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Splat: another bank goes bankrupt

Zion, IL
By A.B. Dada
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Fresh news this morning as the FDIC reports on another bank, the third one in this credit bubble crash, going under. Miami Valley Bank, in Ohio, is now in receivership with close to US$90 million in deposits. According to the Reuters report, the bank has deposits totaling over US$14 million that don’t qualify for FDIC insurance due to being over the US$100,000 cap on deposit insurance per depositor. This is a lot of money for people left holding the bag, who become “creditors” instead of depositors. If you’ve ever had a borrower declare bankruptcy on a loan you’re holding, you know how much you usually end up with: zero.

For the average depositor, this means as much as 19% of their deposit value wiped out. For the rest of us, it could mean a hit in our own deposits if the Fed needs to print away to cover the losses. Usually, when the FDIC declares a bank insolvent, other member banks pick up the loss and cover it themselves. If we continue to see banks go under, we might see member banks unwilling or unable to pick up the hundreds of millions, or even billions, in losses that could flow out of the insolvency.

I’m not a fan of FDIC insurance. It creates an undue burden on well-run banks to pick up the trash of the badly-run banks. This means that investors in a well-run bank have their return decreased from the premium of the bank having to worry about being forced to be the first step insurer to other banks who go belly up.

When you put money in the bank, rarely are you a depositor. A depositor puts money into an account to secure it: in a full reserve banking system, this means that you specifically tell the bank to protect your money, not to loan it out. Today, even your checking accounts and small saving accounts are not deposits, but investments. The bank quickly finds a short term to medium term loan product for you so that they can make money, and giving you a piddly 1-1.5% return for your risk. Most “depositors” are unaware that fractional reserve banking defrauds them of their security in a deposit, with the bank making the profit and the depositors having to spend countless hours worrying about how much of their deposit is insured, and how much that insurance is actually costing them.

We don’t have any full reserve banks in the world today, because they are uncompetitive. If a bank told you they’d charge you 1% a year to secure your deposit, you likely wouldn’t go near them, even if they’re really just putting your cash in a vault. You’d rather deal with a 0.5% return than pay someone to watch your money. Most of us would feel wiser with the cash under our mattress than lose 1% plus whatever loss inflation puts on the value of our money.

In a full reserve bank, banks would give you two choices: pay them to secure your savings (they wouldn’t re-invest them), or accept some risk and let the bank invest your money in a variety of loan or credit products. I believe a full reserve bank makes the best sense for a free and truthful society, because the owner of the money has full control over how that money is used. You may be willing to give up 1 year of access to your money so the bank can make a 1 year loan to a business or homeowner — this would give you a nice return if the bank was charging 8% for that loan, with competitive forces giving the investor 5-6% of that profit back. Many banks could exist just fine on a 1-2% profit, considering the billions that would accrue that small percentage.

The Reuters report is just a drop in the well, with a future fear of torrents of banks going insolvent due to bad loans and risking too much for too little. When you include the derivatives market, there is an even bigger fear of massive loss.

Here’s a question, though: when a bank goes insolvent, it goes under because borrowers can’t pay them back for money they borrowed. The money they borrowed was spent, so it exists, somewhere. When billions of dollars worth of value get wiped out, we still have to understand that the money exists SOMEWHERE: maybe a home developer, maybe a kitchen rehabber, maybe a car manufacturer, or a furniture retailer. The money is there, it isn’t destroyed and it surely isn’t lost forever, never to be seen again. This means that another bubble, somewhere, is waiting to rear its ugly head.