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Commentary: Specter of failing banks should lead to radical solutions

This article first appeared in the St. Louis Beacon, Feb. 23, 2009 - What if a person goes to his or her bank branch to make a routine withdrawal and encounters a big sign that says "Out of business - Your money is gone." Ha, you say - this is America and that sort of thing doesn't happen here.

It is true there have been no bank failures with accompanying losses of depositors' funds since the 1930s. (Keep in mind that it happened frequently then).

In our modern enlightened era, there are, of course, failing banks, but regulators have decided to never let a bank fail with loss of depositor funds. If a bank's loans all go bad and the bank does not have the funds on hand to pay the depositors, phone calls get made by the regulators; and, presto chango, the failing bank is purchased by a more successful bank, the customer finds that his local branch has a new name and, from the customer's perspective, the transfer is seamless.

I suspect that in some cases this works through "gentle persuasion." The bank examiners call the executives at a strong bank and say that if the strong bank ever wants any more favors from the regulators the strong bank is going to have to buy the weak bank. Maybe there is a little back room discussion and the strong bank receives an assurance that, if the losses at the weak bank are terrible, the government will cover them. The strong bank goes along and buys the weak bank.

So, let's have a thought experiment. What if on some particular day there aren't any strong banks? What if there is no one left for the regulators to call?

I expect that in that event the government will just cover the customers' deposits at the weak bank and the weak bank will go on in business pretending nothing is happening. Let us recall that only a few months ago there were whispers of a run on money-market funds. The government immediately declared blanket government insurance on those funds.

This leads me to conclude that while - according to the letter of the law - the FDIC is supposed to cover only deposits up to a certain amount, in reality there is federal deposit insurance on all the funds in all the deposits in all the banks.

The government is really, really afraid of people lining up outside the banks and demanding their money. Indeed, in the age of instance news, should a bank refused a depositor's request to withdraw funds, a run on the bank could quickly escalate: Within an hour, all of that customer's friends, co-workers and family members are demanding cash from their banks. Passers-by join the lines, as no one wants to be the fellow behind the last guy to get his money.

In a matter of hours, the problem has spread internationally. Asian manufacturers and Mideast oil producers start selling dollars. Our currency goes into free fall.

I assume that the government has plans to assure that this particular doomsday bank run scenario does not occur. I would speculate that, when the first citizens line up at that first bank, our beloved currency regulators will drive up with truckloads of currency and let the customers take out as much money as they want. Who cares if the bank doesn't actually have the money on its books to pay those depositors? The government is likely to lend (give) a failing bank as much as it needs and tell the people in charge that "we will settle up later." There is no way the government is going to let a bank-run spin out of control. If you doubt me, you must explain the insurance on the money market funds I describe above.

But the decision to prevent bank runs will not stop the problem of currency failure.

When people see the trucks driving up and unloading the hundred dollar bills to pay off depositors, the people will lose confidence in the currency anyway. The dollar will go into free fall even if there are no lines at the banks. Merchants will intuitively understand that they will have to suddenly and dramatically increase prices to have the funds available to buy the inventory needed to replace the inventory being sold. The Asian manufacturers and the Mideast oil barons will still start dumping dollars.

So, let us examine what short- and long-term policies the government might follow to stop such a horrific outcome.

In the short term, the government must cut the budget. I am not talking about a little here and a little there. I am talking about shutting down vast programs and trimming those that remain. (My "what to cut" list will be in a future column). I envision around a 50 percent cut in government expenditures. The prompt effect will be to stabilize the people's expectations about the currency. (I admit there is no inflation now - but give it time).

In the long term, we should examine paths to private competing currencies. This idea is a bit "radical," but we must face up to the fact that as long as Congress has a monopoly on the money supply and so can spend money at will, the benefit of having one currency for all transactions will be outweighed by inevitable depreciation of the currency and accompanying economic and social dislocation. Those members of Congress just can't help themselves.

Only with competition in the money supply will entrepreneurs believe the future is stable enough that it is worth the risk to engage in the sort of business activity that will create new products, put people back to work, and continue the march toward ever higher standards of living.

Are current economic policies of "stimulus" with accompanying gargantuan deficits making you more or less confident in the long-term stability of the economy? Do you think businessmen have confidence in the future right now?

Bevis Schock is an attorney in private practice in Clayton.

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