks do provide, and you have to pay for it.  But if you put your money on deposit with the expectation that it will grow, you should be prepared to take the risk that your money might be lost.

The Financial Crisis was a Perfect Storm whose Elements are Known

One of the elements of that storm was the partial repeal ofGlass-Steagall, coupled, however, with the partial repeal of the BankHolding Act [both in Gramm-Leach], and made deadly by the CommodityFutures Modernization Act of 2000 and the subsequent vacuum intowhich fell Enron’s “off the books” activities, the burgeoning ofunregulated credit default swaps backed by zero insurance reserve, andthe unregulated “securities” called collateralized debtobligations. See the various press releases from SEC, especially2001-2002, and their joint releases with the Commodities FuturesTrading Commission, to get the sense of “oh, wow, this is gonna begreat” that was pervasive.
Oneresult was government insurance of deposits in commercial banks thatcould then be leveraged in very risky and unregulated transactions. “What does seem impractical, however, are the current arrangements.Anyone who proposed giving government guarantees to retail depositorsand other creditors, and then suggested that such funding could beused to finance highly risky and speculative activities, would bethought rather unworldly. But that is where we now are.” MervynKing, Bank of England, October 2009.  

Thereare other historical elements. When we gave Citibank thevariance – the “temporary” approval – to merge with TravelersInsurance years earlier in contravention of the existing Bank HoldingAct we were playing with this fire. When we began the incrediblebipartisan push for 100% mortgages to barely qualified borrowers wewere creating tinder to be fed into the unregulated CDOs that were inheavy demand because of a tidal wave of cash looking for a home. When FanFred participated in the Goldman-Sachs model of wealthcreation we further implicated the future governmental response.
Irecognize some compelling arguments for looking elsewhere. See
Again,consider the banks in western countries that were NOT shaken to theirroots, that were not crying for bailouts. “Canada’s experienceseems to support those who say that the way to keep banking safe isto keep it boring — that is, to limit the extent to which banks cantake on risk.” The dreaded Krugman, 2-1-10
Iconcede that is an argument for regulating risk taking, not forregulating the wall between “commercial” and “investment”banking, per se. However, the contribution from tearing down thatwall is that investment banking runs a far chancier, and more global,set of risks than is required for good lending practices. The set ofrisk averse regulations historically applicable to lendinginstitutions would stifle an investment banker. Even now we see theindustry fighting against maintaining mere ten per cent in reserves. I remember when 18% was typical for a local bank.
Ipose that separation would be a net good and reduce future risk inthe way suggested by Mervyn King.
Fora world class primer on line refer to:
This is conveniently found through the “baselinescenario” link on the right of your page.

 I’m outta here!  At least, for now.  Hook ’em Horns! 

Morning Open Thread (Saturday)

Morning, all. Sorry I missed yesterday completely. My work day totally exploded and I worked late and then tumbled straight to bed. Some days are just like that.

I have nothing more important on my mind yet than coffee, and I have not yet had a chance to partake of that or to review all of the posts from yesterday. What a great way to spend my early Saturday morning!

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