> If the big banks die the entire US economy dies with them.
Can you clarify exactly how this happens? This has been claimed before, that these banks are "too big to be allowed to fail", but I haven't seen an explanation of why, and it is certainly in the interest of the banks to promulgate the idea "if we die it's the apocalypse" regardless of whether it's true.
Because of fractional reserve banking. 90% of the money in your bank account are in fact credit created by the private banks out of thin air. If the banks fail, 90% of the money in the entire system will suddenly disappear. Imagine that.
I'm not necessarily a fan of how things currently work, but I believe the FDIC is supposed to insure up to $250k on each bank account. That would seem to mean it wouldn't hurt most people, only people (and institutions?) that put much more than that into individual bank accounts. I suspect most of those would have also put lots into other types of investments, so I don't think anyone would be completely wiped out. That doesn't sound apocalyptic to me.
I have no idea how this became such a popular misconception. Fractional reserve banking allows banks to use a portion of their deposits to make loans. This doesn’t create money out of thin air. It does affect money supply, but in a completely different way. Because deposits are withdrawn from circulation, and loans allow a percentage of that to be returned to circulation. If a bank folded, it would simply have a list of debtors (loan holders), and creditors (depositors). The value of the liabilities may exceed the value of the assets (in which case it would be insolvent), but no money at all will be withdrawn from existence.
Banks collapsing in this crisis exacerbates confidence issues. The market operates on perceived confidence. There are already morons, sorry, my misanthropy is just peaking lately, the general public are already withdrawing cash from banks, stocking up on toilet paper. A real intellectual bunch we’re talking about here.
Whether things are solvent or not, right now everything has to look like it’s totally under control. Perception is very critical here.
So, if a couple of banks collapse and many people lose confidence, then exactly who gets hurt and how? If a bunch of "morons" go pull their money out of a bank, that might ruin the bank, but FDIC insurance is supposed to protect against the worst of that. What's the path that leads to the "entire US economy dying"?
Yes, I think most folks here know what a back run is. The FDIC was instituted after the Depression specifically to limit the damage caused by bank runs.
2008 was a completely different circumstance than this.
People have a tendency to call everything a bank. Lehman Brothers was an investment bank. AIG is an insurance company. They were buying and selling mortgages and credit default swaps, but they weren't savings banks or mortgage banks.
What happened in 2008 was that the mortgage banks (spurred on by government policy) were making mortgage loans to everybody. People with bad credit. Interest only payments. Because the regular banks were selling the mortgages to Lehman Brothers or buying credit default swaps from AIG, so they didn't care if people would default. This naturally caused housing prices to soar.
Then interest rates went up a little and people did start to default. Then people started to notice how uncreditworthy those borrowers were and didn't want to buy those mortgages anymore ("toxic assets"), so banks stopped making them. Which tends to cause housing prices to crash, which tends to lead to more defaults as people notice they're underwater, and so on.
If housing prices came down a lot there would be too many defaults, so the Fed responded by lowering interest rates. That gets people to borrow more and bid up housing prices again, but that's only kicking the can down the road unless they plan to leave interest rates low indefinitely... except that's just what they did.
Meanwhile they also had to do something about the companies selling these credit default swaps, which were basically insurance banks bought against having their borrowers default. If AIG went bankrupt then so would all of these actual mortgage banks who they had insured and were about to have claims to file. And if all these mortgage banks went bankrupt -- even though they were the ones being smart and buying these credit default swaps -- investors would start to view mortgage lending as a risky investment in general. That would tend to raise mortgage interest rates, because investors would demand a higher return for this newfound risk. But they needed lower interest rates to keep housing prices from crashing and causing defaults/foreclosures, so they bailed out the dumb investors and insurance companies to save the "smart" mortgage banks who didn't expect their insurance scheme to be so successful that it bankrupted the insurance company.
This time, in 2020, it isn't a question of bailing out some insurance companies. The problem right now is that nobody really wants to borrow more money, despite literally zero interest rates, because they've been so low for so long that everybody is already leveraged to the hilt. But we're also experiencing deflationary forces from this coronavirus, which generally requires some kind of inflationary force to counter it and prevent a deflationary spiral -- commonly done by lowering interest rates to increase borrowing, except that everybody's already tapped out.
So what that leaves is having the government counter deflation by creating new money, and ideally give it directly to real people and not Wall St which has no excuse whatsoever to get it this time.
Perhaps “die” is the wrong word. I prefer “nationalized and converted to financial utilities”. Shareholders? Gone! Existing management? Gone! Put adults in charge and have a relationship similar to the USPS or the Fed. Require an open platform so the APIs and underlying back office are solid but innovators can still get access to innovate (Europe mandated this via PSD2).
Public goods must be protected. USPS does pretty well IMHO, as a similar example. No reason to recapitalize with public shareholders if you don’t need them. The Fed doesn’t have them (their shares are unique and essentially non transferable).
Can you clarify exactly how this happens? This has been claimed before, that these banks are "too big to be allowed to fail", but I haven't seen an explanation of why, and it is certainly in the interest of the banks to promulgate the idea "if we die it's the apocalypse" regardless of whether it's true.