Deficit Owls's video: Against Free Banking: The Liability Side Isn t The Place For Market Discipline

Warren Mosler, former banker and investor, discussing bank regulation, and specifically the institutional structure called "free banking." In free banking, the government would not backstop the banks at all, and instead private citizens would have to choose which bank was safest when deciding where to keep their money. If the bank fails, then the depositors lose their money. Contrast this with the situation we have today, where the federal government backstops the banks. It does so in two ways: first, the Federal Reserve will lend to any bank that is illiquid (meaning that the bank is still solvent, but that it's incoming cash flow isn't enough to meet its cash outflows). And second, the government provides deposit insurance to protect bank customers. In the event that a bank is insolvent (meaning that its assets are greater than its liabilities (or, in simple terms, it owes more than it owns)), the Federal Deposit Insurance Corporation will ensure that bank customers get their money back. Many free-market types (particularly Libertarians) point out the problem with this situation: with the bank's customers' welfare guaranteed by the government, the bank is effectively playing with "house money," and has incentive to do irresponsible things with it. It's sort of like saying "if your bet goes well, you get to keep the profits. If it goes poorly, the government will bear the costs." Big incentive problem. One possible response to this would be to have free banking, where there is no government backstop. However, this makes the system excessively prone to bank runs, to private citizens losing their savings for no real reason, and to general financial panics. It also means that there won't be "par clearing," so that $1 in your bank account might not actually be worth $1. We used to have this in the United States, and each bank printed its own banknotes, so that there were hundreds of different currencies circulating at once. Merchants had to keep books telling them at what rate each banknote was being accepted for (perhaps CitiBank's $1 notes would be accepted for $0.98, while Bank of America's might only be accepted for $.70.). The system proved quite unpopular, and so the government took steps to stabilize the system. The alternative approach is to acknowledge that the government backstop creates perverse incentives for banks, and also that it effectively turns them into public/private partnerships. As such, the government should treat them as vehicles for enacting the public purpose, by regulating what they can and can't do, to make sure the banks' actions are consistent with the goal of the development of the economy. Watch the whole video here: https://www.youtube.com/watch?v=1RJP52bwmcw Follow Deficit Owls on Facebook and Twitter: https://www.facebook.com/DeficitOwls/ https://twitter.com/DeficitOwls And follow our sister page, Modern Money Memes: https://www.facebook.com/ModernMoneyMeme/ https://twitter.com/ModernMoneyMeme