Wednesday, September 24, 2008

If Banks Disappear, It Doesn't Mean Lenders Will

What's clear is that a bunch of financial institutions have made mistakes and lost money. What's unclear is why anyone (other than the owners and managers) should care. People make mistakes and lose money all the time. Restaurants fail, grocery stores fail, gas stations fail. People pick the wrong stocks, they buy the wrong cars, and they marry the wrong spouses without turning to the Treasury for bailouts.

So what's special about banks? According to what I keep reading, it's that without banks, nobody can borrow, and the economy grinds to a halt.

Well, let's think about that. Banks don't lend their own money; they lend other people's (their depositors' and their stockholders'). Just because the banks disappear doesn't mean the lenders will. Borrowers will still want to borrow and lenders will still want to lend. The only question is whether they'll be able to find each other.

That's one reason I feel squeamish about the official pronouncements we've been getting. They tell us bank failures will make it hard to borrow but never that bank failures will make it hard to lend. But every borrower is paired with a lender, so it's odd to state the problem so asymmetrically. This makes me suspect that the official pronouncers have not entirely thought this thing through.

In the 1930s, a wave of bank failures did make it hard for borrowers and lenders to find each other, and the consequences were drastic. But times have changed in at least two relevant ways. First, the disaster of the 1930s was caused not just by bank failures, but by a 30% contraction of the money supply, which is something today's Fed can easily prevent. Second, as any user of can tell you, the technology for finding partners has improved since then. When a firm wants to raise capital, why can't it just sell bonds over the web? Or issue new stock? Or approach one of the hedge funds that seem to be swimming in cash? Or borrow abroad?

In other words, I'm not sure these big Wall Street banks are really necessary, and I'm not sure we'd miss them much if they were gone. Maybe there's something I'm missing, but if so, I think it should be incumbent on Messrs. Bernanke, Paulson and above all Bush to explain what it is.

~Steven E. Landsburg "Not Buying It" in The Atlantic


At 9/24/2008 8:48 AM, Anonymous Anonymous said...

When banks fail, there is a significant loss of wealth because it is "other people's money" that goes up in smoke. Are we to imagine that investors losing their shirts is somehow immaterial?

The thought that we can all become part-time bankers and that our efforts would duplicate those of a financial institution seems highly optimistic to put it politely.

I seem to be missing something here.

At 9/24/2008 11:17 AM, Blogger Bret said...

Sorry, this one's quite lame.

There are far more "depositors" than "lenders". The banks turn "depositors" aggregate deposits into loans. Most "depositors" have absolutely no interest or even ability to be lenders because their specific balance fluctuates significantly (think a small business with a quarterly sales cycle). It's only over a large number of "depositors" that a bank can lend and maintain an adequate reserve requirement.

Of course, for medium term, moderately sized deposits, depositors already use money markets, but for shorter term deposits, banks' aggregation of those deposits is required in order to turn them into loans.

At 9/24/2008 1:43 PM, Blogger ... said...

I don't buy these comments and agree with the article. Not all banks will fail if nothing is done (see Carpe Diem post on historical number of bank failures:

Furthermore, aren't one of the most renowned investor's of our time, Warren Buffet's actions further evidence to this article's thoughts that there is and will be a market for debt?

At 9/24/2008 3:12 PM, Anonymous Anonymous said...

Depositor owned credit unions work just fine.

At 9/24/2008 3:17 PM, Anonymous Anonymous said...

i wish someone would really explain what's going on and why we can expect "dire consequences if we don't give 700b " with no strings attached? did they stop short selling to prevent investment banks/ aig failures from triggering credit default swaps/ derivatives contracts [600trillion $ in an unregulated market]creating a dominoe effect worldwide that no can control or "bailout".what was it that bernanke said that "silenced the congress". are they afraid that if they told the american people the truth we might panic? someone needs to tell us the truth so we know who really didn't do their job!!

At 9/24/2008 4:00 PM, Blogger David Foster said...

For a small company to "just" sell bonds over the web would involve significant regulatory compliance issues, and the cost of the documentation & filings could exceed the amount of money raised.

At 9/25/2008 11:30 AM, Anonymous Anonymous said...

If you really want to know who didn't do their job, take a look in the mirror. "We have met the enemy and he is us!" Everyone of us! Yes there was a lack of leadership, but we elected those leaders who put their personal agenda ahead of the country's. But the time for blame games is past. Now is action time. The reason action matters is the nature of the markets. Markets operate on perception and confidence. Right now the perception of the financial underpinnings of the economy is very negative and confidence is shot. Everyone is afraid to trust creators of debt and equity or their products and everyone is having trouble valuing those they own because a "market bid" is not reflective of true value because there are "no bidders" short of ultra cheap bottom fishers. Because most balance sheets are now accounted for on a mark-to-market basis, marking to the current illiquid bid would produce losses so great that many businesses would become instantly insovlent. This is not somebody elses problem this is everyone's problem. With all that capital impared and/or those banks and other institutions insolvent, who is going to lend to GM or IBM or P&G or any other company or business to keep their payrolls and inventories and production capabilities intact? No one. That's why this has to get fixed and if it takes $700B, that's cheap...unless, of course, you are volunteering to be the first to lose his job and go stand in line at the soup kitchen. We can go after the greedy SOB's who really exacerbated this mess later and try to find a way to make sure it doesn't happen again later, but now we have to restore order and confidence and find a way to make those impared assets go away and release the capital tied up in them so that even small banks can start lending again. Remember, not every one was a "bad guy". Lots of innocent bankers bought, for example, FNMA Preferred Stock thinking it was a "safe" investment (which it should have been), only to find now that they are having to take major losses on those investments. Those losses, unless offset by purchases from the Treasury under the proposed program, are monies not available to lend and, in some cases, represent loans that will have to be recalled to cover those losses and that means shrinkage of the entire economy. Surely you are smart enough to understand that even though you and I didn't cause this, it is our problem and it doesn't have a damn thing to do with saving Wall St. That train has already left the station empty.

At 9/25/2008 12:40 PM, Anonymous Anonymous said...


You put the case very well. Let us hope this works. Up to now, the FED and Treasury have had success stabilizing the situation only in the short term but the market for securitized instruments has no floor.

It will be interesting to see how this turns out.


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