01 Aug 2014

More on FDIC

Shameless Self-Promotion 32 Comments

I wrote up my stance more at LibertyChat. The conclusion:

FDIC as implemented thus gives us the worst of both worlds: It lulls depositors into a false sense of security, so that there is little market discipline reining in reckless lending by the banks. Yet at the same time, given that the system is pushed to embrace risk, FDIC nonetheless carries a very paltry defense against defaults. In the event of a major downturn, the government would have to freshly dip into taxpayers in order to take money from us, so that it could give us our money back.

32 Responses to “More on FDIC”

  1. Josiah says:

    It could be that the FDIC is a bad idea for the sort of moral hazard reasons that you mention. But there’s nothing in the post supporting the claim that depositors have a “false” sense of security. On the contrary, depositors confidence that they will get their money even if a bank goes bust is perfectly justified.

    • Tel says:

      I think that what Bob is saying is that the limit of what government can do is socialize the loss (i.e. spread the loss around to taxpayers, inflation, etc).

      They cannot make the loss go away.

      • Josiah says:

        I think that what Bob is saying is that the limit of what government can do is socialize the loss (i.e. spread the loss around to taxpayers, inflation, etc).

        They cannot make the loss go away.

        I’m pretty sure Bob is smarter than that.

        In general, insurance works not by making the loss “go away” but by “spread[ing] the loss around”. Life insurance doesn’t keep you from dying. This is true whether the insurance in question is run by the government or by the private sector.

        On the other hand, one feature of deposit insurance is that it prevents bank runs. To the extent that bank runs cause losses that otherwise wouldn’t occur, deposit insurance *does* in fact make the loss go away.

        • Bob Murphy says:

          OK I’m glad you brought up life insurance, Josiah. Table 14 from this report shows life insurance policy reserves increased throughout the crisis, though they fell a tad in 2012.

          As of 2012, net policy reserves were $2.3 trillion. You’re telling me that if, instead, it had been say $3 (i.e. 300 cents), and that it had gone in the red hundreds of billions of dollars for two years straight until it pre-charged its clients for several years’ worth of premiums, that it would be absurd for someone to say, “Uh, remind me again why you’re protecting your family with life insurance, when they have $3 in reserves covering trillions of dollars of outstanding policies?”

          You don’t think an outsider looking at the books of the insurance industry should assess the quality of its claim to provide coverage in any way on how many reserves they have, backing up the policies?

          Then to tighten the analogy, if insurance companies had the legal ability to take money from all of their clients *after losses were experienced* that would make it all better? Nobody should care whether they have $2.3 trillion in reserves (reality) versus $3 (my made-up scenario)?

          • Ken B says:

            You are moving the goal. The post was about “a false sense of security”. That implies a reasonable fear that the deposits will not be covered in case of loss. Now you are asking if it would be *better* to have more reserves to pay those losses out of rather than taxes.. It would indeed be better. It is usually better to be rich. But that doesn’t address the substance of the post.

            If the government could be trusted to not bail out banks or depositors or the FDIC beyond the posted limits then of course a small fund or a history in the red would imply a false sense of security. But that is emphatically not the case.

            • Major.Freedom says:

              Moving the goal? Bob isn’t intending to shoot at Josiah here.

              You are conflating two different things. Money available in your bank account to pay your client’s insurance claims, and you being promised by the government that they will give $100k (actually I think it is $250k now) to your client who deposited money with you should you fail to make good on their withdrawal requests because you “recklessly lent” money, are not both moral hazards.

            • Major.Freedom says:

              And only one is socializing the loss Ken B. I do not “lose” by paying insurance premiums that total more than my own claims, that is, “my” payments are used to finance other client’s claims on net.

              The insurer does not owe me what I pay in. They owe me what my policy says are payable events. If those events do not occur, they owe me nothing.

              With demand deposits, what you pay is what the bank owes you. If they cannot satisfy their claims, and you are paid back with devalued money, then the government did socialize the bank’s losses, because what all clients get back are devalued notes.

              No, it doesn’t matter for the purpose of this argument that you are not promised purchasing power, only the number of dollars. This is because unlike insurance claims, inflation is grounded on violation of property rights in order to even exist. In a free market of money, if it happened that the money you use is being devalued by increases in supply too much for your liking, then you don’t have to keep using it to store value.

              The socializing of losses means socialist violence spreading the losses on innocent people. It does not merely mean a mechanical, mathematical diffusion of costs from one to more than one cost center/individual.

