The Fed Abstracting Away Banking Pain

Aug 1st, 2008 | By | Category: Economics, Lead Article

Anthony asks if this:

is bad.

Anthony, it depends on how abstract you want to be.

When you save money at a bank, most of the money gets lent out to someone else. Look at your account balance. Shift the decimal place one to the left. That’s about as much of your money your bank actually keeps around.

The whole banking system relies upon the notion that:

1. These loan investments (made with your money) will eventually be repaid.
2. Huge numbers of people won’t ask for all their money back at once.

Let’s say 1 ends up being false–say because banks invested in a bunch of secured debt that ends up having no verifiable assets securing the debt. All of your money the bank lent out is gone. Poof.

You come by to cash a check. If we’re living in the the early 1920’s (or the early 2000’s) the following occurs:

You: I want my money.

Bank: One moment sir!

Bank turns from you and cries out.
Bank: Calling all suckers! Please place your money here!

Sucker: Here’s my money!

Bank takes the money and turns to you.

Bank: Here’s your money sir!

You: Thank you!

After the last sucker has been found and fleeced (1929 version):

You: I want my money.

Bank: One moment sir!

Bank turns from you and cries out.
Bank:
Calling all suckers! Please place your money here!

No suckers arrive.

Bank turns to you.

Bank: Fuck you, your money is gone.

You: Fuck you! I’m ruined!

After the last sucker, 2008 version:

You: I want my money.

Bank: One moment sir!

Bank turns from you and cries out.
Bank:
Calling all suckers! Please place your money here!

No suckers arrive.

Bank turns to the FDIC and asks for a loan. Receives such a loan.

Bank takes the money and turns to you.

Bank: Here’s your money sir!

You: Thank you!

Ready for the trippy part? The FDIC, ultimately, is secured by the full faith and credit of the Federal Government. In turn, the credit of the US Government is secured, well, by you and me. The taxpayers.

The incompetent, failing bank–that has both made huge numbers of bad loans and lost the confidence of new investors–can count on one last big sucker to pay us back. Us.

Heller could not write it better.

My primary bank account is at Washington Mutual. Like everyone else who has money saved at Washington Mutual, I should be concerned. I’m not. My account is FDIC insured. Even if the whole bank goes belly up, as IndyMac just did, up to $100,000 of my investment will be returned to me. Since I’m a Stranger writer / graduate student, I do not even vaguely approach the $100,000 limit. Even if WaMu sinks, I’ll float. Because, through the FDIC, I’ll pay myself back all the money WaMu lost me. With my money, that I pay in taxes.

Well, not exactly. For now, the FDIC is solvent and doesn’t need an infusion of cash from the Federal government. And, while investors are increasingly terrified about lending to banks like WaMu, they continue to buy up US government debt. In other words, the investors have decided most banks are too risky, forcing the banks to borrow from the FDIC instead. The FDIC in turn borrows from the federal government, that in turn borrows from the same frightened investors. Brain hurting again?

Welcome to the land of leaky abstractions.

Anthony, you’re a computer guy. I have the perfect metaphor for you.

TCP, the protocol underlying the majority of the web, absolutely guarantees that a given message will arrive, complete and in order. TCP does this by using IP. IP guarantees absolutely nothing. So TCP makes the promises and attempts to deliver them with IP. Most of the time, it works splendidly.

If someone trips and pulls the ethernet cable out of the wall, TCP will keep making promises that IP cannot deliver.

The banks tripped, and the global investors are pulling their plugs out. We’re promising to honor all debts, by taking the investors’ money to guarantee the investors’ money. It should turn out great, if we collectively believe it’ll turn out great.