Why Not Let Banks Fail?

With all of the bailouts, all of the bonuses, with all of the controversy, one simple question has got to asked, “Why Not Let Banks Fail”, and simply allow the open market to run as it is intended to run.

The press and the internet are filed with gloom and doom about what is happening to the United States banking system, as we have had 17 bank failures so far this year, and several more according to the FDIC on the warning list.

How many banks failed last year?

Again, according the FDIC the number of failed banks was 25. Will we pass that number this year; the answer is most likely yes and maybe we should. However, where do we hear in the press or see on the Internet the staggering number, again according to the FDIC, of banks that failed during the years 1980-1989, which by today’s number is a staggering 2, 036, or let’s say just for the sake of argument 204 a year for those 10 years on average.

Banks fail simply because they are no longer able to meet there obligations, can’t pay all of their bills, or can’t provide their customers their own deposited money when they go to withdraw it.

We all know that most banks are federally insured, and if you are not banking at a federally insured bank, it’s your own fault. If a bank is taken over it may be ran by the federal government for a time frame, but will most likely be sold to a stronger bank that actually understands the banking concept.

Who bails us out when we can’t meet our obligations, or better yet who takes us over when we can’t meet our obligations?

Let the free market work.

Several people thought that during the “Dot-Com” build up, the bubble, and than the bust, that the Internet and the way it operated may be in serious trouble.

Is not the Internet stronger now than ever and getting stronger every day?

But that was not a lot different than banks failing, as venture capitalists were very quick to lend and showed little or no caution as they basically let the market decide who was going to fail and who would succeed.

The consensus was that low interest rates during 1988 and 1989 helped increase all of the start-up capital, and an amazing amount of internet start-ups were allowed to borrow money even though several of these companies had no solid business plan.

The free-market worked, the bubble burst, people that made a lot of money got out when they could see what was coming, and the people that lost a lot of money on stocks that were way over their market cap for valuations did not see what was coming, and several venture capitalists went under.

According to many “experts” that now look back, the free speeding, the get large very quickly or get lost mind-set, set all of that up as several companies where not making money and in fact had huge annual losses.

And today everything is blamed on the housing markets with the banks, but is it really any different? And don’t all banks have a business plan, in fact a well-defined business plan.

The free market worked. So why is it different now with banks?

The most fundamental way to measure money in the United States is called M1. It is made up of four basic components:

• Currency that is held by the public, or held outside of banks
• Demand Deposits, money that is held in checking accounts—just as a side note, checking accounts did not pay any interest until the 1980’s
• Checkable Deposits, similar to Demand deposits but did pay interest, so today there is not much difference between the two
• Travelers Checks, as they are regularly used in economic exchanges

Credit cards are not considered part of the money supply simply because it is not considers a medium of exchange, a unit account, or has any store of value, thus is not considered part of the money supply.

Banks balance sheets are really quite simple for banks. They are made up of Assets, which is reserves and loans, and liabilities, which is deposits and owners equity.

When any bank first opens, the owners of the bank must place funds in as start up money, or start-up funds, which are referred to as owner’s equity. Owner’s equity increases with profitability, and thus decreases if the bank loses money. If you where the owner’s of the bank, would you not watch the loan ratio very closely?

Reserves in a bank are money that is not lent out, or money that is not available to loan, thus the term reserve. The reserve ratio that is required by the Federal Government is 10% for transaction deposits a zero for time deposits. However, unlike other countries, the United States does not have a reserve ratio that adjusts for inflation.

Banks can keep as much excess reserve as it wants to, but most never do, as they can not make any money on excess reserves. Every time someone deposits 2,000.00 for example, it expands banks ability to loan, but they must keep to the 0.1% ratio, or in laymen’s terms, the 10%.

Bottom line is they now have another $1800.00 open to loan. When banks fails or a taken over, they have violated the basic premise of banking, and after all, the banking institution my merit should be built on trust, we deposit our money in your bank, because the government insures it and we trust that fact and you as a bank.

It does not matter where the money is deposited, it can be as cash or in checking, it has basically reduced that amount of money out of the M1 currency held by the public as it is now held by the bank. 

Let the free market work.

Is our economy really any worse than it was in the 1980’s? And than you have to ask yourself if the “safe” banks can easily acquire the banks that are in trouble, why are bailouts necessary.

Let them fail if they can not operate successfully, and let the banks that can operate successfully take them over, or close them and sell all of their Liabilities.

Everything in business is cyclical, let the behemoths of banking get what they deserve, and than let the responsible bankers take over.