Creature From Jekyll Island by G. Edward

None of this is difficult to understand, yet bank customers are seldom informed of it. They are told they can have their money any time they want it and they are paid interest as well. Even if they do not receive interest, the hank does, and this is how so many customer services can be offered at little or no direct cost. Occasionally, a thirty-day or sixty-day delay will be mentioned as a possibility, but that is greatly inadequate for deposits which have been transformed into ten, twenty, or thirty-year loans. The banks are simply playing the odds that everything will work out most of the time.

We shall examine this issue in greater detail in a later section but, for now, it is sufficient to know that total disclosure is not how the banking game is played. The Federal Reserve System has legalized and institutionalized the dishonesty of issuing more hat checks than there are hats and it has devised complex methods of disguising this practice as a perfectly proper and normal feature of THE NAME OF THE GAME IS BAILOUT

35

banking. Students of finance are told that there simply is no other way for the system to function. Once that premise is accepted, then all attention can be focused, not on the inherent fraud, but on ways and means to live with it and make it as painless as possible.

Based on the assumption that only a small percentage of the depositors will ever want to withdraw their money at the same time, the Federal Reserve allows the nation's commercial banks to operate with an incredibly thin layer of cash to cover their promises to pay "on demand." When a bank runs out of money and is unable to keep that promise, the System then acts as a lender of last resort.

That is banker language meaning it stands ready to create money out of nothing and immediately lend it to any bank in trouble.

(Details on how that is accomplished are in chapter eight.) But there are practical limits to just how far that process can work. Even the Fed will not support a bank that has gotten itself so deeply in the hole it has no realistic chance of digging out. When a bank's bookkeeping assets finally become less than its liabilities, the rules of the game call for transferring the losses to the depositors themselves. This means they pay twice: once as taxpayers and again as depositors. The mechanism by which this is accomplished is called the Federal Deposit Insurance Corporation.

THE FDIC PLAY

The FDIC guarantees that every insured deposit will be paid back regardless of the financial condition of the bank. The money to do this comes out of a special fund which is derived from assessments against participating banks. The banks, of course, do not pay this assessment. As with all other expenses, the bulk of the cost ultimately is passed on to their customers in the form of higher service fees and lower interest rates on deposits.

The FDIC is usually described as an insurance fund, but that is deceptive advertising at its worst. One of the primary conditions of insurance is that it must avoid what underwriters call "moral hazard." That is a situation in which the policyholder has little incentive to avoid or prevent that which is being insured against.

When moral hazard is present, it is normal for people to become careless, and the likelihood increases that what is being insured against will actually happen. An example would be a government Program forcing everyone to pay an equal amount into a fund to protect them from the expense of parking fines. One hesitates even 36 THE CREATURE FROM JEKYLL ISLAND

to mention this absurd proposition lest some enterprising politician should decide to put it on the ballot. Therefore, let us hasten to point out that, if such a numb-skull plan were adopted, two things would happen: (1) just about everyone soon would be getting parking tickets and (2), since there now would be so many of them, the taxes to pay for those tickets would greatly exceed the previous cost of paying them without the so-called protection.

The FDIC operates exactly in this fashion. Depositors are told their insured accounts are protected in the event their bank should become insolvent. To pay for this protection, each bank is assessed a specified percentage of its total deposits. That percentage is the same for all banks regardless of their previous record or how risky their loans. Under such conditions, it does not pay to be cautious.

The banks making reckless loans earn a higher rate of interest than those making conservative loans. They also are far more likely to collect from the fund, yet they pay not one cent more. Conservative banks arc penalized and gradually become motivated to make more risky loans to keep up with their competitors and to get their