          • Josiah says:

            You don’t think an outsider looking at the books of the insurance industry should assess the quality of its claim to provide coverage in any way on how many reserves they have, backing up the policies?

            Here’s the thing: not only do you know I don’t think this, but I’m pretty sure you know exactly the distinction I would make between the two cases. So what’s the point?

            • Bob Murphy says:

              Josiah wrote:

              Here’s the thing: not only do you know I don’t think this…

              You know who else uses “Here’s the thing”?

              So you’re upset that I said something that implied you didn’t know an obvious fact? In that context, then, can you see why I was exasperated when you explained to me what FDIC does?

              Last thing and I’ll drop this: I think many people don’t even know there *is* an FDIC fund; they think, “The government will cover me if the bank fails, period,” and don’t wonder about how they can afford to do that.

              But for those who think beyond Stage 1, and especially that subset who vaguely knows there is a fund set aside and filled with premiums paid by banks, many would be surprised to know that the fund went way negative after the crisis, and that it currently backs less than a percentage point of the outstanding insured deposits.

              I would ask you to conduct an informal poll of your coworkers, except that’s silly since anybody who’s anybody reads Free Advice and would already know.

        • Major.Freedom says:

          Josiah:

          “In general, insurance works not by making the loss “go away” but by “spread[ing] the loss around”. Life insurance doesn’t keep you from dying. This is true whether the insurance in question is run by the government or by the private sector.”

          No, it is different. The government spreads losses by inititations of violence. These are involuntary incurred costs, not voluntarily incurred costs. Market based insurance companies do not spread the losses around by initiations of violence. The costs you incur are voluntary. You do not have to accept anyone’s insurance in a free market. No insurance company can spread its losses on non-customers. If they did, then they would be considered criminals.

          What is with the perpetual sloppy analogies between the market and the state? They are mutually incompatible. Oil and water. If one process is used, the other cannot be used. You can either respect people’s property rights, or you don’t. People can either successfully defend themselves from aggression, or they cannot.

          “On the other hand, one feature of deposit insurance is that it prevents bank runs. To the extent that bank runs cause losses that otherwise wouldn’t occur, deposit insurance *does* in fact make the loss go away.”

          So let’s ignore the costs of credit expansion facilitated by government? Let us ignore the costs of deposit insurance? Myopic thinking is the hallmark of statist ideology. Impose costs of business cycle on innocent people. Impose costs of inflation on innocent people. But if the costs are incurred by market means, i.e. bank runs, THEN let us pretend costs have started, this is now the baseline, and now pretend that adding more government backstops of cartel banks can eliminate the market costs.

          Eliminating market driven bank run costs by coercive spreading of losses is not an elimination of costs. The costs are actually greater, precisely because coercion is needed for people to incur them! If a voluntary society has bank runs, then this is a reflection of the fact that sich costs are less than the costs of coercive deposit insurance of coercive cartel banks in a coercive inflationary system.

          • guest says:

            To the extent that bank runs cause losses that otherwise wouldn’t occur …

            Bank runs don’t cause losses; They are preventions of, or responses to, losses.

            And no longer having access to loans is not a loss because that service didn’t belong to anyone in the first place. The bank always has a right to loan or not loan – it’s their property that they’re loaning (except in the case of fractional reserve banking).

            As an aside: Joseph Salerno makes a good point about how problems arise when you fail to keep separate the banking functions of warehousing and loaning/borrowing:

            The Economics of Fractional Reserve Banking | Joseph T. Salerno
            https://www.youtube.com/watch?v=33RXhv0IuPc

            • Ken B says:

              I don’t think that is right. A bank run can result in sound and viable loans being withdrawn suddenly causing the collapse of business transactions. Seems like harm. In fact isn’t that part of the case against fractional reserve banking, that it can lead to such things?

              • guest says:

                In fact isn’t that part of the case against fractional reserve banking, that it can lead to such things?

                Well, there is a loss that takes place due to fractional reserve banking, and that’s a bad thing.

                But, more precisely, the loss is happening because the FRB is stealing real wealth. So the losses take place before people realize what’s happening.

                The bank run is a response to loss or expectation of loss.

                The “reserve” is the wealth – the paper is supposed to merely represent the wealth.

              • Ken B says:

                I agree that,s a standard Rothbardian line. But I think you are still discounting the disruption to established business and trade a bank collapse has. Or had in the 30s. I am not convinced in the connected modern world that the disruptions need be as bad.

    • skylien says:

      Oh, I was in false sense of security… And basically everyone I know around me is. But I guess that doesn’t count..

