Tue Feb 28th, 2012 at 08:37:30 AM EST
Banks make money via statistics. The idea is that 1000 people all deposit $1000 getting say %1 interest, and the bank lends $900,000 to other people getting %8 interest. Over a year, the bank earns $72,000 and pays $10,000 plus its operating expenses. In general, withdrawals will be matched by deposits and borrowers usually don't default so the bank can afford to have 90% of the money deposited with it out on loan. In fact, because many borrowers need credit not a lump sum loan, a bank can lend out more than 100% of its deposits - relying on the borrowers to leave large parts of what they borrowed in the bank between expenses. If the bank is smart, it can ride this statistical advantage by lending to people who keep paying back. However over 700 years or so, societies have learned that this business model always fails in the long run. First, the quality of the banks operation (how good its loans are etc. ) is not visible to depositors until something goes wrong - at which point there is not enough money to cover withdrawals. Second, and more dangerous, when there are business cycle recessions or panics or other unexpected (but predictable ) events, the model fails: more borrowers default and customers take money out without putting more money in. So every nation has a complex system of bank regulations to supposedly compensate for the first problem and deposit insurance plus central bank loan programs to compensate for the second problem. Banks can get short term loans from the central bank to keep from sinking under short term imbalances and depositors get their money back from some sort of government insurance if the bank fails. There are three drawback to this model: first, it appears to need regular emergency supplemental bailouts of increasing size, second it's a ridiculous use of public funds, and third it encourages non-productive investment.
The arguments of the so-called "libertarians" against our system of central bank lending and government insurance are, despite the problems noted above, just stupid. Without some system of public regulation, Marx would have been proved right and capitalism would have collapsed. When a bank fails, not only do depositors lose money, but wreckage is generated throughout the economy. A business can't meet payroll because its payroll money disappears in the bank failure. A supplier can't get paid because the buyer's money disappeared. As each component fails in turn more people are forced to pull savings out of banks and default on loans - spreading a circle of failure. By the late 19th century it was clear that modern market economies are so tightly interconnected that bank failures infect the whole economy with fail. And the world economy is far more tightly connected now than it was 100 years ago. Naked depository banking has been tried and it fails. But the New Deal combination of a strengthened reserve bank plus deposit insurance backed by the government - a method that is now in use worldwide - is not working so well anymore.
Suppose the government provided citizens and businesses with deposit services. Let's say, deposits of up to $100,000 earned 3% plus inflation and deposits over that amount earn nothing. Furthermore, business and individuals can qualify for credit up to a certain amount based on statistical measures. If you want to borrow more or earn more, then take your chances in the marketplace. But if you want to keep your savings, your cash deposits from your business, your operating funds, somewhere safe and convenient - go to the government bank. The side advantage of this is that the government would not need to borrow money from banks to run. Consider that nations in the EU now are begging banks to buy their bonds - and the banks have money to buy the bonds only because they have deposits which they only have because the government guarantees bank deposits! This is a scheme that only makes sense to bankers - but they could get real jobs.
(from here )