Banking Demystified

Posted: December 24th, 2008 by Militant Libertarian

by Doug French

Those under the delusion that it was an orgy of deregulation and lack of government oversight in financial markets that has led to the current crash and rash of bank failures and bailouts will be overjoyed to learn that the Federal Deposit Insurance Corporation (FDIC) is doubling its operating budget for 2009 to $2.24 billion and will increase its workforce by 30 percent to 6,269.

The pace of bank busts is quickening, with nearly half of this year’s 25 failures coming in the current quarter. There were only three failures in 2007 as the real estate boom still had fainting signs of life left in it and there were no failures from June 2004 through February 2007 when the boom was in full swing. This boom was driven by huge increases in the money supply created by the Federal Reserve which led to massive mal-investment in: row after row of single family tract homes that were scooped up by panting speculators who financed their punts with cheap no-money down loans, strip malls and suburban office buildings, skyscrapers and casinos the world around.

To the government regulatory world, the banking system was sound while the boom unfolded, but as Murray Rothbard pointed out in his article “The Myth of Free Banking in Scotland” which is included as an appendix in the new addition of The Mystery of Banking, “a dearth of bank failure should rather be treated with suspicion, as witness the drop of bank failures in the United States since the advent of the FDIC.”

As Rothbard points out, the banks may be doing fine when there are no failures, but society is getting the worst of it. “Bank failures are a healthy weapon by which the market keeps bank credit expansion in check; an absence of failure might well mean that that check is doing poorly and that inflation of money and credit is all the more rampant,” Rothbard wrote. “In any case, a lower rate of bank failure can scarcely be accepted as any sort of evidence for the superiority of a banking system.”

With real estate collateral values plunging, credit losses are soaring, decimating the capital ratios of banks all over the world. Large banks that are viewed as “systemically important” such as Citicorp are bailed out. Others are kept alive via capital injections from the government’s Troubled Assets Relief Program (TARP). But many of the small fry are (and will be) seized by regulators and liquidated. Thus, of the 1,400 new FDIC positions, two-thirds will be working on the “closed bank” side with the other third working on the “open bank” side, according to FDIC spokesman David Barr.

The folks at the FDIC evidently think 2009 will be a banner year for bank failures. And they should.

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