Jim Grant: Bring Back The Bank Run
Jim Grant, editor of Grant's Interest Rate Observer, wrote an article originally published in February 1990 that has a lot of relevance to today's crisis. Writes Grant,
The banking dilemma seems eternal, like the monetary dilemma, the tax dilemma, and the marital dilemma. The essence of the banking dilemma, however, is that the depositors' money is not in the vault awaiting the depositors' decision to withdraw it. Instead it is out on loan or invested in the money market or in mortgage-backed securities.
Some of the money is in the vault or on deposit with the Federal Reserve – these funds are called bank reserves – but only a few cents of every dollar. Depending on the specific management, depositors, and financial markets, the average bank may be prepared to accommodate a sudden demand for repayment by a sizable minority of its depositors. Almost no bank in modern times, however, has been able to accommodate a sudden demand for repayment by a majority of its depositors.
Murray N. Rothbard, the economist and libertarian philosopher, has a forcible view on the institutions of fractional-reserve banking: it is "a giant Ponzi scheme in which a few people can redeem their deposits only because most depositors do not follow suit."
Some features of the modern banking dilemma are new, notably the socialization of credit risk during the Reagan years. It was decided that no money-center bank would be allowed to fail and that no depositor, even a sophisticated one, would be allowed to lose his money in a failure, if it could possibly be helped. But other problems are cyclical and still others are chronic. Reading up on the subject, one becomes fatalistic about it.
In gaslight days, before the "too-big-to-fail" doctrine and other modern banking improvements, national banks were bound to hold reserves amounting to 25% of demand deposits. By our standards, this was a lavish margin of safety, even if, as Rothbard notes, capital reserves were often tied up in government bonds. ("[B]anks were induced to monetize the public debt," he has written, "state governments were encouraged to go into debt and government and bank inflation were intimately linked.")
Reserve requirements were reduced to 18% with the advent of the Federal Reserve System in 1913 and stand at 12% today [1990]. Loans as a percentage of assets are higher today than they used to be, however. And off-balance-sheet liabilities – such as standby letters of credit, interest-rate swap commitments, and futures-markets trading – are higher, too.
The rise in the risks attached to banking prompts numerous questions about the nature of lending and the credit cycle. How has the regulatory and monetary climate of the 1980s affected bank lending? If, as seems obvious, it has inflated it, what will be the consequences of it?