Let’s assume that there are two banks in society, with Bank A paying an interest rate on deposits of 5 percent and Bank B paying 25 percent. Let’s also assume that there is no FDIC and no banking regulations to protect people from the choice they make on which bank to deposit their money in.
Both banks use the deposits to lend money out to businesses, which is how they aim to profit. Bank A lends its money only to well-established businesses, and its loans are fully collateralized. The loan interest rate charged is 8 percent, giving Bank A a profit of 3 percent.
Bank B plays it differently. Its loans are to speculators who are using the money to invest in the futures market. Those loans, which are unsecured, are made at an interest rate of 50 percent, which provides an anticipated profit of 25 percent.
Both banks disclose all material facts to their customers.
Most people decide to play it safe, putting their money in Bank A. A few people, however, attracted by the 25 percent interest rate, decide to go with Bank B.
One day, big swings in the market cause massive losses for the speculators, causing many of them to go broke, preventing them from repaying their loans to Bank B. Bank B goes bankrupt. The customers lose their entire deposits.
The customers of Bank B are angry and outraged. “It’s not fair!” they cry, forgetting that it was they who made the decision to place their money in the higher-risk bank while most everyone else was playing it safe with Bank A.
Where is the fairness in forcing the customers of Bank A to cover the losses of those in Bank B? Bank A customers chose to play it cautiously, choosing to accept a lower rate of interest in return. Why should they have their money taken away from them and given to the customers of Bank B?
Moreover, what would be wrong with simply letting Bank B go under? Doesn’t propping up Bank B with taxpayer money encourage behavior that might not otherwise take place? Wouldn’t a banking system that refuses to bail out anyone nurture a sense of responsibility and prudence in both customer and bank?
That’s essentially how an unhampered market economy works. It doesn’t guarantee that people won’t make mistakes or make bad investment decisions or even just lose money when markets go against them. Instead, it acknowledges that life entails those types of risks and simply holds that people themselves must bear the consequences of their own decisions.
In most cases, such a system induces people to be more cautious, wiser, and more prudent. In our banking example, it might well cause them to check the financial status of banks more carefully before depositing their money there.
Eighty years ago, statists offered the American people financial security in exchange for giving up their economic freedom. That’s what Franklin Roosevelt’s New Deal was all about. It consisted of a myriad of socialist and interventionist plans, including the FDIC, that revolutionized America’s economic system.
Roosevelt’s notion was that no longer would people have to suffer the risk of banks going under. There would now be a government welfare program to ensure that people’s deposits were fully protected. Banks would no longer be permitted to go under, with the Federal Reserve arranging buyouts, mergers, and other means to prop up weak banks or banks whose policies were irresponsible, unwise, or imprudent.
When warned about the potential consequences of that fateful decision, Roosevelt and his cohorts told our grandparents and great grandparents not to worry because in the long run they would all be dead. It either didn’t occur to them that their grandchildren and great grandchildren would be alive in the long run or they simply didn’t care.
Thus, today those grandchildren and great grandchildren are witnessing the results of that fateful bargain that our ancestors made some 80 years ago. We now have an entire banking industry that, decade after decade, has been propped up and which is now teetering on collapse. Only massive infusions of taxpayer money or borrowed money can save it, the statists tell us. Never mind that the bailouts, combined with the hundreds of billions of dollars being spent on other socialist and interventionist programs (e.g., Social Security, Medicare, the drug war, Afghanistan, Iraq) are setting the stage for another inflationary crisis down the road.
Meanwhile, Americans have lost fortunes in the marketplace and are scared to death at the prospect of an industry-wide banking collapse that the FDIC couldn’t even come close to covering.
That’s security? That’s what our New Deal ancestors traded economic liberty for? Some bargain!
Given the choice between liberty and insecurity, on the one hand, and loss of liberty and insecurity, on the other, why isn’t the former preferable to the latter?