    • Ken B says:

      ” On the contrary, depositors confidence that they will get their money even if a bank goes bust is perfectly justified.”
      Right. Which is actually the basis for the argument about recklessness and moral hazard. So Bob’s complaints are a bit contradictory it seems. The more shaky the FDIC the less licence for recklessness, and the reverse.

      • Razer says:

        You’re showing your face here again after being publicly booted? Man, have a little pride and walk away.

        • Bob Murphy says:

          You’re showing your face here again after being publicly booted? Man, have a little pride and walk away.

          Just to clarify, Ken B. served his time. I actually think 2q GDP was up because he was using his skills to create rather than destroy.

      • guest says:

        I can write numbers on pieces of paper without the FDIC.

        Why should I care that the FDIC can ensure I get replacement paper?

        Aside: As far as I’m concerned, Ken B, you’re alright.

  2. TravisV says:

    Why does the post indicate that the author is “IanCioffi”?

  3. Major.Freedom says:

    If you can understand that a large prevalence of parents promising to bail out their children against losses no matter what, no matter old they get, just might encourage a lot of those people (not all of course) to choose a life of recklessness and debauchery, is it really so hard to believe the same thing would apply for entire populations of whole countries having a “government put”?

    This is the kind of mentality these pro FDIC folks have. They have in their minds the symbol of children needing parents to bail them out of trouble, when they think about grown adults feom separate families. Since the human race has no higher bailer outer, at least on Earth, the costs have to be muddled and covered up and ignored. It is too difficult for many to think about living “on their own” in the facing up to reality sense of the phrase.

    This is why anti-FDIC advocates only face guilt trip responses. The haters percieve them as parents wanting to throw helpless children, the guilt trippers, onto the streets.

    • Scott H. says:

      Who are you speaking with? Most pro FDIC folks I’ve spoken to talk about the social costs of bank runs.

      • guest says:

        Banks are useful when they can pay their debts, not when they can recklessly lend.

        It does no good to have a bank lend devalued money (except to the politically connected who get to steal from others via the Cantillon Effect).

      • Major.Freedom says:

        Yes, myself as well. That is how it is communicated.

        No such thing as social costs, but it sounds mature and technical enough.

        • Scott H. says:

          This is the internet age. Why not look a term up before you make an ignorant statement?

          • guest says:

            Costs can only be incurred by individuals.

            Even when many individuals’ costs increase due to the same event, the costs are still incurred by the individuals.

            It may be convenient to categorize the individuals for ease of reference, but it’s a mistake to think of the category as a separate entity, or something that transcends the individuals:

            Appendix B: “Collective Goods” and “External Benefits”: Two Arguments for Government Activity
            http://mises.org/media/6738/Appendix-B-Collective-Goods-and-External-Benefits-Two-Arguments-for-Government-Activity

            • LK says:

              “Costs can only be incurred by individuals”

              What makes you think Scott H denies this or that this refutes the statement that bank runs cause serious and negative effects on many millions of people? — thereby causing disruption to economic activity.

          • Major.Freedom says:

            Scott H:

            “This is the internet age. Why not look a term up before you make an ignorant statement?”

            It isn’t an ignorant statement. Social costs do not exist.

            Being able to look something up on the internet doesn’t mean it exists. What a sloppy comment.

            Social costs is derived from irrational philosophy. Costs are an individualistic concept on Earth. Sure, you can have the thought of “social costs” in your mind, but that doesn’t mean you’re referring to something other than individual costs in the real world.

          • Bob Murphy says:

            Scott H. wrote:

            This is the internet age. Why not look a term up before you make an ignorant statement?

            Whoa, Scott H., first of all, there’s no reason to talk like that in these comments, ever. But worse than that, MF is familiar with the standard Pigovian framework and rejects it. Doesn’t mean he’s right, but he’s more informed on this than you are, since you apparently don’t even understand his position.

            • LK says:

              It looks to me like Scott H is using “social costs” in the sense of deleterious externalities to many people in society — not saying that groups or collectivities have minds or denying that at an individual level people perceive subjective costs.

              To say that bank runs cause negative externalities to many people in the community is a straightforward, true statement.

            • Scott H. says:

              Bob,

              If MF doesn’t believe negative externalities exist why doesn’t he bring up that issue? Instead MF and guest seem concerned that I don’t understand that groups of people are made up of individual people.

          • Scott H. says:

            Societies exist despite the fact that they are simply a collection of individuals. In much the same way, social costs exist even though they are entirely comprised of individual costs.

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