Thursday, February 19, 2009

How Long Before The First Run On 'The Bank'?

If you're looking to avoid bad news, then stay away from the financial pages. In the U.S. most states are prohibited from running deficits, so in times such as these they have to slash and burn to balance the books. The other alternative is to raise taxes of course, which in this economy is the equivalent to choosing between a noose or arsenic. President Obama is making billions available to help beleaguered home owners meet their mortgage payments stateside, but when people find themselves out of work...that assistance won't go very far.

Canadians shouldn't feel too complacent in this environment, regardless of how highly regarded our economy and banking system is perceived. There's a global virus infecting the world's markets right now...and while our immune system may be strong it is not impervious. It was only in August and September that concern over the economy gripped our American friends, at a time when Canadians were being told that everything would be okay...sure our economy would cool off, but there was no need for real worry. Our federal government wasn't even going to run a deficit.

I'm something of a contrarian at heart, and for those unfamiliar with the term 'contrarian' means swimming against the stream of general sentiment. The tone I'm hearing from most of our media is that...okay, things are bad...but don't worry too much, solutions are on the way. Its an important message, because our economy runs as much on mass psychology as it does on dollars and cents. Even currencies like the U.S. and Canadian dollars are "fiat" instruments. There's no gold or silver standard, no vaults underground with precious metals to backstop their valuations. Our currencies trade based largely on supply and demand factors, and at the end of the day it comes down to a simple matter of confidence.
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In contrasting the current environment with that of the Great Depression of the 1930s, the biggest difference between now and then in my opinion Seventy five or eighty years back there was no television, and radio was a relatively new technology. The ability of government officials and other interested parties to mass communicate a message was severely limited.

In the absence of comforting words available on TV, people were left to their own devices to a much larger extent than now. Yes there was print journalism, but words on a page don't resonate as well as a CNN special report. People's confidence was shaken, and fearing for their financial well being many wanted their money closer at hand. That meant going to the bank and withdrawing it, and when that sentiment took hold with enough people there was a run on the bank.

Most everyone over the age of 30 has probably seen the Christmas classic, "Its A Wonderful Life". In the movie depositors flocked to the Bailey Building & Loan seeking to withdraw their deposits. That wasn't just Hollywood...that was real life. But in the real world version there were few George Baileys around to calm depositors nerves, and banks failed. The money simply wasn't there. It had been invested...and when the markets tanked it evaporated.

According to Ben Bernanke, chairman of the U.S Federal Reserve, perhaps the biggest lesson of the Great Depression was in the Federal Reserve not stepping in to prop up the banks. As we've seen repeatedly over the course of the past few months, that is a 'mistake' that is not being repeated. Billions have been injected into the banking system worldwide, even here in governments have stepped in to inoculate financial institutions form their exposure to bad, (or toxic) debt.

Without this aid there undoubtedly would have been failures at several large banks, particularly in the United States. But beyond that limited benefit the question must be asked. Is it working for the economy as a whole? While banks have been able to shore up their balance sheets there appears to be little if any loosening of available credit. The banks got their's, yes....but to date they appear to be guarding 'their cash' very cautiously.

Did the U.S. government make a big mistake in handing over hundreds of billions of dollars over to Wall Street? If banks were to fail there would at least be redress for depositors in the form of the FDIC and CDIC in Canada. For those unfamiliar with these agencies, they are government insurance programs that protect depositors up to a maximum of $250,000 in the U.S. and $100,000 in Canada. Insurance programs such as these were not available when the Great Depression started to take hold.

While banks have been able to stave off bankruptcy for the moment, its worth asking if this is on a temporary fix. Banks take money from depositors and put it to work in various instruments. But if the avenues normally used by financial houses aren't returning a profit...Could insolvency not be the unavoidable result?

Hopefully this will remain a topic for academic discussion...But if a run on a major bank does happen I would see it as the proverbial 'canary in the coal mine'. One bank failure would lead to another and then another with only the strongest surviving. In a way though that's is the very precept of our free market economy. It may sound cut throat, but the alternative might turn out to be National Socialism...another result of our last Great Depression.

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