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Separate Banking and the State

stocks-collapseby Jacob G. Hornberger

Have you noticed that whenever something goes wrong in life, statists call for more government regulations? How come they never seem to notice that their beloved regulated economy failed to prevent the thing that went wrong? No matter how highly regulated the activity, in the mind of the statist the fact that something went wrong doesn’t connote the failure of the regulated society but rather the fact that there is still too much freedom in society. Just enact some new regulations and then continue to do that every time something goes wrong and everything will be fine. Of course, total government control of economic activity lies at the end of that road.

The most recent example of this phenomenon involves a $2 billion trading loss at J.P. Morgan. Statists are out in force saying that such an enormous loss shows that more banking regulations are needed.

But banking has long been one of the most regulated industries in the country. Federal regulators have long had free reign over the banks, able to walk in the front door without a search warrant and closely examine the banks’ books and records to make sure that everything is safe and sound.

Yet, notwithstanding the longtime government regulation and scrutiny of banks, J.P. Morgan suffered its enormous trading loss, which statists say shouldn’t be permitted to occur. Statists say that no blame should attach to the regulations and the regulators. It’s all a consequence of too few regulations and too few regulators (i.e., too much freedom still needing to be regulated).

Americans have become so accustomed to the role of the federal government to watch over them and take care of them that many of them simply cannot imagine life under a non-paternalistic state. If the federal government wasn’t regulating banks and protecting people from bank losses, life would be thrown into economic chaos and impoverishment, say the statists.

What’s the libertarian approach to banking?

Treat it like any other unregulated business or investment. That is, leave it totally free of government control, monitoring, and regulation.

Consider the stock market. Lots of people invest their money there. Sometimes the value of their investment goes up and sometimes it goes down. Sometimes they lose everything.

Does the government protect people from losses in the stock market? No. Should it? Of course not. Most everyone would agree that that would be ridiculous. It would be carrying the paternalistic mindset to one more ridiculous extreme.

People know full well that if they invest in the wrong stock, the government isn’t going to be there to bail them out. That causes many investors to be more careful about which companies they invest in. Many of them do detailed research before investing in a stock. Others get advice and counsel from friends, relatives, or professionals. Would they do that if the government covered their stock losses? Nope.

Why should banks be treated any differently? If someone deposits his money in a bank that fails, that is no different in principle from investing in a wrong stock. Government should no more cover people’s banking losses than it should their stock losses.

Let’s assume that there is no banking paternalism and that a new bank opens up. Joe Doaks has just inherited $250,000. Should he put his money into that bank?

If he knows that the government isn’t going to cover his losses, Doaks is much more likely to do some careful research into the bank’s financial situation, just as he would likely do if he were investing in the stock market.

If he wants to play it as safe as possible, he could put his cash in a safety deposit box, where, of course, it wouldn’t earn any interest. Or he could keep it in a home safe or under his mattress. Of course, no place is 100 percent safe. There is always the possibility of theft.

But as soon as Doaks opens an account at the bank and deposits his money into it, he knows he’s placing it at risk. He knows — or should know — that banks lend the money to borrowers. If the bank makes a bunch of bad loans, it’s conceivable that the bank will go under owing to its inability to repay its depositors.

Again, how is that different from investing in the wrong stock? In a society where the government is not charged with taking care of people and protecting them from their own mistakes or from the vicissitudes of life, people will tend to do more careful research as to which banks are more viable than others. If a bank is paying higher rates of interest to depositors than others, then that might be a sign that placing one’s money in that bank might be riskier. As with the stock market, the consumers would have to decide how much risk they would be willing to take.

What if some banks go under, as some would undoubtedly would? Then people who have placed their money in those banks would lose it. But how is that different from investing in a company that goes belly up? How is it different from investing in a high-flying stock that suddenly plummets to zero?

Over time in a free-market banking system, the banking industry would actually be strengthened as poorly run banks went out of business. At the same time consumers would be more careful and wary about where to put their money.

Compare the free-market scenario with the paternalistic system under which we live. For decades, the federal government has protected depositors from losses while merging poorly run banks with better-run banks. Not surprisingly, that has left us with a banking industry that is shaky. Sure, the government continues to promise that if a bank fails, it will cover depositors’ losses. But what happens if there is an industry-wide collapse? What’s the government going to do then — tax everyone the amount of his deposit and then send him a check for that amount to cover his loss?

The welfare-state/regulated-economy paternalistic way of life has wrought untold damage to the American way of life. No where is this better exemplified than in the banking industry, a tightly regulated industry in which consumers have been inculcated with the notion that it’s the government’s job to take care of them.

The best thing Americans could do is free the banking industry (along with the rest of the economy) from government control and regulation, take personal responsibility for their financial choices, and prohibit the government from taking care of people.

Jacob Hornberger is founder and president of the Future of Freedom Foundation.

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