Banks on the Dole

American money was never more sound, or banking more free, than 200 years ago. Since then, it's been a long, steady decline from the gold standard and competitive banking to our Fed-run system of inflated paper currency, deposit insurance, and perpetually shaky banks on the dole.

The dreadful consequences include allowing the public sector to expand exponentially. The government crossed the $1 trillion mark in 1982, and is now headed for $1.7. Today, the national debt approaches $5 trillion. While the Fed holds only 7% of that debt at the present, its printing presses stand behind every outstanding claim.

When the new Congress was first elected, Wall Street Journal columnist George Melloan wrote (November 14, 1994) that the new Congress might scrap deposit insurance, which, he said, should have been privatized 15 years ago. He, like many voters, hoped this Congress might do something right. It turns out, however, that the Congressional leadership would sooner increase spending.

When the hour of banking reform arrives, Congress will likely make a mess of it. Like education reform, banking reform has usually made the system worse by benefiting the system's managers at the expense of everyone else. That's how the system gets less stable, less accountable, more inflationary, and less competitive.

The last round of reforms unleashed the S&L industry to toss good money after bad projects. In the popular press, deregulation took the heat for what followed. The trouble was not deregulation as such, but the unleashing of private initiative under the socialist institution of deposit insurance.

Today the Republicans are listening to Clinton's Treasury Secretary Robert Rubin, a man who should be forced to wear a suit of devalued pesos. He orchestrates a $50 billion bailout of the Mexican economy, pretends it's just the usual way America does business, and then presumes to suggest how we should reform banking laws to make the financial system work even better.

Rubin, like so many others, proposes that we do away with restrictions preventing commercial banks from dealing in securities, corporate underwriting, and insurance coverage. Dole and Gingrich are set to go along. They call this "deregulation," and it might qualify if money were sound and banks were held accountable for their actions.

But today, this reform signals a misidentification of the problem. The government long ago gave banks the right to hold Treasury debt as an asset. This allowed the banking system to "monetize" government debt – use it as an asset on which to pyramid more credit. The change benefited everyone but people who save money and enjoy liberty. Congress, though it should, has never considered getting rid of this power.

The Banking Act of 1933 separated commercial and investment banking (the "Glass-Steagall" restrictions) and insured deposits against failure. Beneath the surface, as Alexander Tabarrok has shown, the Glass-Steagall attack on investment banking was an attempt by the Rockefeller-dominated Roosevelt administration to cripple the Morgan financial empire.

Preventing banks from dealing in securities didn't make banks more safe. The real cause of bank failures was central-bank sponsored credit inflation. There's no point to forbidding certain types of investment on grounds that they're unsafe, while guaranteeing deposits with other people's money.

No business can be insured privately against entrepreneurial error. Its success or failure is not a random act subject to actuarial assessment. Public insurance only subsidizes recklessness. More than any institution since central banking itself, deposit insurance has made the banking system less safe and less secure.

Deposits were first insured up to $2,500; today they are protected up to $100,000. The amount customers leave in each account closely tracks this upward trend, proving that consumers want 100% reserve banking, in whatever form they can get it. The exceptions are corporate prime borrowers who bank in institutions too big to fail.

Deposit insurance changed banking so dramatically that today it is the very life of an otherwise bankrupt system. We only have to imagine what would happen if deposit insurance were abolished tomorrow. Thanks to what economists called the "contagion effect," much of the system would collapse. Deposit insurance has turned the legitimate business of banking into a welfare client that profits at everyone else's expense.

Repeal the entire Banking Act of 1933, and Austrian School economists will cheer, especially if the current system were replaced by a 100% gold coin standard and 100%-reserve competitive banking, with no central bank. That banking reform would give us a sound money system, meaning no more business cycle, bailouts, or inflation.

Instead, the Congress is seizing on reforms that could make a bad system worse. They would keep deposit-insurance welfare while tossing out Glass-Steagall restrictions on what can be directly or indirectly insured with other people's money. The combination offers more financial socialism, not less.

Insurance and securities lobbyists are fighting this reform, a fact which the Wall Street Journalsays means that a Republican bill "merits support." But is it really surprising that two whole industries object to being outcompeted by a third, which is in league with the government in all aspects of its operations?

If they operated like other businesses, banks should be able to sell whatever products they want. But there is no free market in banking. The government-banking cartel regards the bank run – the threat of which used to keep wanton investing at bay – as against the national interest.

As a result, the industry is perpetually shaky, and the largest banks are a menace to public life itself. Take a close look at the Mexican bailout. Here we see the results of cooperation between Wall Street and the banking industry. A mere one year passed between Nafta's debut and the Mexican bailout conspiracy among money lenders, stockjobbers, and the politicians they fund.

The chilling cooperation among these groups (October 1994 to January 1995) was revealed during Alfonse D'Amato's hearings on the Mexico crisis. Fewer than ten people decided the fate of $50 billion of everyone else's money. Congress was relieved not to cast a vote on it, and the president couldn't rest until he saw a smile on the face of his benefactors once again.

Current Congressional plans for banking reform will only further unite banks on the dole and shameless fund managers in a war against taxpayers and savers. Unless we put a stop to this now, the U.S. could eventually find itself the de facto lender of last resort for the world – a prescription for hyperinflation and a possible World Central Bank.

To work properly, competition and markets require certain institutional prerequisites, including private property and strict liability. Businesses in a market economy cannot impose the costs of their mistakes on the whole economy. Neither should banking.

Let's hear no more whining from the Fed, the apex of the banking cartel and the inflator-in-chief, about all the things it's not allowed to do. Let's return to sound money, sound banking, and a banking system of profit and loss, with no subsidies for this industry or any other. Then the Fed can be abolished on grounds that no institution should hold the fate of the dollar and our savings in its hands.