There's a passably helpful post at The Economist blog here explaining "Why Banks Are Unstable." A few of the comments are also sensible. The principal cause of bank financial instability is, as the post observes, the mismatch between flighty bank deposits and long-term bank loans. We don't want our deposits tied up for thirty years so how can we expect banks to make 30-year loans? Until the 1920s in America banks didn't make such long-term loans and it was one of the federal government's first forays into the business of subsidizing home ownership that made possible the typical 30 years mortgage. By guaranteeing or simply buying 30-year home mortgage loans, the federal government "created" a financial product that previously did not exist, and one we take for granted today.
But back to my point. One way governments solve the "mis-match" problem (short-term deposits vs. long-term loans) is by guaranteeing short-term deposits. That's the job of the FDIC in the United States. But since the 1970s that hasn't been enough. The rise of direct consumer access to money market accounts maintained by non-banks like mutual finds has drained many billions of deposits from banks. Even fractional reserve banking can't solve the banks' problem of falling deposits. In short, banks can't lend what they don't have.
So what's a bank to do? There are only two market solutions: get more capital or borrow money from sources other than depositors. While the former would be ideal, who's going to invest big bucks in banks when the return on capital is less than other investment opportunities? (The non-market-based answer is anyone who believes governments will bail out bank and let investors keep their ownership interests. That's truly a bad idea--and practice.)
But back to my point again. Since not so many want to invest capital in banks, the banks borrow money from investors like pension funds at much higher rates than they pay depositors. While this solves the short term problem of getting money to lend, it increases the banks' cost of funds and squeezes their profits. Not a bad idea, you say? To the extent profits go down, capital investors flee, which simply increases the need for large-scale lenders, and the cycle continues ever downward.
Unless--mirabile dictu--banks can earn more money by engaging in financial transactions other than long-term lending. It was investing in obscure financial transactions that contributed to the financial crisis of 2008. And it to prohibit banks from doing so again that provided the impetus for the so-called Volcker Rule that has now issued in 1000 pages of regulations for American banks.
My point is simply this: we beneficiaries of the modern system of banking can't have our cake and eat it too. If we want a system of financial intermediation that allows the ability to write a check here and have someone accept it there and if we want to get 30-year mortgage loans, we have to be willing to pay for it. We can do so either by increasing the costs and pricing more people out of checking accounts and mortgage loans or we can let governments subsidize the system at taxpayer expense. Make me pay now or make me pay later but one way or the other I (we) must pay for what we have come to expect.
But back to my point. One way governments solve the "mis-match" problem (short-term deposits vs. long-term loans) is by guaranteeing short-term deposits. That's the job of the FDIC in the United States. But since the 1970s that hasn't been enough. The rise of direct consumer access to money market accounts maintained by non-banks like mutual finds has drained many billions of deposits from banks. Even fractional reserve banking can't solve the banks' problem of falling deposits. In short, banks can't lend what they don't have.
So what's a bank to do? There are only two market solutions: get more capital or borrow money from sources other than depositors. While the former would be ideal, who's going to invest big bucks in banks when the return on capital is less than other investment opportunities? (The non-market-based answer is anyone who believes governments will bail out bank and let investors keep their ownership interests. That's truly a bad idea--and practice.)
But back to my point again. Since not so many want to invest capital in banks, the banks borrow money from investors like pension funds at much higher rates than they pay depositors. While this solves the short term problem of getting money to lend, it increases the banks' cost of funds and squeezes their profits. Not a bad idea, you say? To the extent profits go down, capital investors flee, which simply increases the need for large-scale lenders, and the cycle continues ever downward.
Unless--mirabile dictu--banks can earn more money by engaging in financial transactions other than long-term lending. It was investing in obscure financial transactions that contributed to the financial crisis of 2008. And it to prohibit banks from doing so again that provided the impetus for the so-called Volcker Rule that has now issued in 1000 pages of regulations for American banks.
My point is simply this: we beneficiaries of the modern system of banking can't have our cake and eat it too. If we want a system of financial intermediation that allows the ability to write a check here and have someone accept it there and if we want to get 30-year mortgage loans, we have to be willing to pay for it. We can do so either by increasing the costs and pricing more people out of checking accounts and mortgage loans or we can let governments subsidize the system at taxpayer expense. Make me pay now or make me pay later but one way or the other I (we) must pay for what we have come to expect.
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